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Central Bank Digital Currency, Tax Evasion, and Monetary Policy with Heterogeneous Agents

Author

Listed:
  • Adib Rahman

    (University of Hawaii)

  • Liang Wang

    (University of Hawaii)

Abstract

We investigate the effects of central bank digital currency (CBDC) issuance in an economy where individuals can evade taxes by using cash. Our tractable model features agent heterogeneity with unobservable idiosyncratic shocks and voluntary exchange, where CBDC and cash compete as payment methods. CBDC's transparency enables governments to collect a labor tax that proves non-distortionary in our quasi-linear environment. Agents with higher marginal utility voluntarily pay fixed fees to access interest-bearing CBDC when their debt constraints bind, allowing the implementation of optimal policy with strictly positive inflation and nominal interest rates. We demonstrate how CBDC enables redistribution between agent types that is not possible in cash-only economies. We conjecture that an optimal CBDC policy involves higher nominal interest rates and lower inflation compared to cash regimes. By reducing tax evasion incentives, the introduction of CBDC can increase both output and aggregate welfare.

Suggested Citation

  • Adib Rahman & Liang Wang, 2025. "Central Bank Digital Currency, Tax Evasion, and Monetary Policy with Heterogeneous Agents," Working Papers 202505, University of Hawaii at Manoa, Department of Economics.
    • Handle: RePEc:hai:wpaper:202505
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    File URL: http://www.economics.hawaii.edu/research/workingpapers/WP_25-05.pdf
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    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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