The penny may be worthless, but let’s keep it anyway

There has been a growing war on cash in an attempt to curb terrorism and tax evasion.  Much of the focus has been on abolishing large bills, such as the decision to eliminate the €500 note from circulation.  However, politicians are also targeting smaller forms of money for elimination.  U.S. Senators John McCain and Mike Enzi introduced legislation in March 2017 to eliminate minting of pennies and switch the dollar from paper to a coin only.

The movement to eliminate small coins has already happened in some countries.  I was in Canada not long ago and paid for a purchase with cash.  I was expecting to get back a few pennies in change but didn’t because Canada eliminated their penny in February 2013.  Australia eliminated their penny in 1992 and is expected to eliminate the nickel, the five cent coin, shortly.

Parts of the U.S. government have already eliminated using pennies.  The army and airforce have banned pennies since 1980 in all overseas military exchanges, which provide shopping for soldiers and their families on bases outside the U.S.  The military banned the coin because they were too heavy to transport.  Numerous public transportation systems also ban pennies.  Nevertheless, some tax protestors have been able to pay their bills with the coin, which has miffed tax authorities

Reasons to eliminate pennies and nickels

Opponents list many reasons for eliminating low value coins.  The most compelling argument is that it costs governments more money to mint the coins than they are worth.  In formal terms this is called negative seigniorage.

The U.S. Mint’s most recent figures show in 2016 it cost 1.5 cents to make each one penny coin and 6.3 cents to make each nickel.  This is actually much cheaper than just a few years earlier because metals price fell.  In 2014 the Mint reported it cost almost 1.7 cents to make a U.S. penny and almost 8.1 cents to make a nickel.

In 2016 the U.S. Mint produced over nine billion pennies and 1.6 billion nickels.  This means the U.S. government lost almost $46 million on pennies and almost $21 million on nickels in just 2016.  Moreover, this loss on every one and five cent coin is not a recent phenomenon.  Both the penny and nickel have cost more to produce than their face value for the past eleven years.

The loss of millions of dollars is not the only reason some people want to eliminate the penny.  A pocketful of low value coins simply annoys some people like Professor Jeff Gore, head of the advocacy group called Citizens to Retire the Penny. He feels “it’s a big, horrible waste of time,” dealing with the coin.

Reasons to keep pennies and nickels

Getting rid of pennies and nickels is not easy to do since both coins enjoy widespread popular support.  When polled about their feelings the majority of U.S. individuals don’t want either coin eliminated.

Beyond sentimentality there are a number of practical reasons to keep these coins.  In countries like Canada, which don’t have pennies retailers are required to round cash purchases up or down to the nearest 5 cents.  This means if a purchase is $1.01 or $1.02 then the merchant only charges you $1.  If the price is $1.03 or $1.04 then the merchant charges the customer $1.05.  Credit and debit card payments are not subjected to any rounding.

This rounding algorithm is perfectly fair if prices are spread out evenly across the board.  However, for most products merchants set the price.  Most prices in North America end in 98 or 99 cents.  This means that merchants who strategically set prices can make one or two extra pennies on every cash transaction.  Chipotle Mexican Grill in 2012 tried this rounding method to speed up its lines, but faced customer backlash.

This strategic price setting is called the “rounding tax.”  Professor Raymond Lombra estimated this could cost U.S. consumers “no less than $600 million a year.”  Moreover, since the poor and disadvantaged use cash more than the rich the rounding tax would fall disproportionately on them.

Lombra’s calculation of a large rounding tax, however, is in dispute.  Robert Whaples, using purchasing data from one convenience store chain, believes the overall rounding tax is non-existent.  He points out that sales taxes change the actual amount owed by consumers into a more even distribution of final digits.  Rounding the total amounts including sales tax did not consistently favor stores.  However, Whaples’ assumption is that stores will not change their prices to take into account both sales tax and rounding rules if the penny is eliminated.

A recent article by Marko Raseta provides data that supports Lombra but argues that since many cash registers are now mini-computers the rounding tax can be eliminated by having the cash register randomly decide at the end of each transaction if the total is rounded up or down.  How consumers will react to a cash register that randomly picks their final cost is not known.  My guess is most consumers will dislike shopping in stores where they face a low stakes lottery every time they check out.

In contrast, when Israel eliminated its lowest value coin, the drug store chain SuperPharm advertised widely that it would round the total of all bills down.  It gained a competitive advantage by making customers feel like they were getting a bargain instead of paying the rounding tax.

Conclusion

The main argument for eliminating low value coins is that the government loses money when minting them.  This argument is unconvincing since the U.S. government loses money on many of its activities.  For example, the U.S. Post Office lost $5.6 billion in 2016 and government watchdog groups point out billions in pork barrel projects.  These losses are hundreds of times larger than the money lost minting pennies and nickels.

Senator McCain and Enzi’s proposal to eliminate the penny is poor public policy because so many U.S. individuals like the coins.  So, what can people and officials that dislike the low value coins do?

The answer is simple.  Convince a few major chains that do a large cash business, like Walmart and McDonalds, to round down like the drug store chain SuperPharm did.  Inducing people to transition away from low value coins with occasional small monetary bribes will be a far more successful strategy than forcing people to give up using low value coins they like.

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