Let's talk about taxes

#2     Let’s look at Tax-why is the economy like a washbasin?

In #1, we looked at how we have all been led to believe that Governments spend “taxpayer’s money”, and can only afford to spend what they receive in tax receipts. “There’s no magic money tree, dear”, Theresa May told a nurse who asked why they were only getting a very small pay rise, in 2018. What’s the real story about tax? What is taxation really for?

We worked out, in #1, that tax receipts are not something any Government, with its own currency, needs in order to spend on all the things Governments provide for their people. So why do governments have taxes? Well, first of all, if you are a government with your own currency, such as pounds, dollars, roubles etc, you can create whatever money your country needs, but to do that, you need to make your currency the one that everybody uses. If half the people in Britain are trading in dollars, or krone, or something else, you have no control. So, to make everyone trade in pounds, you demand and collect taxes in pounds. The people then need the pounds you have created, to be able to pay their taxes.  And, if they don’t pay their tax, you can cause them big problems by using the law.

Let’s recap on how money is created. A Government decides (“fiscal policy”) how much money its country needs to provide all the public services they need, and everything that goes with that. Plus defence, social security, pensions, etc etc. The government then orders the Treasury to put suitable numbers on a spreadsheet, so the Bank of England can issue it. It can also authorise other banks to create a certain amount of money to lend to businesses and people, in the same way. It can also control things like interest rates, and under what terms banks can lend (“monetary policy”).

Okay, if we agree on that, what else are taxes for? Governments can create as much money as they choose, and stimulate the economy. But, what happens if the country gets to a point where everybody who is capable of working is fully employed?  And  there is no ability to create any more goods and services for people to buy? Then, you get a situation where too much money is chasing not enough stuff to buy, which is when prices are forced up, which we call inflation. (We already have this in housing prices, because the housing market has for years been rigged to ensure more demand than houses/flats available to buy or rent. Over the last 30 years, if all prices had followed housing prices, a loaf of bread would be about £10, and an oven-ready chicken about £50.They get away with this, because those who already have houses enjoy thinking they are wealthy.) 

A government does not want runaway inflation to happen (because the people get extremely outraged), so it uses taxes to reduce (claw back) some of the amount of money in the general economy. If the people have, in effect, too much money to spend, taxes reduce that a bit to balance things up (“dampen down demand”).

Sounds odd? Think of it as a washbasin with water (the economy) in it. The water (government-created money) comes from the tap, and the government controls the tap. The waste plug is used to drain excess water off (tax), to prevent the basin over-flowing.  The water (money) drained off goes down the drain. So, in the country, the money that governments take in tax is simply cancelled on the Treasury master spreadsheet (the same one that money is created on). It is not actually paid out to anyone. “Taxpayers money” is nothing more than a very simplified idea of what happens. (Some call it a “fairy-tale”). This is very useful, if you are a government that wants to pretend that the country cannot afford to pay fair wage increases to nurses, or other things.

Now, apart from making people trade in pounds sterling, and countering runaway inflation, what else can a government use taxes for?

Taxes can be used to encourage more fairness in the economy, or tax concessions can be used to encourage particular industries to develop, or regions to attract new industries. So for example, people on high incomes are taxed at a higher percentage rate than folk on low incomes. (Although we know, in reality, that very rich people can manipulate the tax regulations to minimise how much they pay). This area can be a minefield for governments. When the government in the 1980s tried to replace the old system of local taxes, the Rates, with the Poll Tax, it was seen as a grossly unfair burden, and there were violent riots in the streets. The government had to backtrack.

 

Taxes can also be used to persuade people to do certain things, or not do things. For example, tobacco can have its tax duty increased, to discourage smoking. In Denmark, the government wanted to make people use bicycles or public transport more, so the fees for registering a vehicle were raised substantially.

In the words of Australian economist Ellis Finningham:

“The question, then, for tax policy is, “What kind of society do the people want?” and then once the voters speak, the UK government aims its spending and tax policies towards creating and maintaining that kind of society.”

This may not happen, though, if a government wants to pursue its own agenda, and can convince the voters that it is acting in their best interests.

I am indebted to the writing of Ellis Finningham, and the economics journalist John Harvey, for much of the material in this article.  

What is "Taxpayers money"?

   #1.  What really is “Taxpayers’ money”? (approx 3 minute read)

 From the early 80s, the idea that Governments can only spend what they receive in tax, was heavily promoted, especially by Mrs Thatcher. The concept of “no magic money tree” was created, and it sounded quite convincing. Because we all understand “budgeting”. But let’s think about it.

Almost all of us have an average income of, say, £x per month, and  outgoings/expenditure of say, £y per month. If £y is less than £x, then happy days, we’ve got more to spend next month. If £y is more than £x, we have to spend less next month, or borrow some. We’re all familiar with this, so it has been easy to convince us that government money works the same way. I used to believe it, too.

So, if it isn’t true that governments spend only what they receive in taxes, where does money actually come from? It’s created by governments, by spending money into the economy.  If they didn’t, there would be no money in the economy for people to spend, businesses to build, or taxes to be paid. Still think it comes from everybody earning money in various ways, spending some of it, and paying tax with the rest? That went out with the barter system, hundreds of years ago. We can’t dig money up from the ground, or grow it in fields, and if we hire an industrial unit and manufacture our own, the police take a dim view. So, it is created by the State.

How? The money governments create is used to pay for things like the NHS, schools, Police, Courts, roads, buildings, etc etc. Much of that goes on wages, which are spent to sustain lots of other businesses. Or, on materials needed for these, which creates more economic activity. Part is given to councils to help pay for all the services they provide, because council tax isn’t anywhere near enough. Some goes on social security, so that people with no access to income have some money to spend (remember, benefits tend to be spent on buying goods & services, not stashed away in the Cayman Islands!). All this business creates tax income back to the state.  So the whole economy is based on Government money.

A government with its own currency, such as the UK, can create as much money as it chooses to.It's called "fiscal policy". (About £400bn was created in 2008, to rescue the banks from the consequences of their greed and irresponsibility, without causing inflation or any other problem.) And no, it doesn’t “have to be paid back by future generations”, because we effectively borrowed it from ourselves, and don’t have to ask for repayment. The papers talk about “printing money”, but that is nonsense- when you go to the bank for a car loan, they don’t go to the vault and bring back a big sack full of banknotes. They press a few keyboard keys. In this example, a high street bank is doing exactly what a government does- create money (except, high street banks are subject to controls which governments are not.). The "printing money" scare story dates back to when money was linked to the value of gold (long gone).

So, how does taxation work? It’s actually a sort of regulating valve, which prevents the economy from over-heating. It regulates the amount of money sloshing around, and under-pins the economy. . It can control excessive inflation. (more details on this in my second blog piece, "Let's talk about tax"). Our tax system is fairly efficient (except when we allow large multi-national companies, or very rich people, to pull a fast one.)  But, tax is not a government’s source of money to spend. In fact the opposite, because until a government "spends" money into the economy, there is no money to be paid in taxes!


A country, with its own currency (e.g. pounds, dollars, yen, krone), can just order its central bank to create funds, to finance investment or proper funding of services. As much as it chooses to. And if it does, then, for example, the healthier level of public sector wages gives all those workers more to spend, so they spend it, creating more business activity, creating a healthy economy, creating more tax income, etc, etc. Remember, nurses, fire-fighters, prison officers etc don’t usually have expensive accountants advising them how to pay less tax! 

But what happens if a country creates too much money, and uses it un-productively?  If a country spends money un-wisely, a weak currency, or hyper inflation, can result. If a government creates so much money that demand rises more than jobs can be created, factories built, materials to provide stuff can be found, then, yes, runaway inflation can result. But, if a government uses it's power to create money, to invest that in things which create better services and greater, fairer wealth for the people of that country, then there is no effect on inflation. An example of this, is the growing call in the USA (the "Green New Deal") and UK, for investment to be used to create widely-available positive, valuable, and decently paid skilled jobs for everyone who is able to work, and wants to. These could be in areas such as healthcare, environment (e.g energy-saving), or building the genuinely-affordable homes that we are desperately short of. And, there's still plenty of scope for us to do these things.

If Jill and Jack Jones borrow, say, £5000 and spend it on a luxury holiday, they will come back with great memories, but nothing else to show, except increased loan payments. But, if Jill borrows £5k for a train season ticket to travel to a new job at a much higher salary, then she not only saves a lot against the cost of buying a ticket each day, but also the loan payments are easy to cover out of the bigger wages. This is how positive investment works.  But, for a government with its own currency, such as the UK, USA or Australia, there is no need to "borrow" to invest. And no need for "tax revenue". 
I will talk about debt and deficit more, in a later piece.

I am grateful to Mike Hall, for his many insights into  modern, progressive ideas about money policy. Also to David Harvey and David Vigar  for suggesting edits to this article.

Next time:  More about taxation- "Let's talk about tax"

To find out more: here are a few links to information on the modern understanding of  how public money really works, rather than the false and misleading beliefs which have been around for a long time. It's known as MMT, Modern Monetary Theory.

This is from a highly respected American Economist, but exactly the same principles apply here. (Trailer advert before it starts)  https://www.cnbc.com/video/2019/03/01/stephanie-kelton-explains-modern-monetary-theory.html?__source=sharebar|facebook&par=sharebar&fbclid=IwAR1SHvO7hIVIz4cZRfoJ7f1QHgmBHechvefmeUcKvs-Av9-xDil54RUqs6c

Another explanation of MMT:,
https://gimms.org.uk/mmtbasics/

Lots of information from a leading UK group of modern economists:
https://www.progressiveeconomyforum.com/blog/

About

Stop this Nonsense

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For years, Governments have used most people's ignorance of basic economics, to spin us a web of half-truths or fantasies, in order to suit the agendas of their backers, and get support for their policies, such as "austerity".

This blog aims to tell people a bit of reality about governments and money.

I don't pretend to be any kind of qualified economist. I'm just here to tell you about what I have learned from highly-respected economists.To open people's eyes.

This is a non-commercial, non-profit blog, for educational and campaigning purposes. I do not collect any data about any reader, apart from possibly replying to anyone who contacts this blog.

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