Cash and tax evasion

Economists and public policy experts contend that paper currency facilitates tax evasion. However, due to the illicit nature of tax evasion, limited empirical evidence exists to document or quantify this claim. I use the staggered implementation of the Electronic Benefit Transfer (EBT) program to identify a decrease in local cash circulation that holds constant the level of income to provide empirical evidence on the role of cash in tax evasion and offer magnitude estimates. The EBT program replaced cash-based government distributions with an electronic system. I use the staggered implementation of the EBT program across all states to estimate an increase in reported taxable income between $0.56 and $1.15 for every dollar replaced with electronic payment. Next, I use the staggered implementation in the state of Missouri to estimate an increase in reported taxable sales between $3.83 and $8.48 per replaced dollar. Overall, my results suggest that cash transactions are an economically significant means by which small businesses evade both income and non-income taxes. The results are of interest to academics and regulators as they seek to better understand the impact of cash circulation on tax compliance and evaluate policies to improve tax compliance.