Paying for public
services, in a monetary sovereign state by Dr Steven Hail
If
our national Government was to spend more than the currently budgeted amount on
your health care system next year, it would be good to know how they would
finance that spending. It is a question that advocates of more health spending
are always likely to be asked. More generally, exactly how is the total public
spending which is currently budgeted for across the next year going to be
funded? Do the various charts you see, linking the total tax take and
government borrowing to items of government expenditure make any sense? If not,
then why not?
The conventional view
The conventional view is that public spending
must be paid for through taxation, government sales of assets, or issuing
government bonds – in other words, through taxes now, ‘selling off the family
silver’ now, or borrowing at interest now money which will have to be repaid in
the future, and presumably setting up a burden of additional taxation for
future generations.
Your reaction to this conventional answer
might be a “conservative” one, which is to say, austerity to keep government
spending down and privatisation, in order to keep taxes low: or a “progressive
one”, which is to say, tax the rich and the multinationals much more highly,
because the Government needs more money from rich people so it can pay for our
public services.
Both
of these reactions are wrong, or at least misleading, because they are based on
that conventional view of public sector finance which I mentioned above. It is
a conventional view which suits many conservatives, but is also (wrongly) accepted
as being valid by many progressive people. It is – and this might surprise you
– a view which the majority of highly credentialed economists, including Nobel
Prize winners, know to be incorrect, but which many of them justify as a
mechanism for imposing some restraint on politic-ians. They believe that if
politicians only knew the financial options which are actually available to
them, they would abuse these freedoms, ‘spend like drunken sailors’, wreck the
economy.
Sharing the truth
I
don’t believe there is ever a good reason for remaining in ignorance about
something this important, and I think we have other ways of restricting what
politicians do than telling blatant lies to the public, so I want to share the
truth with you.
To
keep this as brief and as straight-forward as I can, I am not going to dwell on
the current institutional practices, conventions and rules, as they are applied
in 2016. Current practices are very different indeed from how things were done
before 1979. All the sets of conventions and rules which have been applied down
the years have, to a greater or lesser extent, obscured the truth about public
finance, which I can summarise in two sentences. Let’s call them two ‘laws’ of
public finance (based on Lerner’s laws of functional finance, from the 1940s).
1 A government with its
own currency (like the dollar), its own central bank (like the Reserve Bank), a
floating exchange rate, and no foreign currency debt, faces no financial budget
constraint at all.
2 Such a government
faces real and ecological constraints, but no financial constraint.
Monetary sovereign – no need to tax before
spending
Let’s
be clear what we are talking about here. We are not talking about Greece. We
are not talking about an independent Scotland, if Scotland were to keep the
pound or join the euro (which I have recently advised a Scottish political
party to stop saying they would do). We are talking about a genuine ‘monetary
sovereign’. We are talking about the USA, Japan, Australia and the UK, among
many others.
The
Australian Government is a monetary sovereign. Every time the Australian
Government spends a dollar, it does so by crediting the reserves of a
commercial bank which are held at the RBA (Australia’s central bank) by that dollar,
and having the commercial bank credit the bank account of whoever has been the
beneficiary of that spending. In other words, every time the Government spends,
it creates money. Not some of the time – every time. All of the Governments
spending creates money, and all this money is created using the equivalent of
keystrokes on a computer.
The Government does not need to receive your money in
taxes, or borrow your money by selling bonds, or raise money from you by
selling you shares in government owned utilities …. before it spends. Think about it for a moment. It isn’t, in a literal sense, your money
in the first place. Who issues the nation’s currency? The RBA. And who owns the
RBA? The Australian Government. The Government doesn’t need to collect its
money, which it creates, from you before it can spend.
Every
time our national Government spends, it creates some of its money for the
purpose. I know commercial banks create a great deal of deposits for
themselves, and a great deal of what is normally defined to be ‘the money
supply’ by lending to their customers, but they can only do this because they
have access to Government money, in the form of their reserves at the RBA.
There are two ways for this money to be created. One is the Government spending
this money (permanently) into existence, and the other is the RBA lending this
money (temporarily) into existence.
How can we pay for an increase in health
spending?
We
have come to the answer to our initial question. How can we pay for an increase
in health spending? The same way that we pay for all public spending. The
Government will spend the money into existence. The way the accounting is done
these days, and current institutional practices, obscure this truth, but they
do not change the fact that it is a truth. It is not a theory. It is a plain
fact.
Let
me put it more simply. Money does not grow on trees. It is easier than that.
Money comes from nowhere. It exists mainly in the form of electronic entries on
spreadsheets (these days), and you can say it is typed into existence. Our Government can no more run out of
dollars than the scorer at a cricket ground can run out of runs, perhaps
something to remember the next time our Australian boys go over to England to
win the Lords’ test match. In this sense, the Government really does have a
‘magic pudding’.
You
might ask me whether I am talking about ‘printing money’ to pay for the
Government’s spending. You might conjure up visions of Zimbabwe or Weimar
Germany. I’ll deal with those briefly in a footnote below, but let us be clear
– in a sense, all of Government’s spending always involves ‘printing money’.
Except, I hate using that term, because of its associations, and because it is
a little misleading. Very little modern money is actually printed, remember –
it is nearly all electronic.
Why are we paying taxes?
The
question is, then, why do governments tax people at all? Taxes do not ‘pay for
government spending’, after all. Taxes do not pay for the education service.
Taxes do not pay for Medicare. It might make you feel better to know that your
taxes are not paying for military weapons. They really aren’t. The Government
doesn’t need to get money from rich people before it can spend. Your taxes, in
a literal sense, do not pay for anything. Taxes, at least in a monetary
sovereign state, pay for nothing at all.
So,
why do we pay taxes? There are many distributional, or microeconomic, functions
which the tax system fulfils. However, at the macroeconomic level, the purpose
of taxation is very simple. It is necessary for people to pay taxes to destroy
(to use a provocative word) some private sector spending power, to make room
within the economy for the government to conduct its desired spending on public
goods and services, without pushing total spending in the economy beyond the
productive capacity of the economy and causing inflation. Taxes limit inflation, helping us to maintain the spending power of
money, so that people maintain their confidence in the value of money.
We
have reached the second law I wrote down above. As a society, we cannot run out
of dollars, but we can run out of people, skills, technology, infrastructure,
natural and ecological resources. There are limits – but the limits are ‘real’
and not financial. When planning for the future, governments should use their
freedom from financial constraints to plan wisely to manage the real and
ecological constraints which will always be with us.
The Government, then, cannot spend without limit,
because it would push total (private sector plus public sector) spending beyond
the current capacity of the economy, and be inflationary. So we have to pay
taxes.
Budget deficits essential ……
This
does not, however, mean that governments need to ‘balance the budget’, or
should ever attempt to balance the budget, or limit its deficit to a specific
proportion of GDP. In fact, most Governments (including Australia) have hardly
ever run balanced budgets or budget surpluses in modern times, and when they
occurred they tended to be just prior to economic downturns. For example, there
were very small and very temporary fiscal surpluses in the UK in the late 60s,
the late 80s and the late 90s. The rest of the time, the UK Government has been
in continuous fiscal deficit, since the early 1950s.
This
is not only true for the UK – it is true almost everywhere, with almost all the
exceptions being relatively small and oil rich countries, like Norway. In the
case of Norway, what makes it possible for the government to run fiscal
surpluses is not the ‘sovereign wealth fund’ you may have heard about. It is
simply Norway’s consistently large trade surplus with the rest of the world.
Most
governments most of the time historically have run budget deficits. This is
essential, because if the rest of us want to build up our savings in dollars
(including foreigners in ‘the rest of us’) it turns out the Government will be
forced, one way or another, to run a deficit. A good deficit will prevent a
recession from happening, and a bad deficit would be the consequence of a
recession happening and tax receipts crashing while welfare payments rise, when
everyone wants to save and not spend. To explain the logic properly would mean
going into too much detail here, but believe me it is a mathematical (or
accounting) fact of life.
Doesn’t
all this mean the Government getting further and further into a burdensome
‘debt’, which future generations will have to repay, so that government
borrowing is somehow immoral, and especially so if it isn’t to pay for
investments in the future?
Not
once you understand that monetarily sovereign governments don’t and can’t really
borrow in their own currencies, at all, in the conventional sense of the term.
If you or I, or a business, or a local authority, borrow in dollars, then later
on we will have to repay that debt and the interest on it, or we will go broke.
We are (obviously) not monetary sovereigns. We face a financing constraint.
It
is different for our national Government. I have already said that the
Government spends new money into circulation, and then uses taxes to destroy
some of that money so that there won’t be rising inflation. Ideally, the
Government should spend more than it taxes, when it is running a deficit, to
ensure that total spending in the economy is at the right level to maintain
full employment. The total level of public spending, how it is divided up
between public goods, and the structure of the taxation necessary to limit
inflation, are then political issues.
Government bonds, bank rate – times of change
Until
the Global Financial Crisis, and before some central banks started doing quantitative
easing, it was necessary for their governments to sell government bonds to more
or less match government spending net of taxes, in order to keep control of
interest rates. The reasons are a bit dull, but if you bear with me I will try
to explain.
Interest
rates in general depend on the interest rate banks charge each other when they
lend each other money for liquidity management purposes for very short periods
of time. A fiscal deficit effectively feeds cash reserves, or liquidity, into
the banking system. In the past, it was necessary to remove those reserves
again by selling government bonds, or this interest rate would fall below the
level the central bank wanted it to be at. Banks with plenty of reserves of
cash don’t need to borrow from other banks. Sales of government bonds were
about keeping the supply of cash to the banking system limited to the right
level to stop interest rates falling.
That’s
all changed now – at least in the UK, the USA, Japan and the Euro-zone. The
central banks of all those countries first cut interest rates to virtually
zero, after the Financial Crisis, and then used quantitative easing to
deliberately flood the banks with cash reserves, by purchasing large amounts of
(mainly government) bonds from the private sector. The so-called ‘bank rate’ is
now not a rate of interest at which private banks lend to each other – it is
now the rate of interest that central banks pay on the huge amount of reserves
the commercial banks have on deposit with it. Rather than seeking to limit
those reserves, the central banks have been deliberately increasing them.
Yet the old practice of each government selling its
bonds goes on. It is rather ridiculous at the moment, because as the
governments concerned are selling new government bonds – in a conventional
view, to raise money – their own central banks (which are owned by each
government, remember) are kept busy buying those same government bonds second
hand from the private sector, in order to increase the amount of money in bank
reserve accounts. It’s very strange and anachronistic. Economists like me view it as something of a muddle.
Government bonds/debt – a form of money
We
have learned in recent years that there is no genuinely good reason for selling
government bonds at all, if you are a monetary sovereign government. Indeed, it
would be better to convert them into term deposits at the central bank, and to
regard them as a form of money.
After
all, at the moment bank reserves held at the central bank are (in an accounting
sense) Government liabilities, on which the central bank as part of the
Government pays interest, but are not seen as Government debt: government bonds
are also government liabilities, on which the central bank on behalf of the
Government also pays interest, but they are seen as Government debt.
Moreover,
if the central bank, as a part of QE, buys Government bonds from the private
sector, it is just swapping one interest bearing government liability for
another. No wonder QE doesn’t work! It isn’t ‘free money’ at all. It is
basically swapping two very similar assets for each other. The private sector
used to own Government bonds and receive interest. The private sector now owns
reserves at the central bank, and still received interest.
Why
would that arrangement act as much of a ‘stimulus’ for the economy? Why,
indeed?
To cut a very long story quite short:
1 When the Government spends it creates money.
2 When the Government taxes it destroys money.
3 Government ‘debt’ should not be thought of as ‘debt’ in the
conventional sense at all. It is better thought of as a form of money.
4 The Government cannot run out of money, and as long as it doesn’t
guarantee to convert its money at a fixed rate into anything it could run out
of, it faces no financial constraints at all.
5 However it faces real and ecological constraints, because we can run
out of people, skills, technology, equipment, infrastructure, natural
resources, and ecological space.
6 The Government is NOT a household and NOT a business, and has nothing
at all in common with a household or a business, where financial matters are
concerned.
7 When progressives understand this and start framing their arguments in
this light, I believe they will be able to argue their points far more
effectively and persuasively, and free themselves from what are sometimes
called ‘neoliberal dogmas’ (i.e. conservative and ‘new labour’ nonsense).
Understand
all of this, and I think that it will change your perspective on many things.
And ought to make you a great deal more confident when dealing with
interviewers. If they approach you using the conventional view as a framework,
remember that it is either because they have never really thought these issues
through or because they are being dishonest for some reason (sometimes it is a
mix of the two, and people can, of course, be dishonest with themselves, or at
least suffer from cognitive dissonance).
Footnote: Mugabe’s Zimbabwe and Weimar Germany
Zimbabwe 2008 If you engage in a poorly planned and violent land reform, regardless of
your motivation, there will be consequences. Zimbabwe’s govern-ment managed to
wipe out its vital agri-cultural system, while at the same time alienating most
high income country governments, and facing sanctions. The supply of food
failed. The Government then (literally) printed vast amounts of money to buy
non-existent food, and inevitably the price level sky-rocketed. Ever higher
prices then led to ever more money being printed, so that at least the friends
of the government and the army could be provided for. The result was
hyperinflation. The lesson is that if you destroy the supply side of your
economy and try to make up for it by printing loads of money, you will be able
to create hyperinflation. Zimbabwe 2008 has no lessons for Australia 2016.
Germany 1923 Germany’s productive capacity had been destroyed by war and by the
resolution of that war. In addition, Germany had been required to pay vast
amounts of gold to its former enemies. The only way to obtain the gold was to
buy it, using marks which could then only be spent into a German economy
already on the brink of famine. There were some other issues, but it’s
basically similar to Zimbabwe 2008. If you destroy the supply side of an
economy and then print loads of money, you will push spending far beyond the
productive capacity of the economy and create inflation.
Dr Steven Hail, lecturer in economics at the University of Adelaide, with a special interest in macroeconomics
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