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. It has been called, “handbag economics”.
So, if that isn’t true, where does money actually come from? It’s created by governments, by spending it into existence. If they didn’t, there would be no money in the economy for services to be provided, public buildings, roads, the NHS, businesses to grow, banks to lend, or people to spend or pay taxes. 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 spent into existence on things like the NHS, schools, Police, Courts, the Civil Service, Armed Forces, 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 companies, jobs, etc. 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. The Government can also control how much money the banks can lend to allow businesses to build, or consumers to buy stuff. 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. About £400bn was created in 2008, to rescue the banks from the consequences of their greed and irresponsibility, without causing any inflationary problems. 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 media 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. The Government of the UK, effectively, does the same, via the Treasury and the Bank of England.
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 be used to damp down demand, if for a while, there aren’t enough people/materials resources to be utilised. My third piece, “Let’s talk about taxes”, explains this more, and talks about what else tax does. Our tax system is fairly efficient (except when we allow large multi-national companies, or very rich people, to pull a fast one.) . But, taxation is not a government’s source of money to spend.
The money collected in tax is just cancelled on the master balance-sheet, the same one that is used to spend.
If you are uncomfortable with the realisation that the UK Government can spend as much as it chooses to, you may be glad to hear that there is a situation where Governments need to rein in spending, or take back money through taxation.
When is that? It is when:
*Everyone who is capable of working is fully employed for an appropriate number of hours at fair pay
*All reasonable demand for health and social care is met promptly and to a high standard
*Education is freely available to a high standard
* There is enough decent, affordable housing to go round.
*There is still enough bricks or other stuff needed to build houses, hospitals, etc
*Energy consumption and pollution have been reduced to a minimum, by conservation and “green” generating
This list doesn’t cover everything, but once all these are in place, excess government spending into the economy will cause demand which cannot be met, resulting in high inflation. Ain’t gonna happen anytime soon, though!
A country, with its own currency, can just order its central bank to create funds, to finance investment or proper funding of services. 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!
I am grateful to David Harvey and David Vigar for suggesting edits to this article.