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This is the transcript:
I was asked recently what is the difference between tax-and-spend and spend and tax when it comes to economics and modern monetary theory?
The person who asked me said it's all just semantics, isn't it? It doesn't really make a difference. Well, the answer is, it does, because the government always spends first and taxes later. And it has to, because if it didn't spend first, there would be no money available with which to pay the tax, and that's important because ordering does matter in economics.
The order tells us whether we are describing reality or pretending something else happens.
Now, just have a little thought exercise here. Imagine you are driving in the UK and you approach a roundabout, and you want to get to the opposite side.
We know what the correct route is. You turn left and go around the roundabout, the proper way. Everyone understands what you are doing. The rules of the road are respected. Traffic flows safely. And you reach your destination. That's what spend and tax describes. It literally describes the reality of the way the world works, and policy respects that reality, and so outcomes are predictable.
But the alternative is that you do what economists claim and go the wrong way round the roundabout. You turn right. You ignore reality. You pretend you make the rules. You claim the system works differently to everybody else, and chaos, of course, follows.
This is what tax-and-spend economics does. It refuses to accept how money actually enters the economy, and policies built on that misunderstanding lead to bad decisions and, even, and let's be clear about this, crashes because that will probably happen on your way around that roundabout.
Confusion, economic damage, and crashes will result from getting this understanding wrong.
So we face a choice. We can design economic policy around how the monetary system really works, or we can keep pretending that it works the other way around.
We can crash, or we can get safely to the other side. Which approach should we use to run the economy? There's a poll down below, and I'd really like to know what you think.
Poll
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I quite like the bath-tub analogy.
Water flowing into a bath is similar to government spending.
Water flowing down the plug-hole is similar to taxation.
The water level in the bath is the money in the economy that makes it work (the “national debt”)
You can’t fill a bath by just recycling the waste water.
I like….
Not sure if Zack Polanski would be able to use this analogy (or Richard’s magic roundabout) to explain how the Greens would fund increased public spending to Laura Kuensberg or a Newsnight presenter?
Probably not.
But I liked it.
Richard, I do understand that the spending happens first, then taxation withdraws money from the economy to control inflation (tell me if I’ve got that wrong). But I’m not clear how this works in practice when, for example, the government wants to invest £20 billion into the NHS. I know they can instruct the Bank of England to create the money by putting it the appropriate NHS bank accounts, with a balancing debit I the government’s account – effectively creating an overdraft. Would the government then sell government bonds and/or deposit tax payments received to pay off the overdraft? And if taxes are not used to pay off the overdraft and reduce the debt where does it go when HMRC takes my monthly income tax payment? Sorry for the long question but I just don’t know how I would explain it to a potential Green voter on the doorstep.
Clive
You have the sequence broadly right, but the accounting is often misunderstood, so let me clarify it.
When the government decides to spend, for example £20 billion on the NHS, Parliament authorises that spending and the Treasury instructs the Bank of England to make the payments. The Bank credits the reserve accounts of the commercial banks used by NHS suppliers and employees, and those banks credit the accounts of the recipients. New money has been created in the process.
At that point the government’s account at the Bank of England moves into what is effectively an overdraft position. But that is not a problem in itself. The UK government, through the Bank of England, is the issuer of the currency.
Government bonds are then issued by the Debt Management Office. Their primary purpose is not to “finance” spending that has already happened, but to manage the level of reserves in the banking system and help the Bank of England maintain control of interest rates. In other words, bonds are part of monetary management, and nothing more.
Tax works differently again. When HMRC receives your income tax payment, the reserves used to settle that payment are removed from the banking system and the government’s account at the Bank of England is credited. In practical terms, the money is extinguished from the private economy.
So taxes do not “repay” government spending in the household sense. What they do is withdraw spending power from the economy. That helps control inflation and creates space for public spending.
Explaining it this way on the doorstep is actually quite helpful: government spending puts money into the economy; taxation takes some back out again so that inflation does not get out of control.
Richard
It’s a more than decent analogy in my view.
The other thing tax and spend does is enter the roundabout at too high a speed – there is no slowing down, assessment of risk or anything, just an assumption, ignoring other users and ‘rights of way’ just like people do on real traffic islands.
My dad described an incident from his youth where a friend of his decided to reverse back round a large roundabout as he had missed his turnoff. It did not end well!
I often think of the economy as a swimming pool with a deep and shallow end. The many in the shallow end struggle to keep swimming it the water level drops while the few lucky enough to be swimming in the deep end continue to happily swim oblivious of the plight of the many.