Taxative

People who think that taxes pay for government spending need to ask themselves where the money comes from. Once you've accepted that you don't have a good answer, you will correctly conclude that it must come from the government in the first place.

This is obviously the case. There are no money trees and no business actually creates money. What businesses create are goods and services that consumers buy. Those consumers must get the money from somewhere. But where?

One source of money is from bank loans. Most of us believe -- wrongly -- that banks take in deposits and then lend them out. Some are more sophisticated and believe that banks make loans backed by the deposits they have in some proportion. They believe this because a/ banks generally have "reserve requirements" and b/ those reserves are somehow involved with the government bank. Reserve requirements say simply that for a given volume of loans outstanding, a bank must have a proportionate amount of reserves. People mistakenly believe this means the bank must have x amount of reserves to cover the loans in some way. However, there are countries -- I believe Canada is one -- that do not have reserve requirements and banks still make loans.

In fact, banks will make loans to anyone who is creditworthy and wants money. They find the reserves afterwards, and this is easily done, because (b) is true. If a bank is short of reserves at the end of any given day, it can borrow them at the target rate from the central bank. It does not onlend the reserves.

It should be common knowledge by now, but it doesn't seem to be (hats off to our education systems, which are excellent at ensuring that we are very poorly equipped for our world), that when a bank makes you a loan, it simply writes the amount into your account and credits itself with an asset. Say the bank lends you $100K. It does not go into its vaults and find $100K. It simply credits your account for it. The bank has an asset (the loan it made you) of $100K, and you have a liability (the loan you have to pay back) of $100K.

The asset and the liability net out, but you also pay interest. That has to come from somewhere. Where?

(It's important to understand that in the private sector, assets and liabilities do net out, so the private sector's net financial position has to be zero. It cannot create new financial assets because there is no available source of money: no free assets.)

Furthermore, when you pay taxes, that money must also come from somewhere. It cannot come from bank money (if it did, credit would have to rise by the amount of government spending every year before growth in the economy was even possible: this in fact has been happening in most Western economies because governments have refused to run big enough deficits, among other reasons).

It comes from government spending. When the government taxes the economy, what it is doing is taking away liquidity that it has injected. It can at the same time redistribute the national wealth by deciding where it will reduce that liquidity. It doesn't need the taxes to pay for anything: if it didn't spend in the first place, there would be nothing with which people even could pay taxes.

Why do people think taxation is needed to raise revenue? Well, there are basically two reasons they think that. First, when our economies were on the gold standard, it was somewhat closer to true. Dollars were proxies for the state's gold holdings, and were exchangeable for gold on demand. The state could, in theory, only spend as much as it held in gold, or would have to borrow the deficit.

We are not now on the gold standard. We have fiat money, which is not exchangeable for anything but itself, or for foreign money for those who need it to spend in our economies or settle contracts made in it.

The second reason is that conservative governments pretend that their budgets are constrained as though they were on the gold standard so that liberal governments cannot use the government's unlimited spending power to help the poor. There are vanishingly few governments, whatever their professed politics, that are not conservative economically.

I mean, I say pretend, but actually, they are basing their policies on neoclassical economics, the horrendously wrong orthodoxy that has gripped that dismal science. But surely it must be right? Tons of guys with doctorates say so.

Well, they do, but they are like scientists in a lab who never walk outside into the real world. They are like botanists who theorise plants without leaves, because leaves don't fit their model; like chemists who imagine a world with only one element, because they can't figure out how it would work with 100 and however many; like linguists who pretend everyone speaks English. With a vocabulary of a hundred words. It's that bad. Almost every time neoclassical economic models are measured empirically, reality just refuses to confirm the models. No wonder. They are built on mostly ridiculous assumptions, which cannot hold in this or any other world. It would be fine if economists stuck to playing with toy economies, with easily controlled variables, but they do not. They pretend that what works with one idealised consumer buying one idealised good from one idealised seller works in the real world.

Sadly, most of us get our views of the world from some of the least educated, laziest, intellectually void people in our society: journalists. That's right, we have our understanding of the world mediated by people whose idea of "investigation" is to ring up the contact on the bottom of a press release and ask for a quote. And who pays and directs the agenda of those guys?

Well, not the poor, let's put it that way. Not anyone who would benefit from us having an informed view of what actually goes on.

posted by Dr Zen @ 9:22 pm