23 March, 2007

LENZ: The high cost of inflation tax: the elimination of a penny

Posted by alex in economy, Financial Column, George Lenz at 5:43 pm | Permanent Link

By George Lenz

With the recent introduction of the new dollar coin, and reported shortages of pennies, some administration officials and members of Congress have publicly called for elimination of the penny. Thus I decided to look into economic consequences of removing the penny from circulation.

It has long been recognized that removing the penny from circulation would require cash purchases to be rounded to the nearest nickel: if the total of a cash purchase ended in a 3,4,8, or 9, the resulting sum would be rounded up to the nearest nickel, while if the total ended in 1,2,6, or 7 the resulting sum would be rounded down to the nearest nickel. Many advocates of removing the penny assume that the net effects of such a rounding scheme will be close to zero-on average, the number of transactions leading to rounding up will be roughly offset by the number leading to rounding down. Such an assumption is predicated on the distribution of the final digits of prices of individual goods being relatively flat, with the proportion of prices/sales ending in each digit from 0 to 9 being roughly 10 percent. To move away from the world of assumptions, I looked into the direct, indirect and dynamic effects of such a change in our payments system.

I begin with an experiment designed to simulate the net effects of rounding on consumers. I have obtained the price list for a typical convenience store. Focusing on just such stores makes sense since most of their transactions are in cash. As is obvious and has been documented for a long time, the overwhelming proportion of prices of 1 227 items on sale end in 9.

The next step is to simulate 10,000 transactions of from one to five items each across the full spectrum of 1 227 items. Each transaction represents, in effect, a single customer, purchasing a random set of one to five items from among all those available in the store. The bill is calculated for each transaction and the rounding scheme described above is applied to the total. The results show that between 67 percent and 92 percent of the transactions result in rounding up, with the lower figuring resulting when up to five items are purchased and the higher figure resulting when one or two items are purchased.

The last step in the simulation is to arrive at the total number of cash transactions in the economy in a given year and apply the above percentages to estimate the range of net rounding in dollar terms. I utilize data provided by drawn from the famous “Nilson Report”. For the year 2005, the number of transactions by consumers is estimated at 176 billion. The estimates of the proportion of total transactions, which are in cash, range from 42 percent to 71 percent. Applying this range for cash transactions to the range for the proportion of cash transactions rounded up from the simulations above gives an estimate of upper and lower bound for the dollar value of rounding for the economy as a whole. The estimated range for the direct effect is $436 million to $928 million – and this is a very conservative estimate.

By definition, the rounding tax estimated above would raise the overall price level, as measured, say, by the Consumer Price Index. The effect would be quantitatively small. With consumer spending in current dollars at $6.9 trillion in 2005, the estimate of the rounding tax range would represent an increase in prices of about 0.00013. While the effect on the CPI would hardly be noticeable, in dollar terms, even such a seemingly small effect could cumulate over time to a considerable sum given that virtually all government outlays, including social security benefits, welfare payments, interest on the public debt, and many private sector costs, such as wages and salaries, are indexed or tied, formally or informally to the CPI. Utilizing the Congressional Budget Office estimates of the effects of higher prices on Federal government outlays show that removing the penny would raise government outlays by about $1.9 billion in 2010 and by $3.6 billion in 2015

Taken together, the direct and indirect effects, presented above on the government and private sectors would be no less than $2.35 billion over five years and $4 billion over a decade. The estimates should be regarded as conservative and static: they make no allowance, for example, for adjustments in firms’ pricing policies.

Looking into the aggregate effects of eliminating a penny, available data suggest that those least able to shoulder such costs will bear a disproportionate share of the overall burden. Federal Reserve surveys indicate that 14.5 percent of American families do not have checking accounts-a total of nearly 15 million households. The vast majority of these families (85.6 percent) had incomes of less than $25 000. Since only cash transactions will be subject to rounding, it follows that removing the penny from circulation will impose a regressive tax on those making a disproportionate share of their transactions in cash-the poor and under-represented members of our society. This implies, in turn, that the existing regressivity of the sales tax will be reinforced by the rounding tax.

To sum up:

– Removing the penny from circulation will have significant adverse direct effects on consumers. The resulting need to round prices will generate a rounding tax of no less than $430 million a year. Moreover, the “rounding tax” is likely to be regressive, affecting the poor and other disadvantaged groups disproportionately.
– The inflationary impact of rounding will probably be small. However, even a small effect will cumulate overtime to a considerable sum. Utilizing the results of simulations of the degree of rounding likely to occur, and Congressional Budget Office estimates of the effects of higher prices on Federal government outlays, show that removing the penny would raise government outlays by about $2 billion in 2010 and by $3,5 billion in 2015.

Thus, we must say resolute no to advocates of corporate welfare in the administration and Congress, who want to give the retail sector a gift of at least $2.35-$4.0 billion at our expense. Hence, should talk of eliminating a penny from circulation intensify, we must contact our congressmen and urge them to stand up for this little piece of metal that stands between us and even higher inflation.

* * *

The market rallied, propped up by the relaxed monetary stance of FRS, benign tightening of ECB and BJ and rumors of Chinese purchases of U. S. equities driving the unsustainably high valuations still further upward. Yet, the valuation models do not give ground for this rally: the mortgage crisis potentially affecting at least 20% of U. S. residential real estate is still in place, as rising unemployment, worsening budget and balance of payments deficit. Thus in the next two to three weeks we will either witness the correction to 12 000 – 12 050, or, if the liquidity will continue to pop up, a significant acceleration in the U. S. inflation rate.

Currently I am looking into AMD – a good target for short selling. The company is in turmoil, with a high level of debt, faltering product line and dim prospects in the future (stock intrinsic value $3.82 vs. stock market value


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  7. One Response to “LENZ: The high cost of inflation tax: the elimination of a penny”

    1. New America Says:

      Two comments, and one idea:

      One, getting rid of pennies is simply a reminder of the imbalance between the physical economy, and the financial economy. That “Dr. Copper” is worth more than “Mr. Penny” is a certain proof that the Authorities will continue to blame the temperature on the thermometers.

      Two, “currency” is but one aspect of “money,” and ALL fiat currencies have, over time, been reduced to the intrinsic value of paper.

      Thus, “currencies” are matters of contract, and faith.

      Three, we have moved to a VERY profitable – for the banks – electronic currency, known as the debit card. They are now charging a de facto transaction tax on ALL transaction, regardless of how small they are.

      Good news – the convenience store and fast food stores get that marginal dollar.

      Bad news – they gt it DIRECTLY out of the pocket of the owners.

      This, in effect, privatizes what was formerly a government function – the sales tax, applied to ALL purchases – food included, unlike the current case in many states.

      Banks win again!

      There is something far more sinister in this.

      Not only do banking consortia now makes their own private currency, with a sales tax built in that is not subject to substantive political checks and balances – VISA BUXX, for example – the dematerialization of currency (Buckminster Fuller!) allows it to take on all manner of new, taxable forms.

      For instance, in Singapore, they simply use their cell phones as debit cards; works perfectly well, and THIS time, the telecoms cartel gets a piece of the action, as well. No need to carry paper currency in most of Singapore; indeed, soon, no need for paper currency at all.

      In an NS State, along the lines envisioned by Bill White and Harold Covington, these systems would be regulated by the government, in the public interest.

      There is something explicitly White/Western in this, and that is the money supply is NOT created by a system of banks and loans; rather, it is simply CREATED, and taxed per use – the use of fees, for service, rather then interest, tied to the life of the money, and not the life of the loan.

      New America

      An Idea Whose Time Is HERE!