I posted this video, which explains why more government spending in the UK is likely to require more tax revenue to be raised, at least whilst the benefits of that spending are generated if infaltion is to be avoided, on YouTube this morning:
The transcript is:
Do we need to raise more taxes if the government is going to spend more? It's a really important question and one that people are asking me because I've written the Taxing Wealth Report. That shows that the government could, by simply changing the rules on some of our taxes with regard to the way that they impact on the wealthiest people in our society, raise up to maybe £90 plus billion of extra tax a year.
So, people are saying to me, do you think that's what we should do? And is that a precondition of making the extra spending that we want? Let me explain what the relationship between government spending, money and tax is, because that provides the answer to the question.
The government creates our money.
If you doubt it, look at a five-pound note. Who made it? Ultimately, all the money in our economy was made by the government, just like that fiver.
I know some of it is theoretically created by banks, but they can only do it because the Bank of England gives them a license to do so, and who owns the Bank of England? The government does. So, in other words, all the money that is ultimately created is done by or under license from the UK government.
How does that money get into circulation? In the case of the government, and they start the whole process rolling, it is by spending. That five-pound note was not gifted to somebody by the government, it was spent into the economy.
They used the fiver - of course they could have used a bank account as well, but in this case we'll say the fiver - to buy something. They spent. And then they taxed. It has to be that way round, because if they hadn't spent first of all, there wouldn't be the money in existence to pay the tax.
So, it's always spend and tax and never tax and spend in an economy.
But when we look at spend and tax, the tax element is there for one very important reason, and that is to cancel the spend. If the government did not tax, and it spent £800 plus billion a year into the UK economy, and therefore let all that money float free, we would of course have massive inflation.
Now, that obviously isn't possible, so therefore, you have to tax to prevent inflation. That's its primary purpose.
All its other functions - redistribution, repricing market failure, reorganizing the economy through fiscal policy, and so on. - those things are all secondary - important - but secondary to cancelling inflation.
Now, if we are at or near full employment, and we want to spend more - the government wants to spend more - the risk is that it will create inflation by doing so. So, if, as at this point of time, we are either at full employment or we have unused resources that can only be put into use gradually, we have to tax whilst those resources are put into use or else we create inflation in the meantime.
Then we could go into a vicious downward cycle, the benefit of that spend would not be received by society, and therefore things would fall apart. So, the tax is put into place because of the additional spend, but not to fund it. It is part of the transition process to let us grow, that we must tax more.
And that is why the Taxing Wealth Report talks about raising more revenue, because these issues are fundamentally related.
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“Now, if we are at or near full employment, and …..the government wants to spend more – the risk is that it will create inflation by doing so”
What happens if most of the spending is CAPEX focused? & the capital equipment has a low UK contribution?
What happens if most of the spending is CAPEX focused and it uses production capacity that was not @ full capacity (production capacity – not labour).
What happens if production capacity can be added – with minimal impact on employment?
Taking the example of PV production – people are mostly absent from the factory floor – it is a largely CAPEX-driven process – which means it can be expanded with not much impact on employment.
I’m not saying gov spend/high employment/inflation is wrong. But I’m wondering if there are some sectors into which the gov could spend, without impacting inflation, even when employment is relatively high.
But CAPEX on imports creates other risks
Generally CAPEX involves spending on albour with deferred income gains
They will happen – but the sequencing involves risk. That is the issue I am seeking to highlight – that change is necessaery, but whilst it happens there will be need to allow for the ramping up of desirable axtivity and that will for the time being and given our low levels of training, in particualr, require higher levels of tax.
One of the main reasons we need to increase taxes on the wealthy is fairness, which you mentioned the other day. The wealthy are currently undertaxed. They may not feel it because many pay a lot of income tax – but mainly because they have a lot of income and income is taxed at (more or less) progressive rates.
But people who receive millions of pounds in capital gains year after year (like our prime minister) keep more of their gross receipts than most basic rate income tax payers, once you take NIC into account. Recipients of millions of pounds in dividends are paying tax at lower rates than employees or even the self employed. The uncapped exemption for gains on multi-million pound homes, the uncapped inheritance tax exemptions for agricultural property and business property, all of which massively benefit the wealthy, and so the list goes on.
Agreed
But the need is multifacetted
Perhaps I should do a long form video as well….
As an erstwhile sceptic of your TW report I must say this video is the most succinct explanation of how a fiat monetary system works I have seen. It has gone in my armory. I am sure you won’t mind if I show it the next time I give a talk. Probably it won’t happen, though, because I am losing my ability to articulate.
Thanks Nigel
And feel free to use
Your taxing wealth report is extremely valuable because it answers the perennial question “how will you pay for it”. Given the current state of public understanding, which perceives the government as like a household, the TWR is an essential rebuttal to the idea that there is no money.
This post and video is also very valuable because it clearly explains that government expenditure is not funded by taxation and, rather, it is the other way round, “spend before tax”.
However I disagree that just because you tax, it takes demand out of the economy. Or conversely, as Mike Parr suggests, that government expenditure necessarily increases UK demand (at least in the short term).
For example, your TWR, suggests, very welcome, progressive, changes to tax relief on pension contributions. As I recall, this is one of the larger contributions to the tax that could be raised from the TWR suggestions. But a significant proportion of pension contributions do not contribute to UK demand (at least short term – I’m talking short term here and therefore won’t keep repeating this caveat). (Some of) the money is invested in stocks or shares. Such “investment” is paying for a largely fixed pool of shares. It pushes up the price of such assets but does not expand purchases in the “real” economy.
If pension contributions do not (wholly) contribute to real demand then, inversely, increasing tax will not reduce demand.
This is just one example that shows that increases in taxation are only loosely coupled to reduction in demand. That is, tax correlates with demand but the correlation coefficient is significantly less than unity.
That means that spending, for example, £50billion from increased taxes will not necessarily avoid stoking inflation (or vice versa). The two are not directly connected.
The misunderstanding by the public that taxation funds expenditure (thanks again for your efforts to dispel this myth) leads to the idea that government should “soak the rich” to pay for public expenditure. This is likely to be much less effective than might, at first, be thought. The rich are likely to only slightly reduce their expenditure in response to higher tax. They’ll probably continue spending much the same in the real economy. They have more money than they need. They have a low propensity to spend (or economise).
Sadly, to reduce demand, taxes must be levied on those with a high propensity to spend, i.e. the less well off. I don’t like this. I’d rather it made sense to “soak the rich” but it doesn’t. Of course we need to tax the rich more for a host of good reasons but not to reduce demand.
This could be a rather depressing conclusion. It suggests that even if taxes are increased predominantly on the wealthy, as suggested in the TWR, we could not necessarily increase spending by the increased tax take without risking inflation. But I’m much more optimistic. Anyone looking around can see that the economy worked much more efficiently in the past (pre GFC austerity). And does anyone really believe the economy can not work much more efficiently (without rentiers sucking out a disproportionate share of GDP)?
So I think there could be much more public expenditure without increasing, already high, taxes on the less wealthy, and without causing inflation.
But I’d rather we avoided too direct a connection between taxation and spending. To me this is much too close to the false neoliberal narrative.
Noted