Who Pays for Transactions? How Much?

One of the many important questions in the transition to mobile and/or electronic money is who will bear the costs associated with using the system. This question is particularly salient since the Kenyan government announced it was planning to begin taxing mobile money transfers, adding to the cost of the system. The Kenyan government seems to believe that operators will absorb the cost of the tax, but others suggest that it will be passed on to consumers, "picking the pocket of the poor."

Who will bear the cost of the tax and the other costs of operating mobile money systems? On a theoretical basis, this is an easy question to answer: the people who benefit will bear the costs—if those costs are lower than the benefits. In economic theory, it is even irrelevant who is initially charged for the costs, as costs will be passed on to those willing to pay to receive the benefits (known as tax incidence).

Practically, it’s a hard question to answer because we have very little information on the true costs and benefits of any money system. And transaction systems do have significant costs. In developed economies, much of the cost of the most popular form of mobile money, credit cards, are borne by merchants. They pay a “swipe fee” to the credit card companies for each transaction. But even those costs are hard to calculate for merchants. Last month, a post in the New York Times Economix blog by Nancy Folbre detailed the highly complex pricing system that determines the actual price of any particular transaction. No wonder some merchants prefer the seemingly free option of cash.

But of course, cash only appears to be free. The majority of the cost of cash is borne by governments, and therefore the merchants and consumers are paying for cash too, just more indirectly. Beyond that handling cash carries lots of costs for both merchants and consumers.

Folk wisdom tells us that there is a substantial psychological cost of cash as well. It, as the saying goes, “burns a hole in your pocket.” On the flip side, electronic payments often mask the reality of what we are spending—which is why financial coaches often advise people to pay for everything in cash, holes burnt in pockets be damned. Jonathan Robinson has a new paper that illustrates another very real cost of cash for merchants. Forgetting to maintain enough change for cash transactions costs small shopkeepers in western Kenya 5 to 8 percent of profits. There are also substantial time and cognitive costs of keeping track of and protecting cash, as is becoming increasingly clear from research like Portfolios of the Poor and studies by behavioral economists.

As far as I know, no one has systematically studied the true costs of cash in developing economies because there hasn’t been an alternative. Now that there is an alternative, it’s important to better understand the costs and hidden taxes on cash as well as on mobile money. Only then can we get to good answers to the question of who benefits, who pays, and how much.