The one thing you cannot do with cash
There are many theories of why people are willing to hold fiat money without any explicit backing. One theory that I’ve never been very fond of is that the ability to pay taxes with cash is what gives fiat money value. This caught my attention:
DENVER (AP) — A marijuana business in Colorado has filed a lawsuit against the Internal Revenue Service for assessing a penalty for paying taxes in cash.
The IRS charges a 10 percent penalty on cash payments for federal employee withholding taxes. But many marijuana businesses are forced to pay taxes in cash because of difficulty accessing banking services
Thus it seems like taxes are one of the very few things that you cannot pay for in cash, at least not without a sizable penalty.
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13. July 2014 at 03:11
“One theory that I’ve never been very fond of is that the ability to pay taxes with cash is what gives fiat money value.”
I’ve never fully understood that argument. Its validity is severely detracted by the fact that every country with a fiat currency also has a fiat tax code.
For example, in the United States you are obliged to pay your annual taxes in installments. Failure to make adequate estimated payments means that you are subject to an estimated tax “penalty”. In reality, this is an interest charge. Also, interest is charged on other taxes owed but not paid by the due date.
Guess what? That interest rate is adjusted quarterly and generally follows the market rate on short-term US Treasury securities plus three percentage points. In reality, paying other fixed “fiat currency” obligations with fiat currency is potentially much more appealing to the debtor than paying one’s taxes.
I suppose those who make this argument are thinking that other non-government creditors can always demand loans and the re-payment thereon in “non-fiat” currency, but I think the existence of a fiat tax code makes this distinction somewhat illusory. And, the amount of tax due in the first instance may be solely attributable to the fact that the “gains” and tax rates may not be fully adjusted for inflation or adjusted at all.
Come to think of it, it is our “fiat tax code” that prohibits payment of one’s taxes in “cash”.
13. July 2014 at 03:12
Tony Yates attacks market monetarism, relatively sophisticated: http://longandvariable.wordpress.com/2014/07/10/market-monetarist-views-are-a-mish-mash-of-the-good-and-the-silly-that-dont-belong-together-anyway/
(HT Noah Smith on Twitter)
13. July 2014 at 03:19
Would an analysis of the real world that revealed employees paid salaries in cash were under reporting their true income by about 10% on average change your opinion here? Or is it the letter of the law that matters?
Anyway I always that the argument was that since taxes are denominated in dollar units that this gives each unit it’s value–and that this was then carried through to the pieces of cotton.
If you think about it, this 10% thing kind of cuts against what I consider to be the traditional prof sumner version of why bills have value too: this sort of seems to imply that when the government wants to migrate everyone to e currency they might employ a similar 10% excise …
13. July 2014 at 05:07
Scott,
all taxes are paid with cash – though usually electronic cash (reserves) rather than the paper version.
13. July 2014 at 05:24
Saturos,
Yeah, a sophisticated pile of bullsh*t.
The qualification here being that monetary policy means the manipulation of future interest rates.
Gee, and I thought it was about the supply and demand for base money.
That entire article is a lengthy exercise in circular logic. Start by assuming the conclusion … and you arrive at your desired destination. What a surprise !
13. July 2014 at 05:45
“The qualification here being that monetary policy means the manipulation of future interest rates.”
he’s talking here about what the ‘mainstream canon’ says.
13. July 2014 at 05:50
At no point does he mention money supply (or demand). All he ever talks about is interest rates.
I’d say that’s the definition he’s using.
It’s like saying “passing of time means the repeated coming of Christmas” and deriving an entire philosophy from it.
13. July 2014 at 06:25
he does mention money supply, and permanent/non-permanent injections of money, though he doesn’t specifically mention ‘money demand’.
13. July 2014 at 07:20
People hold fiat money because of convenience. Much of that convenience is due to the likelihood that the people that they want to buy something from will accept fiat money as payment. Hence, it’s a coordination issue and so subject to “tipping point” issues. The fact that the U.S. government demands payment of taxes in U.S. dollars (c.f. the Whiskey Rebellion) establishes that holdings of U.S. dollars will be of significant utility to a substantial number of U.S. persons – that’s enough of a tipping force to underlie coordinated general use.
Oddly, if some folks end up paying a fine to the IRS for remitting in cash U.S. dollars we may see that as *increasing* the demand for cash U.S. dollars.
13. July 2014 at 08:22
“One theory that I’ve never been very fond of is that the ability to pay taxes with cash is what gives fiat money value.”
Who is advancing this theory? Who argues that paying taxes in cash specifically is what gives fiat money in general value?
I’ve never seen this. MMT/Chartalism for example states that being forced to pay taxes in fiat money is what gives fiat money value. They don’t say cash specifically. Cash value would be a value derived from paying taxes in fiat money, since people can convert fiat sums in their bank accounts, to cash notes, and vice versa.
13. July 2014 at 08:52
It is also true, contrary to the chartalist myth, that the US government has always from its earliest days accepted taxes paid in non-US currency, and still does.
In today’s world with international currency markets if your income is received in a foreign currency that is traded in the market then the IRS requires tax payment in dollars, with you paying the exchange fee, because it is not going to pay the currency exchange fee for you.
But if e.g. you earn your income abroad and are paid in a currency that is subject to foreign govt currency controls, so it can’t be changed to dollars, so you don’t have dollars to pay the tax, then the IRS will not only accept payment in the foreign money, it will indeed insist!
13. July 2014 at 09:08
Jim Glass:
“In today’s world with international currency markets if your income is received in a foreign currency that is traded in the market then the IRS requires tax payment in dollars, with you paying the exchange fee, because it is not going to pay the currency exchange fee for you.”
“But if e.g. you earn your income abroad and are paid in a currency that is subject to foreign govt currency controls, so it can’t be changed to dollars, so you don’t have dollars to pay the tax, then the IRS will not only accept payment in the foreign money, it will indeed insist!”
An exception to a rule does not refute the rule.
13. July 2014 at 09:16
“It is also true, contrary to the chartalist myth, that the US government has always from its earliest days accepted taxes paid in non-US currency, and still does.”
Neither of those things would be contrary to chartalism, which simply argues that money tokens obtain a value from being accepted in payment of taxes. Some countries don’t even have their own currencies, but that doesn’t refute the argument.
13. July 2014 at 09:17
Saturos, I did see that. I’ll do a post when (if!) I get home.
13. July 2014 at 12:30
I pretty much agree with Scott. I.e. I agree it’s not absolutely essential for taxes to be paid in state created fiat money in order for that money to have value, but it does help.
Other factors that give state issued currency value are first making it legal tender, and second administering the currency responsibly. I.e. if you do a Robert Mugabe, you may find no one wants your currency.
13. July 2014 at 12:56
I think it should be relatively uncontroversial that tax liabilities represent a significant demand for a particular type of currency. What should be controversial and what I have never seen adequately argued, let alone proven, is that tax liabilities are some kind of ‘ur-demand’ for a particular type of currency, which out which that particular type of currency would have no value.
I’m not even sure how you would go about establishing such a case with any degree of soundness.
13. July 2014 at 14:47
Money provides a specific function better than anything else. As a medium of exchange I cant think of anything that compares at present. People need top perform exchanges so that’s how money has value. In the same way a car has value because it is really good for transport so that’s how a car derives its value apart from the value of the materials used to build the car.
13. July 2014 at 15:08
Well…if I had paper currency that the state of California would accept in payment of taxes…would nit it trade close to face value? Indeed, a merchant hungry for sale—auto dealer—would probably accept such currency at par….
13. July 2014 at 17:24
You know my view — the term ‘value’ is way too ambiguous. The notion that paying taxes gives money its exchange value is just silly. (There is this little thing called supply and demand …) That it might help ground fiat money’s transaction utility is not silly. When colonial authorities wanted to introduce (branded) money (i.e. notes and coins), they simply required taxes to be paid in such money. But that is the only way that the transaction utility of fiat money is grounded also seems false.
14. July 2014 at 02:23
Come on Scott, this is a silly argument. There is guaranteed convertibility of physical currency into electronic currency (at par) which can then be used to pay taxes.
14. July 2014 at 02:33
Saturos, I think Nick pretty thoroughly refuted Tony Yates there (I was going to respond until I saw Nick had already gone and done it). I mean, just reading along that post I was humming along “yeah, Scott’s already addressed this point at length…”.
14. July 2014 at 06:16
CNBC just discussed this (left-wing?) New Yorker interview with Janet Yellen……
http://www.newyorker.com/reporting/2014/07/21/140721fa_fact_lemann
http://www.businessinsider.com/janet-yellen-new-yorker-profile-2014-7
14. July 2014 at 07:12
I wonder why it’s so hard to offer banking services to the legal marijuana business. Is it just an abundance of caution on the part of the financial services industry, or is it because of regulation? Is it perhaps that money-laundering regulations place onerous burdens on any bank which tries to serve this industry? It seems like a market failure that no bank has tried to serve this market.
14. July 2014 at 08:11
Daniel:
Your complaint about Yates’ article exactly summarizes your own worldview. That is funny.
14. July 2014 at 10:48
the ability to pay taxes with cash
Isn’t that backwards? I always understood the argument to be a sort of limit to negative contingency, i.e. sovereign tax collections replace the value that would otherwise be destroyed by printing and spending currency instead.
Of course, nothing in that argument suggests taxes give fiat money value, it just says taxation is one potential limit on the destruction of that value.
I’m close to deciding that fiat money has value strictly because a large proportion of people agree it has value, and that not much else useful can be said about the matter.
14. July 2014 at 10:53
What The Hell Happened to Mark Sadowski??????
14. July 2014 at 10:57
O.nate asked: “Is it just an abundance of caution on the part of the financial services industry, or is it because of regulation?”
Yes, and yes. The incremental profit is almost zero, but the potential fines and penalties from a future enterprising NY State AG or DOJ are in the billions. It’s caution in the sense that it’s theoretical, but it’s regulation in the sense that the potential risk outweighs the potential profit by 1000 times.
14. July 2014 at 11:01
What The Hell Happened To Mark Sadowski?????
14. July 2014 at 11:01
Question: Did Chairman Bernanke ever say anything like this?
In the New Yorker profile, Yellen said, “But the financial crisis really diminished the prestige of those who think that financial market are always efficient and work extremely well.”
http://www.businessinsider.com/santelli-meltdown-on-cnbc-2014-7
14. July 2014 at 12:35
David Beckworth:
“Here’s why Larry Summers is wrong about secular stagnation”
http://thefaintofheart.wordpress.com/2014/07/14/deleveraging-secular-stagnation
14. July 2014 at 14:04
“This note is legal tender for all debts public and private.”
What are tax payments if not a debt to the government, and why can you settle that debt with cash?
14. July 2014 at 14:10
o nate,
For banks to provide financial services to pot dispensaries, it could be construed as money laundering.
14. July 2014 at 14:33
Alex, I can convert Hong Kong dollars into US dollars and then pay my taxes with the US dollars. So what is the point?
O. Nate, Three reasons:
Government
Government
Government
14. July 2014 at 14:53
Scott,
people generally want to save, and they are more likely to want to save in a currency for which there is a basic guaranteed demand. A tax obligation ensures that such a demand will exist, so long as the currency-issuing country continues to exist.
14. July 2014 at 15:01
however, mismanagement of the currency would also reduce people’s desire to save in it. So if governments want people to save in their currency, they have to at least manage it properly.
14. July 2014 at 16:58
Morgan Warstler,
I think you’ll LOVE this new analysis by David Beckworth:
“Here’s why Larry Summers is wrong about secular stagnation”
http://thefaintofheart.wordpress.com/2014/07/14/deleveraging-secular-stagnation
15. July 2014 at 06:15
Alex Tabarrok: Jeffrey Lacker echoes Jeffrey Hummel:
http://marginalrevolution.com/marginalrevolution/2014/07/bernanke-v-friedman.html
15. July 2014 at 09:47
Philippe, They couldn’t care less what the demand for a currency is, they care about its VALUE. The German mark could be used to pay taxes in 1923, couldn’t it?
i see your second comment anticipated my point. That’s really all they care about–sound “management.”
15. July 2014 at 10:40
Scott,
it seems obvious that any sort of token will have some value if the issuer promises to accept it in payment, and if people have a reason to make payments to the issuer.
If lots of people have to make payments to the token issuer, then those tokens are more likely to circulate widely.
If the token issuer did not promise to accept the tokens in payment, or if no one had a reason to make payments to the token issuer, then its difficult to see why anyone would accept the tokens in exchange for anything.
15. July 2014 at 11:29
If the token issuer did not promise to accept the tokens in payment, or if no one had a reason to make payments to the token issuer, then its difficult to see why anyone would accept the tokens in exchange for anything.
That only seems difficult to understand until you consider that’s pretty much how precious metals/gems have worked since the beginning of trade: they’re accepted as a store of value primarily because everyone expects them to be accepted, which is far more a function of human psychology than of any particular intrinsic properties. Human psychology can also dictate fiat money has value for no reasons intrinsic to properties of the currency.
A sovereign typically has a monopoly on force which it can use to make people to accept its tokens as legal payment (either by itself or others) so people expect fiat money to have value.
16. July 2014 at 04:59
Philippe, I think it’s enough that other private sector individuals accept cash. It would be nice if the IRS did so as well, but not essential.
16. July 2014 at 06:45
Scott,
so it’s turtles all the way down?
17. July 2014 at 18:35
It’s network effects all the way down.