Categories

Pragmatic Capitalism

Capital for Living a More Practical Life

What are taxes used for if they do not fund government spending?

« Back to Previous Page
0

In 1945, the director of the New York Reserve Bank, Beardsley Ruml, made this interesting statement: “Taxes for Revenue are Obsolete”. The real purposes of taxes were: to “stabilize the purchasing power of the dollar”, to “express public policy in the distribution of wealth and of income”, “in subsidizing or in penalizing various industries and economic groups” and to “isolate and assess directly the costs of certain national benefits, such as highways and social security”.
https://www.constitution.org/tax/us-ic/cmt/ruml_obsolete.pdf

I don’t really any problems with the above statement, but what I don’t understand is where does this tax money actually go to if Governments spend using other means such as bond issuance, foreign debt and money creation? I mean, it gets credited somewhere right? even though taxation is apparently used to tame inflation (i.e. stabilise the purchasing power of the currency) and regulate negative externalities.

Marked as spam
Posted by Incognito 7
Posted on 11/12/2016 7:29 PM
1550 views
Private answer

According to Mosler, taxes paid using bank transfer get erased from the Fed’s computers right away. Taxes paid using cash gets incinerated right away. (Mosler “Seven Deadly Innocent Frauds of Economic Policy”)

Marked as spam
Posted by FUЯ ION
Answered on 11/13/2016 1:02 AM
    Private answer

    This is what the MMT people say. Taxes don’t fund spending. When I first came across it in 2010 it sounded right. I worked through the accounting and it actually makes sense in a certain context. For instance, when the Tsy spends money they are spending from their reserve account. If you combine the Fed and the Tsy as both govt entities then the govt is obtaining its own liability when it taxes. This can’t “fund” spending. It MUST, by definition, destroy the money because you can’t be repaid in your own liability since that would result in a debiting of your own liability. So, if you start the circuit of spending from this consolidated Fed/Tsy account then taxes destroy money and spending creates new money. It’s basically like a new loan. New loans creates new deposits and repaying loans destroys deposits.

    The big problem with MMT is that the reserve system only exists to facilitate interbank payments. The circuit doesn’t really start or end with the govt. It starts with the banking system. So reserves only exist to ensure that banks can smoothly transfer deposits. And deposits are definitely not govt liabilities. As a simple example, you can think of the US system as a one bank system. In this case there is no need for reserves since there aren’t multiple banks needing interbank settlement. So this one bank would be the money issuer for the whole economy. The Tsy would have an account and it would tax and spend from this account. You would never call that bank’s liabilities govt liabilities. You’d call them private bank liabilities. In this case it becomes obvious that the govt does not really issue the money or spend its own money. It is taxing private bank money and spending private bank money. When you add the reserve system back into the equation the same thing is true. In the case of the USA the central bank is acting as a facilitator between private banks.

    You can further prove this point by considering the case of a private individual who has endless credit at a bank. This is essentially the case with a Central Bank who finances govt spending. In the case of an individual you could say that the person does not need income because they can spend in perpetuity. If you can just borrow new money then you are essentially a money issuer. But that’s silly. Who would accept your money if they knew it was a bottomless pit backed by nothing? They wouldn’t accept it. The thing that gives you credit is your assets and income primarily. The same is true of a govt. Govt’s need to finance their spending to prove to the private sector that they have credit. The fact that a Central Bank can issue money in perpetuity does not mean they don’t need income sources to finance their spending. That’s like saying the Bank of Zimbabwe has credit even though it’s causing hyperinflation. That’s just not true. The reason they have hyperinflation is because they have no credibility. No one trusts the govt liabilities so they sell them or don’t want them. The fact that they didn’t run out of money doesn’t mean they never needed a revenue source….

    MMT plays a lot of games with the accounting and tortures the terminology to make the theory fit reality. It doesn't work and I think they do Post-Keynesian economics a great disservice by being so adamant that their theory is right. They intentionally confuse things and confuse people reading their work. Hell, they confused me for over a year when I first came across it. It's too bad because there's some good stuff in MMT, but this sort of thinking on the financing stuff is just flat out wrong.

    Marked as spam
    Cullen Roche Posted by Cullen Roche
    Answered on 11/13/2016 3:47 AM
      Private answer

      Hi Cullen, I guess I’m still confused about your explanation as it mainly seems to be a refutation of MMT which I haven’t really heard of before.

      If tax money cannot be spent, then why do some governments (USA, UK, Australia) show detailed breakdowns of where the tax money is being spent (defence, education, healthcare etc.) like some sort of household budget on their official websites?

      Also you mentioned who would accept the money if it was backed by nothing – I thought fiat money can only have value if a government approves it as legal tender, so its not backed by anything physical if thats what you mean?

      Marked as spam
      Posted by Incognito 7
      Answered on 11/13/2016 5:56 AM
        Private answer

        I am saying that tax money is most definitely spent. This idea that taxes don’t fund spending is wrong. Look at the circuit starting with banks. People pay their taxes in bank deposits and the govt uses the reserve system to transfer those deposits from its account to other people’s accounts. If you follow the accounting flows those tax dollars are definitely getting spent.

        Fiat money is like a theater ticket. The govt determines what ticket will get you into the theater, but this does not mean the ticket is valuable just because the govt says so. The production must be well done in order for the tickets to have value. This doesn’t mean there’s anything physical backing this ticket. But it does mean that the demand for that ticket is based on more than the rules of the theater.

        The same basic concept is true of govt money. The money isn’t valuable because the govt says it’s valuable. It’s valuable because people to use the medium because it gives you access to something you think is valuable….

        Does that all make sense?

        Marked as spam
        Cullen Roche Posted by Cullen Roche
        Answered on 11/13/2016 1:58 PM
          Private answer

          Thanks for your reply, Cullen. Yes, your explanation makes a bit more sense now. I guess I was getting confused because there are so many different schools of thought about money creation, taxes and debt trumpeted around the media and various blogs that its hard to keep an objective view of the actual reality of things.

          Marked as spam
          Posted by Incognito 7
          Answered on 11/13/2016 4:09 PM
            Private answer

            So I get it that taxes do fund spending and the MMT narrative is wrong in this regard. But Govts can also fund spending by issuing bonds and creating new money, right? So the fear mongering you hear in the media, by politicians and the general public of “we are running out of money”, “we are burdening future generations”, “our debts/deficits are unsustainable” are also totally wrong, correct? Are they wrong only if the Govt spends it’s money wisely (say in education or infrastructure) or is it wrong no matter what? If the increased Govt spending is for “entitlements” such as Social Security and Welfare benefits, is that bad? What about wars?

            Marked as spam
            Posted by fnm500 .
            Answered on 11/16/2016 12:37 AM
              Private answer

              The distribution of spending power in future generations is affected by government spending in the present, however its funded.

              Taxing people to control demand side inflation caused by government consumption of resources would not have the desired effect of reducing a parcity of economic resources as once the price inflation is evident the consumtion would have allready occured. You cant releive a derth of resources in an economy by taking money away from people.

              Bank Deposit money is backed by the economic resources that borrowers supply to repay their loans. Those economic resource are real physical objects and services, and thus bank deposit money represents the future supply of those real physical objects and services, and it is that money that the government spends. As Cullen says the government spends bank deposit money.

              Marked as spam
              Posted by Dinero
              Answered on 11/16/2016 4:48 AM
                Private answer

                Hi FNM,

                That’s correct. Here’s the thing. The govt has the ability to sell bonds that are effectively backed by the output of the world’s largest economy. It’s not just a lot of output. It’s highly productive output. When the govt issues bonds they are printing a financial asset that is backed by the income source that is a function of this output. The US govt has unlimited ability to create these assets. And so long as people want them then they will be viewed as valuable. So, the even to be worried about is not a solvency constraint, but an inflation constraint. The time when people will reject US govt issued financial assets will be during a high inflation.

                So, the question becomes a bit different in this context. Yes, we can always “afford” social security and all that. But at what point do we risk running a high inflation that will begin to erode our living standards?

                Personally, I don’t see a big risk there. I think we’re in a sort of escape velocity environment in terms of sheer output. That is, we create so much new stuff so quickly every year that there’s tremendous turnover in our output. This puts huge deflationary pressure on most goods and services. But what it also means is that our living standards are increasing at a rate where we can afford to splurge on other stuff. I wrote a post a few months back about how we spend less income on necessities than ever before. This means we can afford other stuff like never before. And since the govt is just a leveraging of the private sector then the same basic point is true at the govt level. Yeah, we can afford universal healthcare and stuff like that not because we have a printing press, but because we have a fabulously wealthy and productive private sector that has made it possible.

                Make sense?

                Marked as spam
                Cullen Roche Posted by Cullen Roche
                Answered on 11/16/2016 1:34 PM
                  Private answer

                  Thanks Cullen, this was a great explanation! Totally makes sense now.
                  What do you think of the MMT “philosophy” that the Govt should deficit-GDP ratio should be whatever it takes to create full employment? Lots of think tanks like the IMF and World Bank etc always prescribe a certain % like no higher than 3% or it will create inflation and interest rates to rise. And nothing of that sort has really happened in a country like Japan for instance which if I am not wrong has one of the highest such ratios.
                  Anyway, thanks for all you’re doing, great website and blogs!

                  Marked as spam
                  Posted by fnm500 .
                  Answered on 11/17/2016 10:08 AM
                    Private answer

                    Hi FNM,

                    It’s not that simple. MMT likes to use the USA as an example, but the USA is an extraordinary economy for various reasons. Some version of MMT has been tried in many socialist economies over time with many South American economies being the closest thing we’ve seen. But the problem is that a govt’s spending is only as effective as its private sector allows it to be. So, if you have a highly productive private sector that’s creating lots of goods and services which create high demand for the domestic currency then the govt has more flexibility in how they can operate. The US govt has a huge amount of flexibility because the private sector creates a crazy amount of goods and services that result in huge demand for US dollars.

                    So, the answer is that it really depends. Deficit spending is not the right prescription in some economies. In fact, it’s the exact thing that exacerbates economic problems in many economies. So you have to be careful about these general sorts of rules that economists like to use. The world is more complex than that….

                    Marked as spam
                    Cullen Roche Posted by Cullen Roche
                    Answered on 11/17/2016 10:38 PM
                      Private answer

                      MMT is kooky conspiracy theory.

                      Marked as spam
                      Posted by MachineGhost
                      Answered on 11/18/2016 8:07 PM
                        « Back to Previous Page