LFMI: Cash payment restrictions will reduce people’s choice, not the shadow economy

4 December 2013, Vilnius. The proposal to restrict cash payments in excess of 10,000 litas that is being debated by the Seimas of Lithuania is not an effective way to fight the shadow economy, the Lithuanian Free Market Institute concludes based on a recent analysis of the shadow economy and trends in non-cash payments in the European Union. The proposed restriction would reduce people’s choice and competition among means of payments and would increase payment-related expenses for individuals and legitimate businesses.

„The experience of EU member states does not show that an increase in the amount of electronic payments leads to a decline in the shadow economy. It is important to eliminate the real causes of the shadow economy, including high taxes and a low standard of living, rather than the use of cash. Statistics show that EU countries where electronic payments have expanded the most rapidly over the past ten years have not recorded a faster reduction of the shadow economy,” Vytautas Žukaukas, senior policy analyst at LFMI, says.

From 2003 through 2012 the number of electronic transfers in Bulgaria, Lithuania, Poland, Hungary and Slovakia increased the most. The number of electronic payments per capita soared by as much as 373 percent, while the shadow economy decreased by a mere 3.3 percentage points during that same period. At the same time Portugal, Germany, Austria, Italy and France reported the lowest growth in the number of electronic payments but the shadow economy contracted more, by an average of 3.6 percentage points.

Statistical analysis shows a link between the size of the shadow economy and the volume of electronic payments, but this link is not that of cause and effect. According to Vytautas Žukauskas, the popularity of electronic payments and the spread of the shadow economy are determined by the level of a country’s economic development.

„In Scandinavia and Western European countries higher income means lower incentives to engage in shadow undertakings. A higher level of economic development also leads to a higher volume of non-cash payments. People have more trust in banks and use more diverse means of payment. So even though a shrinking shadow economy means lesser need for cash, an artificial, government-inflicted growth of electronic payments, as opposed to an increase brought about by people’s free choice, will not result in a reduction of the shadow economy,” Vytautas Žukauskas says.

According to LFMI, cash payment restrictions will deprive people of their right to make payments in the most acceptable ways and will force electronic payments that inflict additional costs. „If electronic payments are the cheapest, safest and most convenient way of payment, it is people’s choice, not coercion, that will prove this. Restrictions will increase people’s expenses as electronic services have their price. They will affect weekend payments. Many people in Lithuania make their living by selling second-hand cars to eastern countries. How will they be supposed to do it legitimately if cash payments become illegal?” Vytautas Žukauskas asks.

Cash payment restrictions will affect law-abiding citizens but will hardly influence those in the shadow economy. After all, the regulation will not inspire those who pay “envelope” wages, smuggle goods or underreport income to observe laws. It will not obstruct illegal sales of smuggled cigarettes, alcohol or fuel,” Žukauskas says. “Those who have been selling illegal cigarettes in the gateway will not install card scanners all of a sudden.”