2011-07-23

Reforming the economy with multiple currencies

Our national economies appear to be breaking at various points that are hard to fix without substantial reform.

I suggest that many problems within an economy such as the US that have traditionally been addressed by complex, intrusive, and not all that effective legislation, can be addressed more elegantly by redesigning money.

I propose splitting a national currency such as the US Dollar into three or more currencies. These currencies would be:
  • Consumption Dollars, used for retail purchases. Persons would obtain Consumption Dollars by exchanging Investment Dollars they receive as their income. The exchange rate would start at 1:1 and become progressively more expensive as a person acquired more Consumption Dollars in a certain time frame.
  • Investment Dollars, received as income. All dividends, salaries and wages would be payable in Investment Dollars. This currency would be used to purchase companies and shares of companies, and could be lent to others who will invest it in this way. This currency could not be used for retail purchases; it would need to be converted into Consumption Dollars first.
  • Medical Dollars. This currency would be purchased with Consumption Dollars. The exchange rate would start very favorable for an initial quantity of Medical Dollars a person acquires in a certain timeframe. As more Medical Dollars are purchased, the exchange rate would climb to 1:1, and become progressively more expensive as a person acquired more Medical Dollars in the same time frame.
A reform like this would address the following issues:
  • The variable-rate Investment Dollars to Consumption Dollars conversion would replace highly complex income tax and sales tax legislation with a simple, easily administered mechanism. It would reduce government intrusion in the private sphere, and become the primary means of government funding.
  • The variable-rate Investment Dollars conversion would progressively tax consumption by the rich without adversely affecting investment crucial for economic growth, and without adversely affecting the poor.
  • The investment wealth of rich people is difficult for people inexperienced in investment to understand. An average person is used to their income matching their consumption, so they will view the net worth of a rich person as if all of it is there to be consumed. They do not notice a crucial distinction between the income that a wealthy person invests, and the part of their income they consume. Introducing separate currencies for investment and consumption would make this distinction clearer, reducing popular impulse to tax investment, which damages the economy as a whole.
  • The variable-rate Medical Dollars conversion would allow all persons to have access to basic medical care at a minimal cost, subsidized by persons able and willing to purchase much larger amounts of Medical Dollars at less favorable exchange rates.
  • The variable-rate Medical Dollars conversion would reduce monopolization of medicine by the rich, which reduces medicine's overall effectiveness. Medicine is highly effective with the first few dollars spent on each person, but becomes progressively less effective as more treatments are applied to the same person. Beyond a certain threshold, the marginal utility of additional medicine approaches zero, as progressively more expensive treatments are employed with lower and lower chances of helping. Under this scheme, the rich would be able to obtain more medical service by paying more, but would be unable to monopolize medicine due to diminishing returns on purchasing Medical Dollars, and would be subsidizing medicine to the poor as they do so.

Clarifications

Q. Who would perform the exchange between these currencies?

A. A government institution similar to current central banks would fill this role.

Q. If a person is paying more Investment Dollars than they get Consumption Dollars in return, where would the extra Investment Dollars go?

A. Into the government budget. That's how this scheme can replace existing income and sales-based taxation as the source of government revenue.

Q. How do you suppress the black market?

A. Same way as you suppress cheating on VAT. Most goods that people obtain are acquired from corporations. Corporations have strong incentives to comply with legislation. Corporations try to change legislation in their favor, but you don't generally see them cheating on sales tax or income tax. They have more to lose than they can gain.

Q. How would you define the exchange rate with an external currency, such as the Euro?

A. You would define another currency, Exchange Dollars, as the freely tradeable currency. Exchange Dollars would be convertible 1:1 into Investment Dollars, and could be purchased 1:1 with Consumption Dollars, but not the other way around.

A foreign tourist visiting the country would undergo this conversion: Euros -> Exchange Dollars -> Investment Dollars -> Consumption Dollars. The conversion into Consumption Dollars would be at an exchange rate specific to this particular tourist, according to the same rules as for everyone else. The tourist's foreign income wouldn't matter; a first time tourist wanting to spend 1,000 Consumption Dollars would be able to obtain them 1:1.

A citizen visiting a foreign country would undergo this conversion: Investment Dollars from income -> Consumption Dollars -> Exchange Dollars -> Euros. This would avoid foreign shopping sprees using untaxed Investment Dollars, and the customs you would have to set up to deal with that.

There may be legitimate circumstances where businesses need to spend Investment Dollars abroad, e.g. to buy a foreign company. Lossless conversion from Investment Dollars into Exchange Dollars could be made available for such cases with a strong paper trail. This is similar to how you currently need a paper trail for business expenses you don't want the government to tax - except you would need such paperwork only for some foreign transactions.

Q. What about a poor person reselling a product to a rich person for Investment Dollars at a markup? The poor person would be able to convert the Investment Dollars to Consumption Dollars at a profit, and the rich person would pay a lower price than they otherwise would.

A. Letting people engage in trade like this is not necessarily bad. The general idea is to throttle consumption by the rich, since its net benefit is lower than consumption by the poor. If a wealthy person and a poor person arrange to trade like this, then the result is a direct social transfer from the wealthy to the poor. That isn't contrary to the purpose of the system.

That being said, trades like this would result in loss of government revenue, and less funding for social services, including services to the poor. If this became the only way anyone buys their Ferrari, then that would be a small lottery win for those who get to do the trade and pocket the profit, and a net loss for others who do not.

It would be possible to simply outlaw this, which would make it too risky for large purchases, and thus restricting the problem in scope.

However, instead of outlawing these trades, it may be worthwhile to formalize them. The central bank could provide an exchange service where poor people could sell their Consumption Dollars for Investment Dollars at a free market rate. This would eliminate illegal trades from the economy, provide income to the poor that everyone can access, and add a control valve preventing rates paid by the rich becoming draconic. It would provide a self-enforcing maximum tax rate, as well as useful feedback helping officials to set gradients for Investment to Consumption exchange rates.

Q. What would prevent everyone from using Consumption Dollars exclusively, e.g. in transactions between individuals?

A. This could be discouraged in the same way as you are currently discouraged from accepting cash for services, and not declaring it for income tax. It is essentially the same problem, and similar solutions can be used.

If the currencies were digital, the system could go further to prevent this kind of tax dodging. For example, for payments from one natural person to another where there's no apparent prior connection, you could simply make a conversion from Consumption Dollars to Investment Dollars automatic.

This simple move would eliminate tax dodging for waiters and others who receive most of their income in tips. Transfers without an automatic conversion would still be possible between people who have prior relationships, e.g. in families.

This would require formalizing financial relationships in cases where there's a need for payments in Consumption Dollars between people who aren't family, such as between new partners and roommates. I think such formalization would be welcome, as it would provide an additional formal step between "strangers" and "married".

However, even without that, it would still be possible to use the same types of discouragement that are in place for income tax today.

8 comments:

dave78 said...

If I understand correctly the price in investment dollars for a certain product would depend on a person buying it.
What would stop a poor person selling the product to the rich person for a 10% higher price (in consumption dollars), even though the rich person would have to pay 100% more in investment dollars?
Another question is: how would you determine the exchange rate for a tourist if you don't know his/her financial data?

denis bider said...

dave78: What would stop a poor person selling the product to the rich person for a 10% higher price?

Very interesting question. I appended a set of paragraphs to the article to address this.

dave78: how would you determine the exchange rate for a tourist if you don't know his/her financial data?

The tourist's foreign income wouldn't matter; a first time tourist wanting to spend 1,000 Consumption Dollars would be able to obtain them 1:1.

boris_kolar said...

Interesting. I assume Consumption Dollars can be converted to Investment Dollars at 1:1 rate? That would make sense, since "taxation" has already happened. If so, what would prevent everyone from using Consumption Dollars exclusively? After all, there is no fundamental difference between selling a service (receiving Consumption Dollars) and being employed (receiving Investment Dollars).

denis bider said...

boris: Reasonable question. I added my response to the article.

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