“Out of intense complexities, intense simplicities emerge”. W. S. Churchill.
Imagine that you personally own, outright, Britain’s largest bank, and you are legally entitled to put any credit figure you choose in your own account. Would you really go out and actually borrow any money from anyone? Of course not. But, you are aware that if word gets out that you have unlimited money available, various fools and chancers, (and a few deserving cases) will come knocking, asking for some.
So you hit on the idea of making an elaborate facade of your “borrowing” this money, rather than just typing it into your account. To make it convincing, you allow institutions with substantial funds to invest, (such as pension funds) to “lend” it to you, in return for some interest. You stipulate that all transactions must be in pounds sterling. This “lending” gets called “Bonds”, and you know that when the Bond matures, you can give them their money back. No need to actually use it, as you have plenty of your own funds, and no need to worry about the interest, as you have an unlimited supply of £ Sterling to pay it to them from. You can then tell the fools and chancers that, sorry, you can’t afford to borrow any more to give them. To convince them, you occasionally add up all these Bonds, and call this scary-sounding total “the National Debt”. You can also, if you choose, tell deserving cases (such as public health care, or similar, that you don’t really care about), that you can only “afford” to give them so much. You can also pretend that the Bank is independent of you, and makes its own decisions.
Get the idea? You’re thinking, this can’t be it, can it? But it’s a simplified version of what actually happens. The UK government, of any party, owns the Bank of England outright, and we all know that he who pays the piper calls the tune. And because of this, it can no more run out of £ sterling, than a football stadium can run out of goals, or a marathon runner short of kilometres.
Still not sure? Have a look at these. C, from a politician, is a fib.
And, if you’re still not sure…..here’s Robert Peston, on ITV News at Ten, 14th May: “…..when you’ve got an independent central bank, as we do, in the shape of the Bank of England, the Government can, er, for a period at least, more or less borrow as much as it likes. The Bank of England buys the debt. That’s what’s going on at the moment. It’s creating new money now.”
(note: The Bank of England is “independent” in name only. It is wholly owned by HM Government and is controlled by HM Treasury. It has a few minor autonomous powers subject to Treasury approval. )
At the present moment, when it’s clear that the imminent economic crisis resulting from the Covid-19 pandemic, will need a massive financial intervention by the UK government to avert a catastrophe, a lot of people are worried about how the cost of this will be met. And, what long-term effects that will have.
So, it may be very helpful to think about how these issues were coped with when we last had a financial seismic shock- in 1940, at the start of World War 2. This letter by Tom Griffiths, quoted by Australian Professor of Economics Steven Hail, does that superbly.
“A recent phone-in comment by LBC Radio’s economics correspondent set me thinking, as it led to the usual nonsense over equating Govt. spending with ‘debt’. There were phrases like “UK Govt is paying the salaries of 60% of Brits- even another month will bankrupt us” etc. I thought of a useful parallel which went on immensely longer, and yet the promised bankruptcy never arose.
Shortly after the declaration of war in 1939, Britain ramped itself up into practically the most single-focused economy ever seen in the modern world. Within 2 years, 6 million Brits were paid directly by HMG in the armed forces alone. That is, at least 25% of the adult population. On top of which, a huge percentage of the UK economy was switched to exclusively war materials output. Domestic car, bus and truck manufacturing stopped completely. As did train manufacture. Dockyards concentrated on war vessels or freighters which often had a very short life.
This continued until early 1946: in other words the UK Govt closed huge swathes of private industry, and more or less directly employed over half the UK population for 5 years uninterrupted. Practically nothing of the ‘traditional’ industries worked for anything other than Government money, apart from farms, food industry, shops and a token amount of clothing and domestic items manufacture. For 5 whole years.
According to enthusiasts of the simplistic “household budget” metaphor, this would have left us with a decimated economy, a crushing mountain of ‘debt’ equal to 5 years or more of GDP, and plunged us into a deep and savage depression.
Instead, the only visible debts were a combination of the real ones: the $6.5bn dollars owed to Canada and the USA for provision of food, oil and war materials, and the sum total of war bond redemption costs in £Sterling. The Dollar debts began repayment in 1950, and the total apparent visible debt was only about a third of what the ‘household’ model would have predicted, i.e. about 2-2.5x GDP
The whole 5-year complete takeover by Govt didn’t lead to much inflation, due to rationing and price controls.
As troops were demobilised in a planned way, because the infrastructure of the economy was still in place, although rather battered, output simply started again. Not quite as simple as turning on a tap, but not far off. The promised depression never occurred, probably helped by the stimulus of having to rebuild lots of things, and re-supply our old markets which had been turned off by the almost 100% cessation of international trade. So the answer to the pessimists is: we weathered a similar international hiatus which involved the Govt paying almost everyone, for a full 5 years once, and bounced back. That is (with this current lockdown scheduled to probably last 4 months) an almost exact parallel economic hit, but 15 times greater in magnitude.”
Professor Hail adds: “
We of course think about Keynes’ pamphlet ‘How to Pay for the War’ when thinking about the economics of resource mobilisation. Real resources had to be transferred from production for private markets to production for the Government and for war.
These days, things are very different . As then, the Government isn’t going to run out of pounds, but now, in the absence of significant foreign currency debt and/or a fixed exchange rate, it doesn’t face a purely financial constraint at all. It has a lot more fiscal space.
In the late 1940s, there were US dollar debts and there was a fixed exchange rate system, but as Tom’s message reminds us, the Government was far from bankrupted – indeed, the Welfare State was introduced – and post-war growth naturally reduced the debt/GDP ratio over time too.”
Imagine a doctor, who is treating a patient for anaemia, deciding to reduce the person’s food intake. Pretending this will be good for him, and will allow him to recover. Accusing his previous doctor of reckless mis-treatment, wasting the hospital’s resources. Think that would never happen?
The year is 2010. Following the Financial Crash of 2008, the banks are still reluctant to lend, businesses are nervous about investing, and consumers are scared to spend. Doctor George Osborne is appointed to take over a patient’s care by new Prime Minister David Cameron. He decides that the patient, United-Kingdom-Economy, who is suffering from a condition close to malnutrition, having been badly weakened by the Financial Crisis, needs to go on a diet, and eat less. He says the hospital is short of food, and has to live within its means, balance the budget, and so on. The relatives and friends all know what it’s like to have to live within a budget, so they agree to this. What they don’t know, is that this hospital has access to unlimited food and medicines, if it chooses to use them. And, that Dr Osborne knows this, and has his own plans for the hospital’s food and medicine.
If you have read my earlier pieces in this blog, you will realise that the United Kingdom has its own currency, so can spend into existence whatever amount of pounds sterling it chooses to. Doesn’t have to “borrow” any, doesn’t have to “pay any back”, in real terms. (Bonds, and their interest are repaid when they mature, but as this is done in £sterling, and we have complete control over how many pounds sterling we have access to, it’s not like debts as you or I understand them. See #4, deficits and debt.) But we have been repeatedly told that “there’s no magic money tree”, that Government “borrowing” is dangerously high. That “fiscal responsibility” is important. That the UK could “go bankrupt”. So, budget cuts had to be made, public spending had to be reined in, the wages of public sector workers such as nurses, police officers, fire-fighters, binmen, etc, had to be capped. As Alexei Sayle’s bitter joke went, we were told that “the Financial Crash was caused by too many libraries in Wolverhampton”. The previous government was alleged to have caused the banking crisis by its reckless spending. (Forgetting that the crash was caused by the greed and irresponsibility of the banks and financial services industry, who had been saved from catastrophe with an injection of funds called “quantitative easing” by Gordon Brown’s government, which then merely maintained normal public expenditure).
So what happened between 2010 and today? Huge and savage public spending cuts. Not challenged by the papers and TV news, who accepted the official story, and faithfully relayed that to a public who understood very little about economics. (What little they did know was based on an utterly false picture painted by the Monetarist School since the 1970s, which most people still believe). here’s what happened to wages:
Public sector workers are no better off in real terms, than they were in 2009. Police officer numbers were cut by 20,000. Council government support was cut by £billions, so councils had to make reductions in the services they were obliged to provide to the public. The funding of schools was cut so much that today, teachers buy stationery for the pupils to use out of their own pockets, class sizes have risen, and staff are demoralised. Fire stations were closed, and staff numbers cut. Legal aid was severely restricted, so poorer people didn’t have help to get fair access to justice.
As zero-hours working increased (now approximately 1,000,000 people), and many were forced to rely on precarious self-employment, this combined with wages being kept down, to cause widespread in-work poverty, on a scale not known since the 1920s.
This, together with a 1920s-style harsh benefits regime, including the notorious Universal Credit, (dressed up as “Welfare Reform”), means we now have more foodbanks providing a lifeline to those in real poverty, than the total of McDonalds and Burger King restaurants combined. Even welfare benefits to support those with severe disabilities, have been withdrawn, often by corrupt means.
I could mention many other serious effects on society, but it’s time to consider what effect that all this reduction in public spending has had on the overall economy. Put simply, when a government takes £billions out of an economy, it tanks. People struggle to pay bills, with, for many, little or nothing left over to spend on clothing, household stuff, eating out, gifts, toys, etc, etc. Once prosperous High-Street giants (Toys-R-Us, House of Fraser, Maplin, Debenhams, restaurant chains, and others) have either gone bust or had to reduce staff and close shops. Not just because of the move towards internet shopping. Many towns in less prosperous areas, have many boarded up shops, and little else besides charity shops, cash-converters-type businesses, and pound shops- and even the pound shops are struggling. Unless you live in the wealthier parts of the South-East or South-West, you will know what I am talking about.
So, what happens to tax revenue, when many people have reduced wages, so they pay less income tax? When less goods are sold, so less VAT is paid? When businesses fold, putting people out of work, and paying less business taxes? When large businesses that do survive, make less profit, so pay less Corporation Tax? As I explained in #4 here, the “budget deficit” is (put simply) the difference between what a government spends and how much it claws back in taxation. So today, we have a (relatively) huge budget deficit, with nothing to show for it. Except either reduced living standards, or actual hardship.
All this economic vandalism, is what happens, when governments, aided and abetted by “journalists” who should know better, persuade the people that a government’s financial management is like that of a normal household, so they have “budget constraints”. That we “can’t afford” proper public services. That we “can’t afford” to pay student nurses while they are training. That support for the sick, disabled, and old has to be paid for out of taxes, so we “can’t afford” it. That we “can’t afford” to pay fair wages to essential workers, such as emergency services staff.
A government with its own currency and Central Bank, such as ourselves, or the USA, or Australia, Norway, Canada, etc can no more “run out of money” than the FA can run out of goals. Yes, it is possible in certain circumstances, for public spending to exceed the real resources (people, raw materials, energy) to provide what a country needs, which could cause inflation. But the UK is nowhere near that situation. And, unless governments spend money into the economy as they should, everybody, (except the very rich) suffers.
The sad thing is, it’s not as if we shouldn’t already realise how public money really works. That governments need to provide funds, for a healthy economy. In the 1930s, following the Wall Street Crash, economist J.M. Keynes knew it, and helped to rescue the UK economy. In the 1930s and 1940s, economist Joan Robinson wrote about it. The British wartime government of 1940, and the Attlee government of 1945-1951 understood it. U.S. President Kennedy understood it in the early 1960s:
To sum up: If you have read as far as here, you will now understand why austerity policy is a political choice,not an economic necessity.(photo: Jeff Morgan08/Alamy)
I am grateful to Malcolm Reavell for his input on some points in this chapter.
It has been reported that if the rise in the cost of housing over the last 30 or so years was the same for everything, a loaf of bread would be £10, a litre of petrol £13, an oven ready chicken £50. Imagine the outcry, rioting… but many seen to just accept with resignation the scandalous cost of buying or renting a home, an equal or greater need. Partly because, I suspect, many already own a home, and most of those bask in the satisfaction of seeing its vastly increased value.
John Harris in the Guardian: “It is, in other words, time we talked about our national predicament – and indeed, what might be at stake in the election, whenever it arrives – by acknowledging that housing is a central issue, and always has been. The nitty-gritty of politics is often reduced to the cliche of “schools and hospitals”. But think of the aftermath of each world war, and the great steps forward marked by the concerted building of council houses…….And let’s not forget: it was housing that tipped the world into the crash of 2008, when the banks finally confronted the lunacy of sub-prime mortgages, essentially a replacement for the public housing the US – and the UK – had forgotten how to build.”
“According to research commissioned by the
National Housing Federation (which represents housing associations), 3.6
million people in England are living in an overcrowded home, 2.5 million are
unable to afford their rent or mortgage, and another 2.5 million are in “hidden
households” they can’t move out of – including house-shares, adults living with
their parents, or people living with an ex. Rates of home ownership among the
under-35s are at less than half the levels of 20 years ago. Homelessness, both
visible and hidden, has become a grimly mundane part of life. A million
families are stuck on council waiting lists; in 2017-18, a pitiful 6,463 units
of social housing were built in England, down from 30,000 a
Let’s look at arguably the strongest factor influencing this insane rise. Cast your mind back to the Thatcher era. If, then or now, you are a seller of goods that everyone needs, but there is a plentiful supply of those goods, and other successful sellers, then you are only going to make a modest profit. Now, imagine you are a large house-building company. You are making a profit, but a lean one, and you would like to bump that profit up.
Your biggest competition is the fact that millions of people can rent a good-standard home at a reasonable rent from their local council, so they don’t really need to buy one of your houses or flats. Suppose you hit on the idea of persuading the Government of the day to reduce the supply of these council homes. You make some big donations to ruling-party funds, and suggest council tenants be given the right to buy their homes at a discount. The bonus for the ruling party is that the lucky former tenants will be thrilled to be able at last to buy their own piece of real-estate, and will be grateful to that government at the ballot box. So Thatchers’s government does just this, making a soon-to-be-forgotten promise to build new social homes to replace those sold. (Actually, I’m not sure whether the developers suggested the scheme to the Thatcher Government. Or, some Conservative strategist came up with the idea as a vote-winner, and the developers said ”Wow, fantastic, happy days, here’s a helping hand for your campaign funds”. See note below. But, the result was the same.
Over the next 30 years the number of
council houses built steadily declines, with a very rapid decline from 2010 as the Conservative
government refuses to allow even Labour or other councils, or housing
associations, to raise finance to build or acquire houses in any significant
number.(Blair’s government,1997-2008, to its shame, did nothing like enough to
counter this. It was too keen to continue with the nonsense of “budget
Naturally, the price of houses and flats rises steadily, helped by a rise in
the population and number of households in that population. Because now, there
aren’t enough homes to go round. (This process was also made made even easier
by Thatcher-era de-regulation of the banks, and global finance trends, which
resulted in greater and cheaper mortgages being easily available.) It becomes
highly profitable for companies, or individuals, to buy homes to rent out, because if the cost of buying homes goes up
in a time of shortage, so does rent.
So, we now
have a situation where the cost of
renting or buying a home gobbles up a huge proportion of people’s income. Not
to mention the misery of homelessness, or living in sub-standard accommodation.
In Bristol, for example, today, there is strong competition to take even the
vastly-overpriced flats offered for rent, which detracts from the ability of
businesses to recruit staff there. They often either commute huge distances
from cheaper areas, increasing traffic congestion and pollution, or live in the
“grey” housing market. This is living in old caravans, vehicles, boats etc.
Bristol is just one example of the problem in many cities in the UK, indeed in
most of the South of England.
worse than that, by a long way. If a
large number of people are spending most of their income on their home,
plus council tax, utilities etc, they have very little left to devote to even
modest expenditure on clothing, eating out, cinema visits, other purchases, etc,
etc. Hardly surprising that formerly successful and
profitable large businesses, such as Sports Direct, House of Fraser, Pizza
Express, Thomas Cook, and many others are either struggling to survive, seeing
profits shrink, going under, or shedding staff. Those redundant staff, or those
on zero-hours contracts, now have even less money to spend, so more businesses
suffer. This has combined with ruthless
suppression of public-sector wages over the last 9 years of Conservative
Government, claiming “budget constraints”. If
you have read my earlier pieces in this blog, you will realise that this is
economic nonsense, a fairy-tale which the media have encouraged for many years.
look at what happened under the Attlee Labour government of 1945-1951. A decision
was made to bring about the building of
hundreds of thousands of council houses, and a programme commenced that
would continue well into the 1950s and beyond. This was partly because of the
urgent need to house returning service-men and women, many of whose homes had
been destroyed by bombing, or who had been living in squalid pre-war slums. The
“baby-boom” was happening, (I was one of those babies!), and young families
needed decent homes. But I believe that Attlee’s government also realised that
a council-house building boom would mean
thousands of good-quality jobs– the building trades, the designers, the
administrators, the materials suppliers/transporters/merchants, etc, etc. And
all those jobs would boost the economy generally, helping to create a prosperity
which would benefit the mass of people,
not just the already-rich. Those lucky enough to become council-tenants at
reasonable rents, and with decent jobs, had some money left over each week or
month to spend boosting businesses generally, which created more jobs. (Not,
stash it away in the Cayman Islands.)
This is a prime example of how a government that chooses to create investment-spending can transform both the economy and peoples’ lives. Contrary to what the “experts” and media are always telling us, “deficits” need not be anything to worry about!
Note: re sale of council housing policy: the sale of council homes to tenants was not a new idea, it had been suggested by Labour in 1959, and by the Conservatives in 1970. (Here’s Dr John Docherty in a letter to the Guardian, “Andy Beckett describes right to buy as a “Thatcherite” policy. It was Hugh Gaitskell’s 1959 Labour manifesto that pledged that “Every tenant will have a chance to buy from the Council the house he lives in”. Then Ted Heath’s 1970 Tory manifesto promised to encourage local authorities to sell council houses to their tenants so that “tenants of today will become the owners of their own homes tomorrow”. But, asDr Peter Estcourt replied to that, “Under Labour the money raised was to be used to improve existing stock and add new builds. Under Mrs Thatcher a large taxpayer-funded subsidy was granted and most of the money raised was diverted to the Treasury. Local government was forbidden to use what little money it was allocated in the council housing sector.”
For more information about the
“National Debt”, see my piece #3 in this blog.
We hear TV
news, the papers, and politicians bleating on about “the National Debt” and
“The Budget Deficit” a lot, don’t we? And, as we all know what it’s like to
have debts to pay, we worry about it. We think, “how is the country going to
pay for…..?” “Our children will be burdened with debt for ever…” Well, it’s
time we looked at the reality.
In my second and third pieces in this blog, we realised that taxes don’t fund government spending, it’s actually the reverse. Governments (if they have their own currency, like the UK) decide how much money the country needs, and then provide it by spending it into existence. ( They also license the commercial banks to make loans, a form of money creation.) They then take some back in the form of taxation, for various reasons. (See my 3rd piece, Let’s talk about taxes). Virtually all other economic activity flows from this government money creation. And this process is often referred to as the “Budget Deficit”.
Even more confusingly, it is often called Government “borrowing”, which is nonsense. It is nothing like “borrowing“, as you or I understand it in our daily lives. If you, or I, were allowed to, and entitled to, put whatever credit figure we liked in our bank accounts, would we really go out and borrow money from anyone?
actually is the “Budget Deficit”? Well, first of all, let’s realise that
“deficit” and “debt” of governments, are frequently used confusingly as meaning
the same thing. Let’s start with
The “Deficit” is actually the total amount
of money injected into the economy each year by the government of the day, less
the total tax collected, plus the “Debt”. It’s not a real thing, like my or your car
loan, or mortgage. It’s an accounting device. At the end of the government’s
financial year, it disappears, and is replaced by the next year’s budget, not
“carried over”. If a government chooses to run a “budget surplus”, this means
taking more money out of the economy than it puts in, which will almost always
cause a recession or slump. Yet, many
politicians talk about it as if it’s a beneficial thing, like us paying off a
loan. It’s actually very destructive. (I will talk about this more in the next
article, on “austerity policy”.) In the words of economist Ellis Winningham, “budget surplus is the act of the UK
government reducing the number of British pounds available for people to save
and to spend.”
What about the “Debt”? Governments can, and do, “borrow” money, in the form of Government Bonds, also known as “Gilts”. Organisations, and in some cases people, “lend” money to the government, in return for a guaranteed repayment, and modest interest. For historical reasons, mainly to control interest rates, governments have sold Bonds equal to the amount of new spending which is over and above its receipts. But this is nowadays really a case of the government providing a safe place for spare cash to be placed, because, in the words of an Australian blog, “Monetary sovereign governments do not need to borrow, and when you understand the monetary system fully, you understand that they do not borrow in a meaningful way at all (as long as they never borrow foreign currency).You can’t meaningfully borrow the tokens you yourself create. You certainly don’t need to do so.”
In the current circumstances, (April 2020), the world’s financial markets are in freefall, so it would be impossible to sell Bonds to anyhting like the huge amounts that need to be spent. If necessary, the Bank of England just creates money to, effectively, buy these Bonds from itself. In Japan, most Government Bond rates are negative, which means organisations pay the Government to store their money.
The “National Debt” figure also includes the amounts people have saved in National Savings and Investments, which includes such things as Premium Bonds. To call these savings “debt” for a UK government, is, as Professor Richard Murphy of taxresearch.org says, grossly misleading. The savers wouldn’t want them “repaid” or paid off, unless they have actually asked to cash them in!
So, how much do we need to worry about the National Debt? Not much, actually. In the words of Richard Murphy of taxresearch.org. “a government that only borrows in its own currency cannot, as a result of this understanding, ever default on its own debt because it can always issue the instruction to its central bank that the payment of that debt be settled.”
President John F. Kennedy understood this, back in the early 1960s: “Is there any economic limit to the size of the debt in relation to national income? There isn’t, is there?….That’s right, isn’t it? The deficit can be any size, the debt can be any size, provided they don’t cause inflation. Everything else is just talk.” JFK to James Tobin. ( James Tobin (March 5, 1918 – March 11, 2002) was an American economist who served on the Council of Economic Advisers and the Board of Governors of the Federal Reserve System, and taught at Harvard and Yale Universities-Wikipedia.)
Those who believe that governments need to raise money by issuing bonds, might be surprised to learn that in Japan, bond yields are negative. That means that the Japanese Government pays no interest on its bonds, in fact the reverse. Organisations acually pay the Japanese Government to store their unused money.
I realise this all sounds a bit shocking, because we have all been conditioned to think government finance is like our own finances. But, think about it: if you were allowed to put as much money into your bank account as you liked, would you worry about paying off debts? The UK government is not only entitled to create money, but has to. And does not allow anyone else to.
Why might a government want to let people/voters think that the UK budget is like our own household budget? Because it may well suit their political agenda. We will look at this in more detail next time, when examining “austerity” policies.
Here’s Mike Hall, of the Facebook group MMT for the British People, 13.02.2020 :
“In reality, when they’re in power, and just like US Republican Party, the Tories don’t care about Gov deficits. Despite all the propaganda media guff that they do, their policies never change because of deficits. When convenient as an excuse, deficit hysteria is invoked, and when it isn’t deficits are ignored, and mass media oblige likewise.”
I will wrap up this bit by giving us two contrasting
statements to consider. Firstly, from
former Chancellor George Osborne:
Note: I have, of course, rather simplified a very complex subject, but not so as to mislead. In actual fact, the term “National Debt” is a rather vague term, and nobody- not even professional Economists- can really define it accurately. To explain why, this video, by Chartered Acountant & professor of Political Economy Richard Murphy, tells you how impossible it is to find out exactly what “National Debt” is, even from official sources. https://www.youtube.com/watch?v=oXwmRDM6InI
I am grateful to Catherine York for proof-reading, and her support.
#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? If raw materials to build hospitals etc, have run out? 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.
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 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” 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.
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.
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, (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 economics journalist John Harvey, for much of the material
in this article.
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.
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. This year (2020), it is more or less openly admitted that most of the Govt bonds issued to cover Covid-related expenditure has actually been purchased by the Bank of England-an arm of Government.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. Sainsbury’s don’t “print” Nectar points, they issue them electronically.
So howw does taxation work? It’s actually a sort of regulating valve, which prevents the economy from over-heating. Amongst other things, 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, if 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.
that? It is when:
who is capable of working is fully employed for an appropriate number of hours
at fair pay
reasonable demand for health and social care is met promptly and to a high
is freely available to a high standard
* There is
enough decent, affordable housing to go round.
still enough bricks or other stuff needed to build houses, hospitals, etc
consumption and pollution have been reduced to a minimum, by conservation and
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, (and not tied to the dollar, yen etc) 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. This is what actually happened in Britain in the 1950s. 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.
most people believed that the sun revolved around planet Earth, instead of the
other way around.
people still believe that a government gathers up all the money paid in taxes,
and then uses that to pay for all the things that governments provide.
actually the other way around-people pay tax out of the money that governments
put into the economy, when it provides what the country needs.
( Unless it
chooses not to, in which case you get
all the hardship and decline that comes from “austerity” policies.)
wrong? We’ve all been told about
“taxpayers’ money” for years, so it must be true?
Well, have a little think about what happened in 1940. The government had to find a mind-boggling amount of money to provide ships, planes, armaments, servicemen, etc, etc, in order to fight the Second World War against Nazi Germany. I don’t know the actual figure, but I would guess about £500 billion in today’s money. Yes? Okay then-
Did they go
to the bond markets to borrow the money? No, there could not possibly have been
enough money to be had like that, even if the bond markets were functioning in
the normal way.
raise taxes, and then wait for the money to roll in? Of course not, it would
have taken many years, by which time tax would have been paid in German Marks,
after the War was long lost.
outsource the war effort to someone like Richard Branson, believing that the
“private sector is more efficient”? Hardly, they needed to run a successful war,
not be ripped off royally.
So they just
authorised the expenditure. Told the Bank of England to produce the money. Of course, it wasn’t digital in those days,
but I don’t expect they actually printed pallet-loads of banknotes. But, the process of government
money creation is often called “printing money”.
Governments wilfully “printing money” leads to rampant inflation, destroying
the economy? So, was there an economic catastrophe after the War? Nonsense. In
the 1950s, the UK was actually more prosperous than ever before in history.
Not in the sense that the rich got richer, though. In the sense that millions of ordinary working people, for the first time, had decent affordable housing, because millions of council houses were built. They could go to the doctor, or a hospital, without fear of a huge bill that they couldn’t pay. Anyone who wanted work, could get a secure job, not hired by the day, or on poverty wages. They could get a pension to live on when they were too old to work, and an allowance, called “National Insurance”, if they were sick or disabled. The railways were nationalised, and became more reliable and affordable. All these things came about because the Labour Government (1945-1951) had the vision to provide them, and created the necessary funding. (despite a “National Debt” of approx 250% of GDP) Just like the War government did between 1940 and 1945) to provide what they needed. This investment drove the whole economy.
(note: an important part of this was the launch of a drive to build a million council homes. This alone provided an enormous amount of good jobs-the builders and finishers, their suppliers, designers, planners, administrators, etc. People who now had decent wages and affordable housing were able at last to afford to spend a little on furnishings for their new homes, leisure, clothing, transport, etc. The whole economy started to boom in a way it had never done before.)
parents were able to buy a house in 1955. (My father had a good job as an
engineer, but was not filthy rich, and my mother stayed at home to look after
my sister and me.) In 1957, Conservative Prime Minister Harold Macmillan made
his famous “You’ve never had it so good” speech, in which he said:
“Indeed let us be frank about it – most
of our people have never had it so good.
“Go around the country, go to the
industrial towns, go to the farms and you will see a state of prosperity such
as we have never had in my lifetime – nor indeed in the history of this
And it was
the same story in the USA, but bigger. So, still think governments can only
spend “taxpayers’ money”? You’ll be telling me the Sun revolves around the Earth
Note- I know, there was an actual debt, in dollars, to the USA & Canada for the armaments, ships etc we bought from them, that did have to be repaid, because the goods were priced in dollars, not pounds. But this debt was managed so that it never became a burden, and did not prevent the UK becoming prosperous.