The idea that government surpluses are good because they create piles of cash waiting to be spent in the event of a national emergency is absurd. All money paid in tax is cancelled on receipt by the government. So, all government surpluses actually do is reduce the amount of cash in the private sector economy.
The audio version of this video is here:
This is the transcript:
A government surplus doesn't mean that a government that collects more by way of tax than it spends into the economy is, as a result, sitting on an enormous pile of cash that it might be able to spend in the future. I hate to tell this to people who think that is the case, but it's simply not true.
And why am I saying this, anyway, because government surpluses are things that, in the UK, we are completely unfamiliar with? Well, that's because, just over the Irish Sea, the Irish government is, at present, running a significant government surplus.
Now, partly that's because there are a very large number of multinational corporations who headquarter their operations in Europe, in that country and record their income there, and as a consequence pay a considerable amount of tax in that country which is not really earned there. So, the Irish economy is totally distorted by the presence of these companies who are essentially tax avoiding in the Irish tax haven, which I've criticised for a very long time.
But, there's more to it than that. The consequence is that Ireland is actually in something of a mess. There is obvious massive poverty, whilst there is also obvious massive surplus income amongst those who are fuelling the needs of these multinational corporations who are locating their activities in Ireland, and there is hyperactivity around the Irish Financial Services Centre in Dublin, yet across the country as a whole, young people can't find homes.
The cost of renting has gone through the roof. There are many people who are simply and straightforwardly homeless as a consequence. Poverty is growing, inequality is rising, social stress is significant, the political system is under enormous pressure because of the desperate attempts of the current coalition government to keep Sinn Fein out of power, and onwards and onwards. Ireland is not an example that we would really like to copy, from being a tax haven and everything else.
But let's go back to that point about the surplus. People in Ireland seem to think that this means that there is a pile of cash for the government to spend. And certainly, when we hear people talking about the need to cut the government deficit and the government's debt in the UK, the impression given is that this would result in the UK government sitting on a significant pile of cash which it could use as the proverbial rainy day fund to cover for any other future unforeseen eventuality like Covid all over again, which is a complete possibility. And that's not true.
The problem with the claim that people are making about government surpluses is that they assume that governments are like households and companies. And they're not. They're nothing like households and companies because for a household and for a company, money is something external to them.
In other words, they have to earn it.
They can't create it.
They don't have their own bank.
They can spend it only if they've got it or they have an agreed overdraft limit with their bank.
But for governments, that is not the case.
Governments, including, by the way, that in Ireland, can create their own money. After all, every government inside the Eurozone does create its own money, within agreed limits with the European Central Bank. And so, the Irish government can create the money that it is now overtaxing out of the Irish economy. And if it doesn't create it, someone else in the Eurozone will have done, which also permits this over-taxation to take place.
And the point is that they can create tax bills that people have to legally pay even if they have got no direct exchange of goods and services with the government as a consequence.
A tax bill, after all, is not a charge for services rendered, which is what we do to get our income, whether it is to ask our employer to pay us, or whether it is, for the self-employed, to send out a bill for something that we have done. Companies do the same thing. They send out invoices for services they've supplied and goods they've sold.
But that isn't true of tax. Tax is imposed by law, and is collected by governments not to fund their expenditure, because that's already been paid for by government money creation, but is instead used to cancel the consequences of that money creation to prevent inflation.
That's what the Irish government is doing. It's charging tax to cancel the consequences of the creation of money that it has spent into the economy over time. But it's now running a surplus. It's taking more money out of the economy than it alone has created at this point in time.
Now, that doesn't mean to say it didn't make it in the past. Let's ignore that point for the moment but also bear it in mind.
My point is, they are taking money out of the economy. And that's all that tax does. If you run a government surplus, you're taking more money out of the economy. So, the government is not creating a pile of cash that it sits on.
It is reducing the pile of cash that the private sector sits on because whenever the government collects tax revenue, it cancels the money paid. It doesn't then recycle it because banks don't do that. Banks do not take money in and then lend it out again. That's nonsense. That isn't how banking works.
Banking always works on the basis of creating debts and repaying them. And so do governments. They create tax debts and they're repaid in money. And when they're repaid in money, the transaction is complete. There's nothing left. There is no pile of cash. Because the government is not like us, we can run a surplus and see a balance in our bank account. But the government doesn't. The money's gone.
And the point then is that the Irish government is not sitting on a pile of cash as a consequence of running a surplus. What it is doing is reducing the cash pile of the private sector of the Irish economy. And that's exactly what would happen in the UK if we did the same thing and ran the surplus that so many on the right wing of politics would like us to do so that government debt is reduced.
Do we really need to see the cash in the private sector of the UK economy reduced in this way? Well, there's an argument that for the sake of redistribution of income and wealth, then maybe that should happen. But my argument would be that would be wrong. If we did tax the wealthy and those on high incomes more, we should redistribute it to those on low incomes so that they could spend it. In other words, I do not think it would be wise to simply withdraw that cash from use in the economy.
And why is that? There are two good reasons. One, we have a growing country. Quite literally, the number of people in the UK is rising. I know partly from migration, and some people don't like that. But as a matter of fact, we have got a growing economy in terms of number of people, and indeed in terms of economic activity. Modest, but growing nonetheless.
And we've also got small levels of inflation, which is the second reason why we need more money because if we have inflation, The amount of cash we need to make the transactions within the economy work does, of course, grow. And taking excess private sector money out of the economy, in that case, is bound to cause stress, bound to reduce liquidity, and eventually bound to cause recession, because there won't be enough cash to go around.
That's what running a surplus means for a government. It means squeezing the private sector's access to cash, which will inevitably lead to recession, and will reduce private wealth.
So why is it that so many right-wing economists and so many right-wing politicians want to do that? I wish I knew because it literally makes no economic sense at all.
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So if Ireland runs a budget surplus AND lots of young people cant afford a home it looks like the sort of situation that doesnt end well.
In view of the ‘Armed Unrest’ in the North and what happened during the formation of The Republic I suggest The Government needs to be very careful.
It means that immigrants will get the blame – that is what is happening in Ireland, even though the Irish government has just given a huge subsidy to (wait for it) dog track racing of all things.
Much appreciated this explanation.
As for Irish politics, it’s often a mixed bag and not all bad.
Ireland’s first marine national park was announced on Monday, incorporating seas off the Dingle peninsula in Co Kerry and important adjoining onland areas including the scenic Conor Pass, which has been acquired by the State for €6M last year Oct 2023 to become a National Park.
Elections in November (?) so the coalition is beginning to pull apart.
That news on the Conor Pass is good…
How do countries that make consistent budget surpluses year free year – like Norway – manage with an ever shrinking amount of money in their economy?
Norway invests via its national wealth fund. That keeps circulation going. Ireland has the euro.
The sectoral balances hold the answer. Norway has a huge overseas surplus. This allows the government sector to be in surplus without the non government sector being in deficit. The ignorance of sectoral balances (along with ignorance of double entry) by what passes for mainstream (neoclassical) macro is shocking and explains very well why we and so many other advanced economies are in such a mess
Trying to get my head around these two replies together.
So Norway makes a government surplus, not because there is a domestic deficit, but because there is a trade surplus. The government is not extracting money from its domestic economy, but rather bringing in money from overseas. Yes?
And then they spend that surplus on investment in their wealth fund. Which ultimately (presumably) benefits the Norwegian citizens.
Is it the same in other countries that usually have a surplus, e.g. Singapore?
So why can’t Ireland do something like that?
Ireland could
But isn’t
I am a bit confused by the statement: ‘If we taxed the wealthy and those with high incomes more, we should redistribute it to those with low incomes so they could spend it.’ How is the money redistributed if the tax collected cancels out the money spent?
I am using a short hand, I admit
The government can tax the wealthy to cancel money and they can then spend afresh.
I agree, I should explain it more precisely.
Richard, you say: “The government can tax the wealthy to cancel money and they can then spend afresh.
I agree, I should explain it more precisely.”
It’s very difficult to hold economic discussions using an understanding of MMT and orthodox economic theory simultaneously. You have my sympathy, but please don’t stop “using shorthand”. Most of us DO get it. Your ‘business’ of changing mindset involves constant repetition, but your acolytes do have to make an effort and keep up.
The parallel which springs to mind is that of another ‘Theory’: that of evolution. It is soooo difficult to discuss evolution without falling into the trap of saying the plant develops flowers to attract the pollinating insect. It’s a passive default process. There is no deliberation but we find it hard to describe things in that way. Even Dawkins can’t quite manage it consistently.
You have to compromise in your use of language or be totally misunderstood. Get on with it. People will follow or they won’t. Those who won’t probably never will.
“That’s what running a surplus means for a government. It means squeezing the private sector’s access to cash, which will inevitably lead to recession, and will reduce private wealth.”
There’s another way of putting this which is that a government running a revenue surplus (like a good little household) is actually reducing the purposes that the private sector wants to pursue including that of saving. There isn’t much social intelligence going on amongst politicians who pursue this approach not least in recognising the rich controllers of capital try to maintain their savings rate by increasing prices if they can get away with it (inflation).
I understand Australia ran a revenue surplus for some years and didn’t have a recession. But they also had a surplus on the balance of payments. A I right in thinking , as I’m a simple soul, that the latter enabled the surplus to continue without a recession?
I have not studied the situation and so cannot say. Sorry
Good blog. Thanks.
Please could you clarify when you say, “After all, every government inside the Eurozone does create its own money, within agreed limits with the European Central Bank.”
I have read elsewhere that this is not the case. I’ve read that Eurozone countries don’t have a sovereign currency. There is the ECB, but that is not under their control. It’s not like the UK which instructs the BoE to pay it’s expenditure (as you have recently described). My understanding, perhaps incomplete,was that Eurozone countries are essentially using a foreign currency that they do not control. So, I what sense, can they create their own money?
Every Eurozone country is represented on the ECB and they all have a central bank
They do all issue currency
They all tax it back
I think the claims to the contrary are overstated
The big problem of the ECB is not on monetary issue, it is on inappropriate interest and exchange rates.
So, should Ireland, for example, decide to create €200billion , for example, could it do so? Or would it have to issue bonds? If the latter, is the ECB forced to buy them (at the request of Ireland) or would the just change the yield on Irish bonds?
Perhaps it’s not so important (though it does seem important to me), but what is the mechanism for the Ireland, or other Euro countries, for creating money?
The question makes no sense Tim
No one ewants to create money
They want to spend
And whether they can spedn depends on whether they can do so within EU agreed limits
I must have phrased the question badly. My apologies. Sure, no one wants to create money unless they plan to spend it. That’s what I meant. 🙂
If the UK government decided to spend an extra £100 billion say, as it would be nice to see the Labour government do, then, from your previous posts, they would instruct the BoE to spend that money into existence; they would create the money. As you’ve said there is, in principle, no limit on how much they can spend (though inflation may ensue).
Can the Irish government do the same?
Perhaps I’m missing something here?
The Irish government can create money but is constrained by Eu budget rules it has signed up to – more silly fiscal rules. But that means the problem in both countries is fiscal rules.
Do people believe budget surpluses produce piles of cash? I am not sure. Governments only very rarely produce surpluses. The major surplus producing states in recent history – like China – did so through vast exports, not spending reductions: that unreliable spending reduction strategy is typically left to archaic, anachronistic, declining states like Britain – which is no longer able to exploit the illusion of being a world reserve currency. When surpluses are created the government purpose is , presumably to reduce the national debt; not the actual debt, which is unlikely to fall, but debt presented as a mathematical ratio; Debt/GDP – which is easier to produce than a fall in the debt itself. This is a rationale for the highly misleading ‘household budget analogy’.
How misleading is this form of smoke and mirrors? If we think of the key State figure in neoliberal ideology; the man who led the triumph of neoliberal ideology and ‘household budget’ myth, Ronald Reagan (Margaret Thatcher on the big stage), it is curious that he was remarkable in his lack of success in reducing the national debt. In a neat list of American Presidents who increased the debt most (Investopedia, ‘U.S. Debt by President: Dollar and Percentage’, 10th September, 2024*), you will find that Ronald Reagan ranks third among all US Presidents; increasing the debt more than all, but Franklin D Roosevelt, and Woodrow Wilson: both, however had to fight a World War; Wilson WWI, Roosevelt WW2. 4th is George W Bush, 6th George H Bush, 7th Richard Nixon, 8th Donald Trump: all Republicans, all neoliberals espousing small government. 5th is Barack Obama, also neoliberal (from January, 2009 – and faced cleaning up the financial Crash).
* Given the huge disparities in time, inflation etc., the ranking is in debt increase in percentage terms, not quantum. This itself is revealing of a crucial fact; it is the government, the ultimate issuer of money, that is alone able to exploit the time value of money for the public good (when spent well), in ways the private sector can never even begin to approach.
Thanks
@John S Warren
“…Do people believe budget surpluses produce piles of cash? I am not sure. Governments only very rarely produce surpluses….”
No but they DO pretend to. They call it ‘headroom’ and it allows reductions in taxes (invariably income tax because that’s the only tax of any account to most voters apparently: say ‘tax’ and people are thinking income tax.). Such ‘headroom only seems to appear in advance of general elections. Funny how that comes about…….
Correct
Richard, if we assume your analysis is correct, I think we can also assume the vast majority of the population will not because of their own household or business experience.
However they could accept this history which amounted to the same thing
https://www.forbes.com/sites/rhockett/2021/11/12/war-on-inflation-part-1-the-lesson-of-world-war-ii/
After the war, the ultra low rates and productive investment continued and the deficit relative to GDP plunged until real rates skyrocketed