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Yes, Taxes Fund Spending

In the last few years MMT has grown in popularity and they’ve promoted the idea that “taxpayers do not fund anything”. While seemingly intuitive, this narrative is fundamentally wrong and MMT misconstrues terminology and operational realities to promote this concept. In this post I’ll explain the errors and how MMT contradicts itself.

When you first encounter MMT you will have to adapt to the idea that government bonds do not necessarily finance government spending. MMT is right about this. The government has a printing press and could theoretically print cash or credit accounts when it spends. They do not have to finance spending from bond issuance. But MMT takes this concept too far by saying “taxes don’t fund spending”.  MMTers love to berate Conservatives for claiming that government spending needs to be “paid for” with taxes and they’re right. The government does not have to finance all of its spending from current income ($ for $). The government doesn’t have to balance its budget and it doesn’t have to pay back the national debt. But saying “taxes don’t fund spending” is also rhetorical overreach, except in the opposite political extreme. It’s one thing to say the government doesn’t need to issue bonds to spend, but it’s entirely wrong to say the government doesn’t benefit from or need to tax trillions of dollars of resources it did not create.

First, let’s get some terms straight because MMTers are masters of twisting terminology.

The word “funding” means a sum of money or other resources whose principal or interest is set apart for a specific objective.

The word “financing” means the act or process of raising or providing funds.

The government obviously doesn’t need to get money to spend money because it has a printing press. This is both evident and uninteresting.

But the fact that the government doesn’t need to get money to spend money does not mean it doesn’t need to fund its balance sheet. It most certainly doesn’t mean it doesn’t benefit from having the ability to tax existing resources. For example, the aggregated private sector cannot “run out of money” any more so than the government can. It borrows in aggregate and does so in perpetuity to finance its spending. But this does not mean the aggregated private sector doesn’t need income or funding sources. After all, anyone can spend on credit by creating money from thin air, but this does not mean there is no constraint on your ability to borrow. And as MMT correctly notes, the true constraint on borrowing or government spending is resources.

And this is where the discussion gets sloppy on the MMT end. The government can create its own financing by printing money, but that does not mean that money was funded by resources. For example, if I build a $1 million house I have invested capital in a real resource that now makes our economy wealthier. I create real economic value by mobilizing resources into a house. If the government were to slap a 1% property tax on that house then I am directly funding their spending. The resources I mobilized fund their ability to spend $10,000 because we can now monetize that asset and extract some of its value for the purpose of public spending. Importantly, I created the real resources to support that money creation.

If, on the other hand, the government were to try to spend $10,000 without me having created those resources then the government would have to print $10,000 of net new money that isn’t supported by new resources. This money creation is financed by printing, but funded by nothing. Therefore, it will very likely just create inflation.

Another common example is corporate stock issuance and revaluation. As we innovate and grow our economy we typically invest in mobilizing resources to invent goods and services that add value to our economy. When corporate America expands from a $1 trillion entity to a now $50 trillion entity we are creating value that wouldn’t otherwise exist. And when the government taxes some of that value they are taxing resources and monetizing those resources in order to spend. If Corporate America hadn’t created $50 trillion of value the government would have that much less in resources to support its spending. The American government isn’t capable to spending $7 trillion per year because it has a printing press. It can spend $7 trillion per year because its private sector has created hundreds of trillions of dollars of real resources that make that government spending non-inflationary in the first place.

Some MMT types seem to think the private sector gets its funding capacity from the government, but the exact opposite is true. It is the innovative power of the private sector that gives the government its funding capacity because the private sector is where most of the resources are mobilized and ultimately monetized for public purpose.

Interestingly, this is where MMT explicitly contradicts itself. They correctly note that resources constrain government spending, but fail to understand that endogenous resource creation is the very thing that makes government funding viable in the first place. Saying the government has a printing press and can always “finance” its spending is, again, uninteresting and unoriginal. So, if that’s all MMT means here then yes, that’s true. Congratulations, your theory discovered that governments have a printing press.

At a more precise operational level MMT misconstrues the accounting behind this topic. They like to consolidate the Central Bank and the Treasury in order to claim that taxes “destroy” money when the government receives its own liabilities. The problem is that we know that’s wrong. We can literally see the balances in their accounts every single day. They are right here, to the penny. But what MMT does here is dirty pool. First, they are consolidating distinctly different entities. Second, they’re misconstruing the fact that Central Banks only exist because most money is created by banks, outside the private sector.¹ And third, they’re ignoring the fact that none of this matters anyhow because even if we did have a properly consolidated Fed and Treasury the government would still be dependent on private sector resource creation to sustainably fund its spending. Having a printing press does not mean the government isn’t reliant on its private sector to create the wealth and resources that make government spending viable.

The key point to understand here is that the government (or banks) is just a liquidity provider who relies on monetizing private sector assets to be able to spend sustainably. This is how all credit based systems work. The ability to issue money isn’t the thing that gives the government power. It is the resources of the private sector that ultimately allow the government to be able to sustainably issue money in the first place. But in MMT the power resides with the government and the private sector is framed as being reliant on the government to issue money. This is completely backwards. Capitalists do not rely on government to issue currency. Government relies on capitalists to build the resources that give the government fiscal space to be able to print money in the first place. But in the MMT world this is all presented backwards and the reader comes away thinking that we’re all sitting around twiddling our thumbs waiting for the government to issue currency and “net financial assets”. In reality, valuable corporations, households and resources very much fund government spending as they create the economic value that makes all money creation viable.

So, when you hear an MMT advocate say that “taxes don’t fund spending” just remember that they’re not only contradicting their own narratives, but they’re spreading ideas that are fundamentally incorrect.

1 – MMTers like to respond to this by saying “but the government issues bank licenses”. So what? The government issues corporate charters to allow every corporation to operate. Should we then say that all corporations are created by the government? Of course not.² 

Further, the government cannot destroy money in any meaningful sense since they did not create that money. Most of the money in our system is created by banks in the private sector and the government uses its internal settlement system to process payments, but it must ultimately return that money to the banking system from where it came. The government has functionally outsourced much of the money creation in our system and is therefore beholden to returning those deposit liabilities to the system where they originated. 

2 – A related point here is that the MMT narrative around their construction of the reserve system makes it appear as though all money ultimately comes from the government. That is, taxes always destroy money and government spending therefore creates money. Of course, most money creation starts with private sector banks and the whole reason we have a Central Bank and Central Bank Reserves is so private banks can settle interbank payments. This means the government is very specifically redistributing bank deposits via central bank reserve settlement. The money literally starts with banks in most instances, but in the MMT world this is misconstrued to give the appearance of always starting with the government. It’s wildly misleading.