#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 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.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 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, 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.