Optimal Allocation of Social Cost for Electronic Payment System: A Ramsey Approach

Using a standard Ramsey approach, we examine an optimal allocation of the social cost for electronic payment system in the context of a dynamic general equilibrium model where money is essential. The benevolent government provides electronic payment services and allocates the relevant social cost through taxation on the beneficiaries’ labor and consumption. A higher tax rate on labor yields the following desirable allocations. First, it implies a lower welfare loss due to the distortionary consumption taxation. It also enhances economy of scale in the use of electronic payment technology, reducing per transaction cost of electronic payment. Finally, it saves the cost of withdrawing and carrying around cash by reducing the frequency of cash trades. All these channels together imply optimality of the unity tax rate on labor.