Politicians tell us taxes pay for public services. In reality, it does something far more important — it shapes our society. In this video, I explain why tax is an economic steering wheel, not a fuel tank or piggy bank, and how we can use it to create fairness, tackle inequality, and protect our environment.
This is the audio version:
This is the transcript:
This video exists to talk about a lie that you have been told, and that is the lie that tax exists to pay for government spending.
It doesn't.
In reality, tax exists to shape our society by controlling inflation, by controlling inequality, by deciding what is good and bad by the way of pricing certain products and services, and by deciding whether we wish to promote certain economic activities or reduce others.
Tax is the steering wheel that drives our economy, but it doesn't pay for government spending, and that's what I hope you'll understand by the end of this video.
The household analogy that we've discussed on this channel suggests that governments must earn before they spend. But in a modern economy, that's false. Governments create the money that they spend - something that I've said time and again, and which is obviously true because every time a government asks its central bank to make a payment, that central bank simply marks up its overdraft and doesn't look to see if there's money in the bank before making the payment that they've been instructed to do by a government with the legal backing to give the instruction, which is why, of course, the central bank can't argue.
So, tax does not exist to fill a bank account with money for ministers to spend from. That is not its role. If you think that tax is the fuel tank which lets the government spend, you've really misunderstood the analogy to the car that I've just been making. Tax is the steering wheel. It's not the fuel tank. And understanding this changes just about everything about what tax is for.
Tax exists to control inflation above all else.
Yes, I know you've been told by central bankers that, in practice, interest rates are used to control inflation, but to be polite to them, and I'm going to try to be polite to them, that's not true. Interest rates can't control inflation, and the best reason for suggesting that is that, firstly, interest rates are incredibly slow to have an impact upon the economy, and so in fact, if you change interest rates to try and control inflation, the inflation will probably have gone away before the interest rates have had an effect. So in fact, the move in interest rates that you put in place to control inflation will probably create deflation in the end of the day rather than inflation, or simply reduce growth: either way, the outcome will be undesirable.
But it's also because interest rates don't affect most of the things that cause inflation. For example, there was no way on earth that changing UK interest rates could change the supply chain disruption that created the inflation that we suffered in 2021 to 2023 as a result of the post-COVID supply chain breakdown and the outbreak of war in Ukraine, neither of which were within the reach of the Bank of England and its interest rate policy.
So we have to control inflation in a different way, and in fact, we always have.
The amount of money that is drawn out of the economy by taxation is the effective way in which the government controls the growth of the economy.
If it doesn't pull out enough, the economy grows too fast, and we might get inflation. If it pulls out too much, the economy grows too slowly, and we could get a recession.
Finding the right balance, that gentle point where we are making a bit of progress, but not with too much inflation, is the whole goal of taxation within macroeconomic policy management, and that has nothing to do with interest rates.
So let's understand that tax is the central mechanism for controlling inflation within any economy.
But, once that fundamental role of tax is taken into consideration, we can also think about a whole load of other things that tax can do at the same time, because, like money, tax can fulfil many roles simultaneously.
It can, for example, control inflation and simultaneously redistribute income and wealth by choosing who should be paying tax to reduce the level of consumption in the economy, and since most excess consumption is by those with high income or wealth, they're the obvious targets for taxation if you're trying to control inflation.
So there is a symbiotic relationship between inflation control and redistribution of income and wealth by taxation. But there's more to tax than that.
For example, suppose that we want to reduce the amount of alcohol consumption in the economy: we increase the tax on alcohol.
Suppose we want to increase the amount of education in the economy: we provide tax subsidies for people who go on lifelong learning courses.
Suppose that we want to improve healthcare: we remove VAT from all healthcare products, and so on.
The point is this, that tax is able to shape what we do by the way, it can change the prices that we pay for certain things.
And it can also support redistribution in a different way. Tax can be used to change the balance between regions and even communities in the country through local taxation systems, and that is entirely possible as well.
So, tax is this massively important tool, which, as I've said, is rather like a steering wheel.
We can target harmful activities such as polluting industries, or we can strengthen underfunded regions via fiscal policy, and we can close the gap between the rich and the poor, and all of that is possible without being trapped in the "we can't afford it" way of thinking that neoliberalism suggests.
If we don't understand tax properly, we can leave wealth inequality unaddressed. And we know that is deeply damaging.
We can starve regions of opportunity within the UK, and we can paralyse future debate on public services by simply permitting the false narratives on affordability that the household analogy and neoliberalism promote.
We have to understand taxes correctly. Tax is not a constraint on anything. It doesn't stop businesses. It doesn't stop people. It doesn't present us with problems which will prevent saving. Tax is, in reality, a tool for justice. It is a tool for creating economic level playing fields. It is a tool to make sure that we have a stable, strong, and progressive economy. It is one of the most powerful democratic levers available to any government.
It is in fact, this democratic control that it affords a government over the economy that is so useful about it. I called it 'The Joy of Tax' in my 2015 book of that name, most of which is, by the way, still entirely relevant today, and is probably worth a read. You can pick up copies secondhand very cheaply now, or you could still buy a new one, and I earn about enough to pay for a decent curry year as a consequence of the royalties I earn from that one. So I'm not doing much self-promotion by putting the idea forward, but it's there for you to have a look at.
Critically, without this understanding of tax inequality is inevitable, so we need to change politicians' understanding of tax.
We have to tell them to stop pretending that tax fund spending when it doesn't.
We have to tell them to design taxes that redistribute income and wealth and, as a result, create opportunity.
We have to use tax to penalise those who are destroying our environment.
Applying tax policy to deliberately rebalance our economy is the duty of the government, and it's time that our governments did that instead of pretending they can't afford to do so.
We need tax systems that work for fairness and not just for revenue, and we need to have reforms that create a genuine steering wheel arrangement so that tax can drive where we are going. We can't build a just economy without knowing how tax works.
So, as is usual at the end of a video, there's a poll.
What do you think?
Do you think tax funds the government?
Or do you think that tax is a tool, as I've explained in this video, to steer the economy in the way that the government wants it to go?
Or do you think that doesn't matter?
Or do you just not know?
Let us know because this does help us to understand where you are and what videos we need to make.
But it also does something else. It helps us understand where public opinion is and what we need to do to help change it to create the fair and just society which is the ultimate goal of this channel.
Poll
What do you think about tax?
- I think tax is a tool to steer the economy in the right direction (96%, 234 Votes)
- I think tax funds government spending (2%, 5 Votes)
- I still don't know (1%, 3 Votes)
- I don't think the difference matters (0%, 1 Votes)
Total Voters: 243
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I voted for tax funding government spending.
What government spends it on then steers the economy.
That’s an approximation but the simplest one and a better one than saying to government, “here’s my taxes, I consider myself well and truly steered”
The question whether governments should balance their budgets like a household makes no sense. Both households and businesses don’t they regularly use mortgages, bank loans, and corporate bonds! This enables a greater creation of goods and services but societies also want government to provide some of these. Few though recognise their government needs a money creation system of its own to do this. They also want government to avoid inflationary and deflationary pressures as part of the necessary provision of money to both sectors of their society. Only government is in a position to do this hence the steering wheel analogy.
Thank you for another excellent explanation. It is so important to counter the myths about the economy and tax in particular in this case.
I hope you’ll excuse me if I disagree with one detail.
Yes tax is key to controlling inflation. Yes tax is vital for increasing equality. But I disagree that the two are symbiotic. Please let me explain why I think this.
Previous blogs, e.g. on trickle up, have explained that the savings of the wealthy do not help the economy because savings are dead money. The wealthy save money because they can; they don’t need all their money for day to day expenditure. They have a low propensity to spend. Conversely, as you have said previously, the poor spend all their money to survive. They have no savings. If you give them money, as benefits, they will spend it all. They have a high propensity to spend. That’s why benefits are good and not a drain on the economy.
So, if you tax the wealthy to reduce inequality, which is a good thing, it will have little effect on the amount they spend. They will just save a bit less. Consequently taxing the wealthy will have limited effect on inflation.
If you want to boost the economy you reduce tax on the poor and increase benefits. You don’t boost the economy by reducing taxes on the wealthy and hoping for trickle down. The corollary is that increaseing taxes on the wealthy does not have a large effect on inflation.
Taxing to control inflation is vital. Reducing inequality by taxing wealthy is vital. Tax can do both simultaneously. But they are not closely related and, at least it seems to me, that they are not symbiotic.
I carefully constructed my words. I think thet are right. I referred to excess consumption. We will have to diagree.
I reiterate my gratitude for your tireless work in countering the pernicious economic myths that proliferate. I don’t wish to be argumentative or waste your time with pointless discussions. Perhaps, if I misunderstood, others may have done so too. So I hope you’ll forgive me if I try to reframe or clarify my point in the hope of greater agreement.
I agree that most excess consumption is by those with high income or wealth. I agree that this makes them the obvious targets for taxation if you’re trying to control inflation. The problem I see is that, if tax is only mildly increased on the wealthy they will simply absorb this by saving a bit less. And they will continue with more or less the same degree of excess spending. Only with more significant taxation will the wealthy start to reassess, and perhaps reduce, their excess spending. Hence mild or moderate increases in taxes on the wealthy may have limited effect in controlling inflation.
So, perhaps, we are merely debating the extent of tax increases on the wealthy that are required for inflation control. It seems to me that it might require quite extensive increases. And that may well be justified, but I wonder if the scale of increases required is at all politically possible. Which does not, of course, mean we should not increase tax on the wealthy; we definitely should. But, perhaps, the scale of increase that is politically possible may not affect inflation very much.
I guess this is another one of those non-linearities in economics (like being able to increase government spending, without inflation, up to the point where the economy is at full capacity). A small increase in tax on the wealthy may have no effect on inflation, whereas a large increase will have disproportionately more effect and will help to control inflation.
I have to disagree.
Just look at the impact of the increase in VAT on private schools. It has not passed without impact. Nor will anything else if properly targeted pass without impact.
You are right in the sense that the wealthy have lower marginal propensities to consume than do those who are poorest. But that is not a reason to tax the poorest most. That is a reason to tax savings more, and to tax excess consumption more, and to redistribute to those who are in need. Because this will not be a perfect tool, and there is no perfect tool available, does that mean we should not try it?
I KNOW that tax is a tool to steer the economy in the right direction.
The tragedy of the tax system is just like any other form of governance – if it falls into the wrong hands, managed by those with sub-standard, anti-social ideologies, it becomes a tool of oppression and social immobility, becoming punitive to certain sectors of the population (look how VAT went up to 20%).
The political influence on tax cannot be understated. Tax has a bad rap anyway, but when it is used as it is being used now, people’s perception of it can only worsen. And that will only help democracy to worsen.
5 stars from the omnibus. Very clear, good analogies.
Thank you.
Thanks
I note that with many voters they argue that the well-off pay the greater share of taxes by value but they never question whether it’s equitable. In consequence they also never bother to ask if this inequitability is in turn responsible for more government spending and hence more taxation!
I’ve been following your blog and painfully weaning myself off the idea that tax exists to pay for government spending, and yes, I’m convinced. But I have a tiny niggle. I used to defend having to pay tax because I could argue that it pays for the necessities of civilisation, such as the NHS and education and all the other things we want our government to spend money on (as well as some that we don’t). This gave me, the taxpayer, a personal stake in, and personal responsibility for, the NHS and the rest. But once I stop believing in that relationship I start to lose my commitment to the virtue of paying whatever tax I owe, because it’s no longer linked to my commitment to the continued funding of these public goods. I’m probably still misunderstanding something crucial, but it seems to me that once you break that link in the public’s mind, people will be less and less inclined to believe they should pay any tax at all. What am I missing?
You are right.
That direct link is broken – in fact, it never existed.
What you have instead is your commitment to make society work for the greater good. You are contributing to the overall well-being of the management of that society and not to a specific issue. Isn’t that worthwhile?
The statement “tax is used to steer a fair economy” explains exactly why tax is vilified and subject to misinformation by those in charge. We can’t possibly know there is better way to do things, not while some are getting rich from the way things are.
So why does the government lie?
To the extent that the uber-rich never let us forget how they pay the most tax, the “taxes fund spending” myth certainly gives them cover.
If it wasn’t for their leveraging of our publicly funded institutions however the wealthy would be busted back to barter.
Whilst the concept of “User Pays” has no part in taxation policy it does provide a moral underpinning to objectives such as fairness and equity that would be useful when discussing redistribution.