#3 Let’s look at Tax-why is the economy like a washbasin?
In #2, 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, because it’s convenient to justify political agendas. “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/issue whatever money your country needs, but to do that, you need to make your currency the one that everybody uses.
Then, if you are a nation’s government, you need people to work for you. You will need teachers, health service staff, transport planners, police and courts, armed services, administrators to organise it all, etc. You’ll need to pay them to get them to do it, so you pay them in your tokens (pounds, in the UK). To make them need your tokens, you will have to make them pay your taxes, by law, and only accept pounds in payment of these taxes. Not Yen, bitcoin, nectar points, or turnips. Similarly, if you need contractors to build roads or hospitals.
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 Bank of England, via the Treasury, to put suitable numbers on a spreadsheet, so the Bank can issue it.
Issue of pounds by the government is often, misleadingly, described as “borrowing”. Government Bonds are just an accounting device. See #11 in this blog for more details.
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 such as the UK’s, 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? A long, long way off, currently. And there is no ability to create any more goods and services for people to buy? If raw materials to build hospitals etc, have run out? All measures to reduce climate change have been taken?
A government can in those circumstances, vary the amount of taxation 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, putting pressure on prices, taxes can reduce that a bit to balance things up or “dampen down demand”. (Not the current price rises, caused by supply shortages, which are largely a consequence of the pandemic. Shortages of goods, some workers, energy, shipping containers, etc. These are nothing to do with too much money.)
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 UK, and similar countries, 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” doesn’t really exist.
Pretending that it does 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, obtaining labour and materials for public services, and countering potential 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. The most wealthy can be taxed heavily, to weaken their power to dominate policies and markets.
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 economics teacher Ellis Winningham:
“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, (such as weakening the NHS to pave the way for privatisation) and can convince the voters that it is acting in their best interests.
I am indebted to the writing of Ellis Finningham, and the economist John Harvey, for much of the material in this article.