OPINIONS
If you want to whiten the economy, payments should be made electronically
Among its EU peers, Romania has two pressing policy issues: a low rate of adoption of electronic payments and a large shadow economy. At first glance these two factors seem to have little to do with each other. But closer inspection reveals that addressing the first issue can also help to fix the second.
Electronic payments comprise only 5-6% of the volume of Romania’s payment transaction. Although this figure has tripled in the past few years, it still lags behind the approximately 35% in the average EU country. Electronic payments bring major payment efficiencies to consumers and merchants, providing fast and secure payment technologies. Indeed, according to a range of studies by several central banks like the ECB, central banks of Brazil and Sweden, moving to a fully electronic payment society could bring efficiencies that could increase GDP by 2-5%. While a fully “cashless” society is distant in Romania’s future, even incremental progress in that direction would bring major benefits to the Romanian economy.
But beyond that, increasing the usage of electronic payments could help to address Romania’s chronic and severe problem of a massive informal sector and widespread tax evasion. Unlike cash, electronic payments create an automatic paper trail that can aid the government in collecting taxes and restraining illegal activity, while at the same time providing law-abiding citizens with proof of their compliance. Thus, not only would increasing the usage of electronic payments prove a boon for Romania’s economy, it would also address the pressing need for more efficient tax collection. In fact, a 2012 World Bank study showed evidence that higher level of electronic payments usage is associated with a smaller shadow economy.
Other countries plagued by a large informal sector have used policies to promote electronic payments as a device to “whiten” their economies by bringing transactions into the formal sector. In South Korea, for example, government policies helped to raise electronic payments from 4% to 50% of the economy in just a decade. In short, greater use of electronic payments is good for the economy, good for the fiscal solvency and fairness of the country, and good for consumers and businesses.
Increasing the use of electronic payments requires policies that promote that end rather than discouraging them. For example, in South Korea, the government introduced tax incentives for both consumers and businesses simultaneously. Here in Romania, legislation is being considered that would improve the tax code, however more needs to be done to improve adoption of electronic payments by businesses and consumers. For a government seeking to increase the use of electronic payments, such ideas are essential.
But direct government encouragement will be ineffective without private incentives to increase use of electronic payments to consumers. This element is especially essential here, where many Romanians still lack a bank account, an essential step toward greater use of electronic payments. Without bank accounts, Romanians will still be stuck in a cash economy, unable to even pay their taxes online even if they wanted to.
The key lever for financial inclusion by the banking system is the “interchange” fee on payment cards, a fee that is an element of the price that a merchant pays when a consumer presents his card for payment. Both consumers and merchants benefit from the efficiencies of the payment card system—but the modern globalized payment card system is expensive to operate. The interchange fee is the crucial component of the payment card system because it is the vehicle by which the cost is allocated between consumers and merchants to support the system.
In Romania, the prevailing interchange fee is 1% The EU has proposed regulations that would reduce it to 0.2%--a 80% decrease. But merely reducing the proportion of the costs paid by merchants doesn’t make those costs disappear; they simply migrate from merchants to banks—and eventually to consumers who use electronic payments. Experience with price controls in Australia, Spain, and the United States uniformly find that where government action forcibly reduces interchange fees, the costs of bank accounts and cards increase for consumers, sometimes dramatically. In addition, these costs fall hardest on low-income consumers, who can least-afford these increased fees and thus drop out of the banking system.
But most important, as payment cards become more expensive for consumers, consumers use them less. For example, in the United States when increased bank fees contributed to driving 1 million consumers out of the banking system, those consumers fell back into the cash economy.
In that case, if Romania follows the EU’s lead by imposing price controls on interchange fees will push against the goal of putting more payment cards in the hands of more Romanians with the desire of increasing the usage of electronic payments. In short, while the EU’s strict price controls might only do modest damage to consumers in Western and Northern European economies with a fully-penetrated payment card market it could strangle Romania’s payment card market in its cradle—and strangle with it one of the most effective means for ending Romania’s tax evasion and black market problems.
One size does not fit all when it comes to interchange fees. Studies show that the economically efficient interchange rate varies according to many factors, including most importantly, the level of existing payment card usage in the country. Thus, before blindly following the EU’s lead, Romania’s Finance Ministry would be well to do an in-depth country-specific study as to the probably effect of payment card adoption in usage in Romania in light of a cap on interchange fees.
Todd Zywicki is a professor at the George Mason University and has participated to the conference „How to whiten the economy and increase tax revenue collection to the State budget?”, organized by Ziarul Financiar.