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Econ Focus

Fourth Quarter 2020

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Will the Penny Get Pitched?

If the coin disruption of 2020 prompts the United States to reconsider the future of physical cash, the first thing on the chopping block could be the humble penny. For years, some economists and lawmakers have called for eliminating the penny because it has long been costlier to produce than it is worth at face value. Despite that, pennies make up more than half of the coins the Mint produces for circulation each year. William Luther of the American Institute for Economic Research, a free-market-oriented think tank, argues that the Mint could be better off shifting productive capacity to other coins to more quickly alleviate the current coin supply issues.

Phasing out the penny would mean rounding cash transactions to the nearest five-cent interval. Several countries have already taken this step. Canada eliminated its penny in 2013. And the United States also has some prior experience phasing out low-denomination coins, having done away with the half-cent in 1857.

But not everyone is a fan of killing off the copper coin. Low-income consumers stand to be most affected by the change because they are more likely to be unbanked and reliant on cash for transactions. In the short term, at least, merchants might round purchases for customers paying in cash but not for those paying with card, potentially disadvantaging consumers who have no choice but to pay in cash.

A widely cited 2001 article in the Eastern Economic Journal by Raymond Lombra of Pennsylvania State University argued that eliminating the penny could impose an estimated $600 million annual "rounding tax" on low-income consumers. Since the majority of prices end in 99 cents, Lombra argued that most cash purchases would be rounded up, harming consumers and benefiting merchants. Other economists, like Robert Whaples of Wake Forest University, have since contested those findings. In a 2007 article in the Eastern Economic Journal, Whaples found that once sales tax was factored in, the impact of penny rounding on consumers appeared to be neutral.

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The COVID-19 pandemic disrupted the supply of many items, including cold hard cash

The overall cost of eliminating the penny could vary based on the size and number of purchases, however. For a single item or small-value purchase, rounding up or down could represent a significant price change. In a 2018 paper published in the Atlantic Economic Journal, University of British Columbia economics student Christina Cheung explored the effects of Canada’s penny-rounding experience. Using a dataset of 18,000 prices from three different grocery stores, Cheung simulated the effects of rounding on different tax rates and for different types of purchases. While purchases of multiple items tended to be neutral in the aggregate, Cheung found that rounding for one- and two-item purchases came at the expense of consumers. She calculated that the rounding tax from these small number purchases cost consumers up to 3.27 million Canadian dollars annually from grocery store purchases alone.

On the other hand, there may be additional, hard-to-quantify costs to using pennies that would argue in favor of elimination. Counting pennies to make change takes time, and as the old business adage goes, time is money. Even if store clerks only spend a few extra seconds per cash transaction counting out pennies to make change, that could add up to substantial lost productivity aggregated across the entire economy. Indeed, there is evidence that some businesses already take this into account. Research by Edward Knotek of the Cleveland Fed notes that merchants that often deal in cash frequently choose convenient prices (such as charging $3.25 instead of $3.27) to reduce the amount of time it takes to complete purchases by requiring fewer coins.

Whatever the future holds for the penny, the COVID-19 coin disruption has at least prompted lawmakers to consider the costs and benefits of coins. Both the House and Senate introduced bipartisan bills in 2020 to authorize the U.S. Mint to alter the composition of circulating coins to reduce the cost of manufacturing them, though neither bill has passed yet.

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David A. Price (804) 697-8018