Why local authorities can go bust and the UK’s central government never can

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As I have noted this morning, Northamptonshire county council has effectively declared itself on the brink of bankruptcy. This raises an important issues. Councils can go bust. A national government with its own currency and central bank cannot. This requires brief explanation.

The essence is simple. Central governments with their own currencies and central banks do not have to tax to spend. I explained this fact in detail recently here, so I will not repeat it. Suffice to say that it is a fact that all central government  spending in this situation is new money created for the government by the central bank and tax cancels the money that is created as a consequence to prevent excessive inflation. For central government in this scenario spend always precedes tax. Indeed it has to: unless the government had spent the money that it requires be used to pay the tax owing into existence in the first place then it follows that no tax could be paid.

The exact opposite is true for local authorities.  They cannot create money. That is forbidden in law. So they can only spend what they can collect and what is allocated to them by central government. For them money receipt has to precede payment. The result is that if there is demand in excess of their capacity to collect funds or grant funding and they have no borrowing capacity they can go bust, which is exactly the risk is Northamptonshire. In essence, local councils do behave like households and businesses because they cannot create their own money.

Central government on the other hand works in the exact opposite way.

What must not be thought is that because Northamptonshire can go bust it is possible that central government might. That is completely untrue, but right now that will have to be said loud and often because the austerity brigade will milk this situation for all it is worth.