The Deficit Myth According To MMT – Why Are Taxes Necessary?

At the center of frustrations with today’s economic policies, one term seems to boil to the top more than any other: Modern Monetary Theory (MMT).

Today we’ll cover why, even though the government doesn’t need the taxpayer to spend, they still bother taxing and borrowing.

Why Bother Taxing and Borrowing?

If the federal government really can just manufacture all of the dollars it could possibly desire, then why bother taxing or borrowing at all? Why not eliminate taxes altogether? The people would rejoice! And why borrow a dollar if you don’t need to? We could eliminate the national debt if we stopped borrowing.

If the government can just print as much as it wants, why not skip the taxes and borrowing altogether and just spend the money to solve our problems?

These are important questions that often come up when someone realizes that currency-issuing governments don’t need to rely on taxes or borrowing to spend.

After all, the government creates money. So, what’s the point of taxes? Why does the government need to take my money in taxes?

MMT recognizes four important reasons for taxation:  

We’ve already touched on the first — Taxes enable governments to provision themselves without the use of explicit force. If the British government stopped requiring its people to settle their tax obligations using British pounds, it would rather quickly undermine its provisioning powers. Fewer people would need to earn pounds, and the government would have a harder time finding teachers, nurses, and so on who were willing to work and produce things in exchange for its currency. A functioning and desirable currency is central to a government’s power, especially in the context of MMT, so taxes are the lifeblood of currency rather than the government itself. 

This brings us to the second important reason for taxation—inflation. If the government merely spends loads of new money without taxing any of it away from people (ahem), it would cause an inflation problem. As we’ve talked about before, it’s not the printing of money, per se, but the spending of money that matters. If the government wants to boost spending on health care and education, it may need to remove some spending power from the rest of us to prevent its own more generous outlays from pushing up prices. One way to do this is by coordinating higher government spending with higher taxes so that the rest of us are forced to cut back a little to create room for additional government spending. That can help manage inflationary pressures, by balancing the strain on our economy’s real productive capacity. More than any other economic school of thought, MMT emphasizes the importance of deciding when tax increases should accompany new spending and which taxes will be most effective at restraining inflationary pressures. Raising taxes when it’s not necessary can undermine fiscal stimulus, and raising the wrong kind of taxes can leave a nation vulnerable to accelerating inflation. 

Third, taxes are a powerful way for governments to alter the distribution of wealth and income. Tax cuts, like those passed by the Republicans in December 2017, can be structured to widen the gap between the rich and the poor, delivering windfall gains to large corporations and the wealthiest people in our societies. Today, there is more income and wealth inequality than at almost any time in US history. About half of all new income goes to the top 1 percent, and just three families own more wealth than the bottom half of America. Such extreme concentrations of wealth and income create both social and economic problems. For one thing, it’s hard to keep the economy strong when most of the income goes to the thinnest slice of people at the top, who save (rather than spend) much of their income. Capitalism runs on sales, not savings. An economy is one-half businesses, one-half consumers. The more currency is flying back and forth between them, the better. To do that, you need a reasonable distribution of income so that businesses have enough customers to stay profitable enough to provide enough employment to keep the economy running well. Extreme concentrations of wealth also have a corrosive effect on our political process and our democracy. Just as tax cuts can be used to exacerbate inequities, governments can exercise their taxing authority to reverse these dangerous trends. Stepping up enforcement, closing loopholes, raising rates, and establishing new forms of taxation are all important levers to enable the government to achieve a more sustainable distribution of income and wealth. So, MMT sees taxes as an important means to help redress decades of stagnation and rising inequality. I know there are those that will read this and feel as though any encroachment on wealth through taxation is undesirable — I’ll reiterate that I’m only relaying what MMT economists believe. In my view, fiat markets no longer resemble free markets due to the corrupting influence of hostile takeover monetary policy. In particular, the actions of the Fed are clearly propping up an oligarchy of their own . . . A topic for another day.

Finally, governments can use taxes to encourage or discourage certain behaviors. To improve public health, encourage pro-climate behavior, or deter risky speculation in financial markets, governments might levy a cigarette tax, a carbon tax, or a financial transactions tax. Economists often refer to these as sin taxes because they’re used to deter people from engaging in harmful activities. MMT recognizes that in each case, the purpose of a sin tax is to discourage undesirable behaviors—smoking, polluting, or excessive speculation—not to raise money for the sovereign currency issuer. Indeed, the more effective the tax at discouraging these behaviors, the less the government will end up collecting, since the tax is only paid if the behavior continues. If a carbon tax succeeds in stamping out all CO2 emissions, it will yield no revenue, but the tax will have served its true purpose.

Conversely, taxes can be used to incentivize behaviors. For example, the government might offer tax rebates to encourage people to buy energy-efficient appliances or electric vehicles.

For all of these reasons, taxes are an indispensable policy tool that cannot be abandoned simply because the government can manufacture its own currency. Most governments routinely spend more than they tax. And they do it, year after year, without creating an inflation problem. In fact, many of the world’s largest economies have been actively trying to get their inflation rates to move higher.

So, why not just spend more without worrying about raising taxes? And what’s the point of borrowing your own currency if you can manufacture it yourself?

We’ll finish up this series tomorrow by answering these questions.