Central Bank Digital Currency, Tax Evasion, Inflation Tax, and Central Bank Independence

Abstract

Can introducing Central Bank Digital Currency (CBDC) improve social welfare? We construct a dual currency model to study whether introducing CBDC with a recordkeeping technology can reduce tax evasion incentives in cash transactions, and further achieve a better allocation than in a cash-only economy. Tax evasion does not occur in an economy only with an inflation tax. However, if imposing a positive sales tax is inevitable for central bank independence, there arises an inefficiency associated with tax evasion in cash transactions. Introducing CBDC with positive interest can reduce this inefficiency and thus improve welfare by discouraging tax evasion, and rewarding tax payments.

Keywords: Cash, Central Bank Digital Currency, Monetary Policy, Inflation Tax, Tax Evasion

JEL Classification: E31, E42, E58, H21, H26