I had a paper published by the Real World Economic Review in the last few days. This is on modern monetary theory and taxation. The link is here: I would add that signing up to get access is not that straightforward in my experience, but that might just be me or my browser.
The abstract of the paper as submitted says:
Modern monetary theory (MMT) has played an important role in advancing understanding of the economic function of taxation, including by showing how it acts to ‘cancel' government spending as part of a spend-tax cycle. To date however, MMT has not fully explored the implication of these insights for how tax can also achieve social, economic and fiscal goals, as well as macroeconomic ones. This omission is addressed in this paper by suggesting that cash paid in tax is a residual figure arising from a plethora of decisions on tax bases, reliefs and allowances, as well as tax gaps that result from non-compliant taxpayer behaviour. The impact of this range of decisions and practices can be interpreted as a form of social policy with distributional and economic consequences. Such decisions and practices require systematic estimation and appraisal, as well as conscious management of their consequences, if effective control of the economy is to be maintained. It is suggested that this process can be supported by a modern theory of taxation (MTT) that, building on the understanding derived from MMT that tax is not a tool for government revenue maximisation, can deliver new perspectives on the use of tax as a critical instrument in economic and social policy management.
I am aware that almost anything written on modern monetary theory appears to be contentious, and that there are those who to seek to belittle my own contribution. I should then add that Randy Wray has already written to me about this paper, welcoming it and the contribution it makes to MMT thinking. Those seeking to dismiss it because I wrote it should, then, tread warily I suggest.
That said, I am aware that I have raised difficult issues, but I hope without offending too many. Suggesting that one of MMT's major contributions is to reverse the understanding of the revenue cycle will, for some, be contentious: they will place the emphasis elsewhere. But that is not key to my argument.
What is key is that if MMT is to be a tool for macroeconomic management, which is what I suggest it is, then its ability to forecast, and take action to prevent, inflation is critical. In that context the appropriate balance in this equation is vital:
G = ∆B+ ∆M + T
where G is government expenditure, T is the sum total of taxes raised in cash during a period, B is government borrowing and M is government created money, with ∆ representing the change in a total during a period.
I hope and suspect few would argue with the fact that this is the identity that explains how a government is funded in cash terms. Few would also doubt the significance of tax in it. The argument in my paper is that to presume T (cash recovered by tax) is manageable in its own right is wrong. Instead I suggest:
The reality is that T in this formulation is a residual figure i.e. the tax paid in cash is only settled after a whole range of other issues have been addressed and their value has been assessed. So, as is noted below, T is influenced by decisions on the tax bases that should actually be subjected to taxation, decisions on rates and allowances to be provided, and taxpayer decisions on the degree to which they will be compliant with the demands made of them. It is not, then, the case, that a decision can be taken in isolation on the sum of tax to be collected: these other factors have to be taken into account in forecasting the sum likely to be recovered from the economy.
The result is that I argue that:
In this context an appreciation of the tax gap is important. Both the IMF (2013) and the European Commission (TAXUD 2018) argue that net tax collection arises after the deduction of two broadly stated tax gaps that reduce total potential gross tax yields i.e.
T = Tt - Tf - Tc
where Tt is the total potential tax due on the tax base, Tf is the net tax foregone as a result of policy decisions and Tc is the tax compliance gap. Both terms require expansion. In the normative typology of the tax base that the IMF (2013) suggests be used for estimation of tax policy gaps:
Tt = (Tb x Tr)
where Tb is the tax base for a particular tax and Tr the standard tax rate for that tax base, and:
Tf = Tp + Ts
where Tp represents the value of tax bases not taxed as a consequence of a policy decision (e.g. wealth) and Ts represents the value of allowances, reliefs and varying tax rates granted within bases that are taxed to encourage varying taxpayer behaviours by way of tax spends, whilst:
Tc = Te + Ta + Tu
where Te is the part of the tax compliance gap resulting from illegal tax evasion; Ta is the part resulting from the avoidance of those tax obligations that a legislature thinks fall on taxpayers and Tu is the part of the tax compliance gap resulting from non-payment of tax debts, or unpaid taxes.
Substituting this understanding in the equation for G:
G = ∆B + ∆M + ((Tb x Tr) - Tp - Ts - Te - Ta - Tu)
This version of the identity previously noted suggests that the task of using tax to manage inflation, whether before or after it emerges into an economy in the fashion that MMT suggests possible is more complex than the basic identity implies. This is because what this identity makes clear is that the variable T — the tax settled in cash during a period - is the residual of a whole range of other decisions within the economy. The new identity that is noted implies that there are at least five tax gaps that have impact on this total:
1. The tax policy gap, which refers to the cost of potential tax bases not taxed by choice e.g. wealth, which is untaxed in many economies;
2. The tax spend gap, which refers to the costs (both positive and negative) of granting higher and lower rates of tax that vary from the norm or standard rate as well as the cost of all allowances and reliefs granted to taxpayers, for whatever reason;
3. The cost of tax evasion;
4. The cost of tax avoidance;
5. The cost of tax bad debt i.e. declared sums owing but not actually paid.
In this context I conclude:
MMT has had a substantial impact on much economic debate in recent years. Amongst its contributions has been the suggestion that there is not a ‘tax and spend cycle,' but a ‘spend and tax cycle'. This is liberating and allows for a re-conceptualisation of the role of tax within the economy. Rather than balancing a government's fiscal equation, with indifference as to how the cash sum that achieves this goal is raised, tax can an instrument of social, economic and fiscal (regulatory) policy. The idea that tax is a sum to be forecast when planning desired levels of inflation, as MMT considers necessary, is only possible if tax collected is seen as a residual of many other decisions implicit within that process. Various social and economic drivers of net tax owing require explicit consideration, as too do the various component elements of the tax gap. That consideration will extend to the requirement that all these sums be actively managed.
If the thinking implicit within modern monetary theory is to ever underpin the economic strategy of a government, assessing the identified five tiers of tax gap, will be critical to its success in imposing control on the economy for which it has responsibility. Tax spillover analysis in both domestic and international arenas is also key to this process of designing tax systems that do not undermine themselves, while achieving social goals and simultaneously assisting control of aggregate demand. Any government embracing MMT will, then, need to adopt this methodology. Tax is key to the success or otherwise of modern monetary theory in practice. To date its importance has been underplayed and under appreciated. If modern monetary theory is to succeed therefore, it has to be paralleled by a more expansive form of modern taxation theory, as explained, aided by tools such as tax gap appraisal and tax spillover assessments.
The paper elaborates these arguments, not all of which are even touched on here. But the point is critical. I have for a very long time suggested that MMT has not taken tax seriously and that this has been a major weakness within it. I was given the chance to explore this issue and have now done so. The aim is to contribute to debate. As I have noted, Randy Wray has already welcomed the piece in a mail to, suggesting it to be a significant advance in thinking.
Comments in that spirit are welcome.
Discussion of whether this should be called modern taxation theory are also welcome. I will be posting more on this issue over the next few days, I hope.
NB The paper is available here
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What has Wray said? Sentence seems to be incomplete.
I have agreed not to reproduce it, yet
But he has been very positive
I agree MTT is far more important than MMT as the latter is only a statement of how money works whereas the former gives us a framework for how to make the world better.
The tax system influences where the money flows. Currently there is too much flow towards globalist rent extraction and environmental destruction, and not enough towards small business, productive environmentally sustainable activities.
Charles
I am going to be working on it…
Richard
Richard, what is your view on Georgist MMT, Georgism and 100% land/location value tax, property tax on unimproved value of location (that does not include buildings.) It could potentially raise a lot more than IHT and function as a wealth tax. Reduce house prices to the value of buildings.
https://kaalvtn.blogspot.com/p/arguments-for-lvt.html
Taxation is the price of a civilised society; civilised society and public services create location values, so let’s fund public services out of ‘service charges’ on location values. That location values are created and belong to the community is a key of Georgist socialism if everyone moved away fromcyour house it would be worth not much.
I was thinking you could use your influence in the Labour party to lobby for a 100% location value tax to reduce inequality.
I confess I have little time for the Georgist view, which I consider niave and potentially deeply inequitable
If you read my ‘Joy of Tax’ you will see that I, like those in MMT, think raising funds a secondary aspect fo tax: I think its social functions more important
LVT wholly misses that point
We need a wide range of taxes. I have no problem with LVT being one of a dozen or more, but by itself it is a co9mplete non-starter
MMT and Tax is a balancing act to me, with tax being the potential economic cooling, containing (impairing the ability build up ludicrous amounts of wealth) and redistributive agent (although the redistribution itself does not lead to investment alone – I’m talking about transfer payments here that might alleviate unfairness that is all).
Well done on the progress you have made and I Iook forward one day to seeing it in action.
Very interesting article.
A couple of questions/points. First, without denying any of the above, for MMTers the second most important function of taxation (after creating demand for a currency) is its role in controlling effective demand and inflation — hence the importance of a progressive taxation. However, this is not viewed as the best or most efficient tool for controlling inflation — rather, the job guarantee and measures to sustain and upskill the workforce is the preferred approach ( so that Government spending into the economy is accompanied by an offsetting real gain). MMTers are not focussed on “fine-tuning” the economy, but seek through progressive taxation and an employment buffer stock to stabilize inflation. So, it seems to me the different tax gaps you identify are very important. However, it does not appear to me that each gap is perpetually important — cannot policy settings be adopted ex ante to effectively “preset” these different tax settings? (MMTers note that introducing a job guarantee could cause a one-time rise in the price level, without causing inflation per se, and one can suppose that a one-time revision of tax settings, to simplify them, especially as regards the tax policy and tax spend gaps, might impose a similar one-time shock). It also seems to me (from my great reservoir of ignorance) that not all tax gaps of equal importance for the control of effective demand in an economy.
Apologies for delay: it was not intentional.
I am not arguing that tax is the only tool for controlling inflation, although in my view it is vital
The JG does not, poer se control inflation in my view, and I know there is disagreement on this issue
I am not diminishing the JG: I want everyone to have the gainful employment they desire
But I do not see how an objective can control itself: what tax does is, first of all, create the environment where full employment is most likely which is why MMT cannot be indifferent to tax. And second, no one can gauge the ‘animal spirtits’ precisely which means when the JG over or under delivers another tool is needed. Tax is that.
This is why the area is so important, and you are right; not all tax gaps are equal and so we must understand them
I never thought I’d get interested in taxation at this late stage, but this debate has identified a number of issues that have piqued my curiosity. If I’m understanding your argument, Richard, effective control of the economy depends on monitoring and balancing a number of dynamic factors including the degree of utilisation of the available workforce, potentially with the aid of Job Guarantee, inflation, demand, private borrowings, tax gaps etc. Given that these factors are in a constant state of fluctuation, tax is the crucial driver in balancing the outcomes of this fluctuation.
This implies a need to massively improve the quality of data and a requirement to ensure that the disparate data sources are expressed on compatible bases so that we can measure the impact of these fluctuations with greater certainty. One obvious area for this has to be improving the quality of assessing tax gaps, which you’ve pointed out are currently suspect.
If this can be achieved, it facilitates detailed planning of the economy and comparison of outcomes (actuals) with budgeted assumptions, which in turn will help to pinpoint where remediation is needed. A major fly in the ointment is that the UK tax code as it stands is inordinately complex and, unless it’s radically simplified, it could make accurate forecasting and coherent planning impossible.
Before the 2014 Scottish Independence Referendum, I viewed independence as a massive one-off opportunity to create a new principles-based tax system with an underlying “Tax Constitution” document setting out the principles on which government should base its tax policies. That approach could ensure coherence in tax policies and avoid the problems and complexities suffered by the current sprawling UK system.
In other words, what’s required looks like a complete redesign of the UK economy and its information systems. Good luck with that!
Ken
I like a challenge
This is the challenge we have to accept
Richard
I’ve yet to read your contribution to the RWE “dump” of articles – I’m working through them. But it does seem to me that many MMTers tend to avoid directly confronting this issue, perhaps because many of its proponents are thinking politically, and breaking the direct relationship between tax collection and spending is one way in which they seek to avoid vested interests from opposing the spending.
And MMT does provide an argument to avoid addressing taxes on wealth.
But this is important. And any MMTer would surely agree that a functional tax system which has the support of a nation’s population (is seen as “fair”) is one element of “monetary sovereignty” in a non-totalitarian state.
Thanks
Monetary Taxation Theory is a very good marketing counterpart to MMT but like anything with theory attached to it it is not a good selling or marketing stance.
Successful marketing should be about facts (I agree that regrettably it often isn’t!) but if you think that what you are selling is actually true, then theory, in marketing terms, has fallen at the first hurdle…
So I would really suggest you avoid ‘theory’.
Suggestions follow in no particular order except the last:
Modern Taxation Harmony would be lovely – but perhaps too much so. It would be a good marketing slogan for a radical chancellor – rather than ‘reduce the deficit’ – for example…
Perhaps,
Modern Taxation
/Proportion
/Symphony
/Evenness
/Symmetry
/Evaluation (probably particularly relevant to the formulas above).
Or dare I suggest in view of that daft economic theory … and when tax reduces inflation then surely it is:
Modern Taxation Equilibrium.
That is really the equilibrium we are all looking for isn’t it?
And it would, at least, have considerable resonance amoung all economists – even if more radical friends would have to take a second or even third look….
Except it is a theory
😀 very blunt Richard, but as accurate as I was thinking 🙂
I’ve just heard ‘ethical finance’ on the radio – and then tried to extrapolate: ethical taxation theory, ethical economic theory, ethical monetary policy theory,,,
Ethical as a word does encompass the GND I would say, it covers the environmental aspect as well as the social aspects. But not sure about using it as part of the titles, but something along those lines might be an option?
Worth thinking about….
When you consider the nonsense espoused by the IFS, it is important to get this issue right,
https://www.theguardian.com/politics/2019/oct/08/no-deal-brexit-would-push-national-debt-to-levels-last-seen-in-60s
I’m not the only one who sees yet more austerity being used long term to balance the Tory election bribes that Johnson is promoting. The balance is provided by effective taxation – not withdrawing money completely.
Goodness – the IFS are so thick.
The IFS do buy the Tory narrative hook, line and sinker
Yes
I applaud your efforts to develop the theory and practice of taxation to align them with the insights provided by MMT, but, as I am sure you aware, the mendacious, self-serving defenders of the status quo will seek to thrash the outcome using the hoary old “tax and spend” meme. And it will attract criticism from potentially sympathetic macroeconomists (who appear to be making efforts to move away from what Simon Wren-Lewis describes as the Consensus Assignment) because it does not deal effectively with the challenge of economic stabilisation.
The range of policy and regulatory tools that should be applied in addition to taxation to address this challenge were set out succinctly by Fullwiler, Grey and Tankus (FGT) in an email which Alphaville in the FT published on 1 Mar. 2019 (and to which I think you linked, but I can’t find the link).
I agree that many tasks have to be performed to overthrow the current benighted policy consensus and that it is not possible to perform them all simultaneously, but it may be necessary to continue presenting (and repeating the presentation of) the bigger picture to provide the context for each task so as to rebut vexatious and mendacious criticisms.
I quote Fullwiler’s piece in my paper
Thank you. I subscribed to the RWER as, in addition to yours, there are quite a few interesting papers in the latest volume, but I can’t gain access to the latest volume. The site keeps sending me downloads of previous volumes.
I have added a link at the bottom of the article now as I have been having the same problem