The coming abolition of cash

The Indian Government’s dramatic cancellation of large banknotes on the same day as the US election last week looks like the drastic solution to a very Indian problem with tax avoidance and the black economy, but it might turn out to be a harbinger of things to come everywhere.

In fact, there is a good case for Australia to follow India’s lead immediately. It would dramatically increase tax revenue by reducing the cash economy and cutting down on welfare fraud and crime. No point robbing a bank if there’s no big notes in it.

There are 300 million $100 notes in circulation in Australia — more than any other note — but they are rarely seen. ATMs only spit out 50s and 20s, so who’s got all the 100s? Only crooks and tax avoiders.

The Modi Government has announced the demonetisation of 1,000 and 500 rupee notes (about $20 and $10), which are the largest notes on issue in India, effective immediately. That is, they are no longer legal tender.

In his address to the nation announcing the move, Narendra Modi said it was designed to “break the grip of corruption and black money”.

“…let me invite you to make your contribution to this grand sacrifice for cleansing our country,” he declared, channelling John F Kennedy. “Let us ignore the temporary hardship. Let us join this festival of integrity and credibility.”

It’s more crusade than festival though. Modi’s great demonetisation was carried out in secret and followed years of meticulous planning. The Reserve Bank was only told at the last minute, and all banks were closed without warning on November 9th, the day after the announcement.

Over the past two years, a simple zero balance, easy-to-open bank account was promoted, which resulted in 250 million new accounts and 200 million debit cards.

In 2015, the Black Money Act was passed, with tough penalties including jail terms. Then earlier this year the Income Declaration Scheme 2016 was introduced to attract voluntary disclosures, with tough penalties behind it — a sort of amnesty with a sting in the tail.

And earlier this year, Modi introduced a national GST, to both tackle tax avoidance and to align India’s tangle of state taxes.

You can see why Modi felt the need to take such drastic action: the amount of cash held by Indians is among the highest in the world — about 12 per cent of GDP — and the black economy is estimated at anything up to 75 per cent on top of official GDP, according to one Government report.

Government data shows that only one per cent of Indians paid tax in 2013 — 28.7 million people filled out tax returns, a bit more than 2 per cent of the population, but 16.2 million of them paid no tax. The average amount paid by those did pay tax, was 23,000 rupees, or less than $500.

So, India has a particular problem, that’s for sure, but every country has a black economy and a problem with cash — including Australia.

In a note to clients this week, UBS banking analyst Jonathan Mott said: “We believe removing large denomination notes in Australia would be good for the economy and good for the banks.”

Apart from the reduction in tax avoidance, and increase in government revenue, there would likely be a spike in bank deposits: “if all the $100 notes were deposited into banks (ignoring hoarded $50s), household deposits would rise by around 4 per cent.

“This would likely fill the banks’ Net Stable Funding Ratio (NSFR) gap and reduce reliance on offshore funding.” It would also accelerate cost reduction by reducing the banks’ reliance on branches.

I remember, with a prickle of shame, making fun of Professor Marvin Goodfriend in this column in August, for his suggestion in a speech at the Jackson Hole central bank symposium that perhaps cash should be abolished.

In my defence, it was a for a different reason than Mr Modi’s: Professor Goodfriend was suggesting it as a way of allowing central banks to cut interest rates below zero, if they needed to respond to another downturn with rates already at zero. If people couldn’t get their money out of the banks, and hoard cash, he argued, then negative rates would be effective.

But maybe the time is approaching for cash to be abolished — not so interest rates could be negative (although that might be a benefit as well), but because it would eliminate tax avoidance and go long way towards eliminating a lot of crime.

To some extent, it’s already happening. According to Jonathan Mott, ATM transactions have been falling at 3.4 per cent a year since 2009, while credit card transaction have been rising at 7.3 per cent per annum, driven by the convenience of the new tap-and-go technology.

At some point, possibly not too far off, the only people inconvenienced by the abolition of cash would be crooks and tax avoiders.

Perhaps the Australian Government should take a leaf out of Narendra Modi’s book and start preparing the ground for that day, and then, when no one is expecting it, pounce.