Calling in the Big Bills

...A dollar bill is really like a government bond that pays no interest...

...The volume of illegal gambling must be at least as large, and perhaps larger...

...Successful currency reforms were undertaken in West Germany in 1948, France in 1959, China in 195 6, and the Soviet Union in 1947 and 1961...

...But this turns out to be false...

...Initially this reduction did take place...

...Organized Crime We have already accounted for perhaps one third to one half of the demand for the “missing” large denominations...

...A currency reform aimed soley at large denominations would be much easier than a general currency reform, since the concentration of ownership of large denominations is so high...

...Furthermore, with price indices rising at annual rates in excess of six per cent, cash, a non-interest-bearing asset, is the worst store of wealth imaginable...

...But some support for these large estimates comes from other available information...

...The first is that it would require an unparalleled degree of secrecy...

...One way to establish an upper limit is to compare the adjusted gross income (AGI) for the U. S. economy that is estimated each year by the Department of Commerce, with the AGI actually reported on tax returns...

...So, even allowing liberally for all the obvious users of currency, we still have at least $40 billion, including most of the large denominations, to account for...

...The mystery is, who is making use of these bills...

...In 1975 the difference amounted to about $75 billion...

...This stock of money being held for tax evasion suggests in turn a total volume of tax evasion in the year, which depends on the velocity with which this money circulates...

...Where is all this cash...

...Ignoring all the factors which suggest a decrease in legitimate business’s need for cash, an outside estimate of the currency now held by non-financia1 domestic enterprise still is only about $12 billion...

...It also happens that both of these activities have experienced growth which coincides with the turnaround in currency demand since the 1930s...

...This “residual method” of estimating income tax evasion is subject to measurement errors at each step of the analysis...

...What would become of his secret fortune...

...Of the new bills issued in exchange for the old $ 5 0 ~an d $IOOS, most would be $10~an d $20...

...James Henry is a Danforth Fellow in eronomics and law a1 Harvard University...

...The chief direct costs would involve the replacement of old bills with new bills and the administration of IRS inquiries...

...Tax evaders simply find it much easier to hide and store large bills...

...So unreported taxable income, computed in this manner, might be as much as $67 to $69 billion...

...Commercial banks are required by the Federal Reserve to maintain a certain percentage of their assets in liquid form, and cash in the vault is sometimes used for this purpose...

...Actually, a third kind of activity which depends heavily upon cash is the illicit receipt of wage income by people who also collect payments from government programs such as welfare or unemployment insurance...

...But even if all bills of $50 or more were turned in, the cost of replacing them with new $ 5 0 ~an d $100~ would be only about $4 million...

...Unluckily he lives alone and doesn’t read the newspapers or watch television...

...An analogy might be drawn between this plan and gun control...

...All exchanges would be conducted through banks...

...Even if a few criminals with “inside information” were tipped off, the average tax evader would be taken by surprise...

...After finding that neighborhood trash had already been collected, he hired a bulldozer for $5,000 and carefully sifted the city dump...

...The volume of criminal transactions is not treated as part of the CNP, even though illegal income is taxable if the IRS learns of it...

...These denizens of the criminal deep would have to surface wit11 the large cash balances which they carry on hand, and the tax authorities could begin to ask questions...

...First, this scheme would not be entirely unprecedented...

...Tax Evasion Our most definite information is on the extent of tax evasion...

...The problem with such estimates is that they usually come from law enforcement officials, or from politicians...

...Without it currency hoarders might be able to convert their bundles in advance...

...The investigation costs are more difficult to measure, but they might be covered out of the new assessments for back taxes which they produced...

...In the early 1950s the Kefauver committee arrived at a figure of $20 billion per year for the annual volume of illegal gambling alone...

...Large amounts of cash which surfaced without explanation would nevertheless provide very useful investigative leads...

...It also doesn’t tell us directly how much actual currency is required to support this volume of “business...

...More recently, drug enforcement officials in New York City calculated that the illegal heroin and cocaine business there was worth between $2.5 and $3 billion per year, and employed 20,000 people...

...Organized crime accounts for another sizeable fraction...

...Or they might refuse to answer IRS questions about the source of the caqli, asserting the Fifth Amendment privilege against self-incrimination...

...But obstinacy alone would not suffice...

...Unlike the distribution of guns, the distribution of large denominations is almost unbelievably concentrated...

...Assuming that those who received the unreported income that year would have been subject to a 30-percent effective tax rate, the loss in federal revenues due to tax evasion amounted to nearly one half of the total money income of the poor...

...A Hypothesis There are only two kinds of activity in the U. S. which depend almost exclusively upon large, untraceable, non-credit transactions...

...For example, the total pret ax income --including government transfer payments-for the 23 million people with incomes below the poverty line in 1973 was only $18.5 billion...

...Here, “however, we have been concerned with the use of large denominations to evade taxes...

...One possible explanation for the renewed attention given the New York heroin traffic during the last few weeks of 1975, for example, was the threat of layoffs in drug enforcement agencies...

...In any case this discounting would have an equalizing effect on the income distribution...

...In the case of organized crime, cash is also useful because it gets around the problem of lack of trust and inherent lack of legal recourse between the interested parties...

...In 1967, the President’s Commission on Law Enforcement estimated the annual profit of organized crime at roughly $7 billion, compared with the $7.2 billion in net profit earned by the top ten U. S. corporations in 1968...

...This would probably be much less dependent upon the use of large denominations, however...

...The evidence as to the size of these activities supports this logical assumption...

...Of course, an unknown proportion of the old bills would not be turned in because of the owners’ fear of legal adversity...

...Participating in such discounting might be made a criminal offense...

...Since almost all members of the salaried labor force are subject to cheatproof withholding taxes, most of it probably goes either to self-employed professionals (doctors, lawyers, and independent contractors, for example), proprietors, or casual laborers (night-club performers, cabdrivers, and waitresses...

...Now, before the reader dismisses this proposal as harebrained, let him or her consider the following points...

...A reasonable figure for the amount of tax evasion using bills of $50 and higher might be $30 billion a year-not $69 billion, but still quite a lot...

...In 1948, the Federal Reserve estimated that of the $25.4 billion of currency then in circulation, only $4.8 billion was held by business...

...Assuming, conservatively, that there are only 200,000 addicts in the U.S., who inations on very short notice and exchange them for new bills...

...But in 1975 this unreportable income only amounted to between $6 and $8 billion...

...This means that there is one $100 bill for every man, woman, and child in the country...

...Well, we can easily imagine a rule which would allow such eccentrics to exchange their bills late upon a showing that they had no reasonable access to notice of the reform and that their wealth was already taxed...

...In any case the substitution would be expensive and time-consuming...

...We do know that the current street price of heroin is about $20 per bag, and that an addict will shoot up between one and five tinies a day, depending upon the supply, consunling one or more bags each time...

...Most of this $15 billion, by far, is spent on attempts to reduce street crime...

...The second is tax evasion by people who arrange to receive cash income and don’t report it...

...As the detectives assigned to this case, therefore, we are left to our own devices...

...Only small retail purchases are routinely made with cash...

...The amount of currency held by non-financial businesses at any one time is somewhat more difficult to estimate...

...It is interesting to speculate about who actually receives this income...

...However, under closer analysis it appears that “cash control” would succeed politically precisely for the reasons that gun control fails...

...In recent years the velocity of money in ordinary transactions has been five (meaning that the average dollar gets transferred five times in the course of the year...

...The establishment of state lotteries in the major industrial states does not appear to have reduced the demand for illegal gambling, since state lotteries do not permit “sports ga.mbling” or daily numbers games...

...Foreign holdings of U. S. currency reached a peak in the years immediately following World War 11, when the dollar was quite strong relative to other currencies...

...Both have a potential interest in exaggerating the proportions of criminal activity...

...It also claimed that illegal gambling proceeds in that year ran as high as $50 billion, that loan sharking was a “mul ti-billion dollar” enterprise, and that narcotics traffic was upwards of $350 million...

...We do know that the current volume of legal gambling each year is at least $5 billion...

...In the case of tax evasion, this is simply to avoid bank records which might prove legally embarrassing, and also to avoid paying spouses...

...The procedures followed were much the same as those which are suggested here, and those procedures worked very well, without chaos or financial panic...

...He arrived home one day to discover his wife had thrown the can into the trash...

...Of course, there are no exact estimates...

...Using econometric techniques (details available upon request), I have estimated that the total value of large-denomination bills ($50 and greater) held for the purpose of tax evasion in 1973 was somewhere between $7.9 billion and $15.7 billion, with the most likely figure being $1 1.8 billion...

...But currency reform would require no more secrecy than that which accompanied the 197 1 dollar devaluation...

...And even without secrecy, the long-run benefits from reducing the number of large bills would be achieved...

...Comparatively little attention is paid to white-collar crime, whose economic effects, at least, are far more serious...

...The real value (in 1967 consumer prices) of currency per capita in the United States has risen from $78.64 in 1929 to $248.38 in 1975, while the real value per capita of denominations of $50 or more has risen from $20.55 to $90.47...

...First, they depend on cash...

...At present the total amount of currency held by the U. s. Treasury, Federal Reserve member banks, and the rest of the financial system is only about one fifth of the currency in existence and less than five per cent of the paper denominations over $50...

...The first is profit-mo tivated crime : illegal gambling, drugs, prostitution, loan sharking, protection, the fencing of stolen merchandise, etc...

...By reducing the usefulness of cash for criminal purposes, the government will decrease the demand for it...

...The historical evidence is even more perplexing...

...This suggests that actual income distribution might be even more unequal than what is reported...

...The faster money is circulating, the less is needed to conduct a given volume of business...

...All told, denominations of $50 or more account for over 40 per cent of the domestic currency...

...Several local studies around the country support this conclusion...

...Most of this probably is in smaller denominations or coin...

...Using large bills, a lot of money can be stored in a very small area, as the following story from The Wall Street Journal indicates: “Tax investigators recently closed in on a Dallas area dentist who stashed $20,000 of unreported income in a coffee can...

...We know from bitter experience that there is no simple relation between more dollars and less crime...

...In general, these escape routes would not be difficult to check, assuming that the reform were introduced with the appropriate degree of surprise and cunning...

...This still leaves well over $60 billion unaccounted for, $30 billion of it in the large denominations...

...But then the ratio began to rise...

...In the longer run, cutting down on large denominations in circulation would increase the transaction costs of illegal activity (by, for example, reducing the amount of money that can be contained in any given suitcase...

...Using cash in large transactions where any legitimate businessman would write a check, organized criminals would be sorely inconvenienced if they had to slip a couple thousand bucks to a judge in the form of $5 and $10 bills...

...Here, however, there are no incomeaccounting or econorne tric methods to lend a hand...

...In the absence of hard facts, this Jolume has been a popular subject of conjecture, not unlike the size of the Loch Ness monster...

...All exchanges at banks would take place under the watchful eye of the IRS, especially those in large amounts...

...To determine how much of this is tax evasion, we must subtract income which is earned by individuals who are below the filing requirement level...

...But the best evidence which I have been able to gather suggests that, considered together, these forms of crime almost certainly yield more net income to their participants than the top ten U. S. corporations earn each year in profits before taxes...

...By 1929 this ratio had declined to $15 per $100...

...This nation spends about $15 billion a year on police, prisons, and courts...

...Whatever this cost might be, the government clearly should be willing to give up this share of the “take” it earns through currency policies which facilitate criminal activity...

...In addition, there is close to $8 billion in $50 bills, and almost half-a-billion dollars in currency denominations above $100...

...Secondly, the economic costs of this scheme would be trivial in comparison with its benefits...

...The Effect The immediate effect of this scheme would be to strike a sharp blow a t tax evaders, dope dealers, racketeers, purveyors of vice, and corrupt officials...

...But approximately 90 per cent of consumer and business transactions are handled by checks drawn against demand deposits (checking accounts...

...Of course the average American carries around no large bills at all...

...If they were replaced with smaller (under $20) denominations, newly issued, the cost might run as high as $50 million...

...The velocity of the average tax evasion dollar almost certainly is much lower than this, since tax evaders put away their bills in coffee cans rather than spend them, to avoid the watchful eye of the IRS...

...For example, what about the eccentric old farmer who arrives in town for his once-ayear fling, only to find that the $100 bills he has been saving are worthless because they had been called in six months before...

...The main recipients of this kind of unreported income are probably the self-employed professionals and proprietors, individuals who would have had above-average income even in the absence of tax evasions...

...Ry 1958 it had reached $25 per $100, and by 1974, $31.32 per $100, close to its 1895 level...

...But these are much less convenient, especially for consumeroriented criminal enterprise...

...At the end of the Civil War, there was about $80 in currency in the United States for each $100 of demand deposits...

...Meyer Lansky was once quoted as saying, “We are bigger than U. S. Steel...

...The United States itself organized several currency recalls in South Vietnam, during our visit there...

...Of the roughly $80 billion in paper currency now outstanding in the United States, over $21 billion is in $100 bills...

...Secondly, both activities have a special need for large denominations...

...it would be a punishable offense to sell large denominations at a discount to other private individuals so that they might exchange them in smaller bundles...

...What I am suggesting is that these forms of illegal activity can explain the demand for the “missing bills...

...Naturally, many criminals would search hard for ways to escape these consequences...

...But it is clear that a general rise in the level of interest rates since 1945, wider availability of short-term bonds and notes, and the expansion of corporate credit have all increased the velocity of business funds...

...The Eccentric Farmer The final objection is that these measures would create serious hardship in individual cases...

...These activities have two things in common...

...A less obvious cost of this scheme arises from the fact that carrying cash amounts to an interest-free loan to the government...

...In other words, even eliminating inflation, the average American has almost five times as much money in large bills as he or she did 46 years ago...

...The ordinary ones, fives, and tens to which most of us are accustomed represent only about one quarter of the paper money supply * This would not seem so odd if consumer credit, the checking account, and price inflation were less important aspects of the American aeconomy...

...Currency reform would be a simple, inexpensive way to identify white-collar criminals, and to make their continued operation more difficult...

...The liquidity crisis which would ensue for tax evaders and other criminals might to some extent be averted by the substitution of other currencies, or other exchange mediums such as precious metals...

...By the time the franticdentist finally located the coffee can, the whole town-as well as interested government agents-knew about its contents...

...To maintain the size of the total money supply, the government will have to issue interest-bearing securities...

...The subsequent weakening of the dollar, culminating in the 1971 devaluation, has no doubt reduced this fraction to under ten per cent...

...Old bills might be redeemable only at a bank in the city where one is register to vote, with cross-checking between banks in each city...

...But banks try to minimize cash holdings in order to hold interest-bearing assets...

...Unfortunately there has been no census of currency holdings in the United States since 1933...

...Even then, the maximum estimate of these holdings was $4 billion, or less than 20 per cent of the currency then available...

...if anyone doubts this, ask your friends, local storeowners, and bank tellers how often they handle $100 bills...

...You might expect that increased urbanization, the rise of real incomes, the invention of credit cards, and the automatic withholding of taxes, union dues, and pension and medical fees would have reduced the demand for cash...

...There are no reliable estimates of the number of heroin addicts in the U. S., but it is clear that the number has increased dramatically since 1966, when the Bureau of Narcotics claimed that there were exactly 59,720...

...Or they might run from bank to bank, cashing in small amounts at each one...

...In recent years, about 92 per cent of the estimated AGI has been reported...

...The second objection is that these measures would be politically unacceptable to the American people, some of whom might consider them an intolerable invasion of “rights...

...No Cash Lobby l’here are only three objections to this proposal which deserve to be taken seriously...

...At first we might guess that a lot of the currency is held by the domestic banking system, non-financial domestic enterprises, or foreigners...

...Unless the reform was carefully implemented they might, for example, convert large bundles by selling them piecemeal at a discount...