{"id":87122,"date":"2025-10-30T07:07:31","date_gmt":"2025-10-30T07:07:31","guid":{"rendered":"https:\/\/www.taxresearch.org.uk\/Blog\/?p=87122"},"modified":"2025-10-30T12:10:10","modified_gmt":"2025-10-30T12:10:10","slug":"where-does-the-money-go-when-the-government-spends-and-when-it-taxes","status":"publish","type":"post","link":"https:\/\/www.taxresearch.org.uk\/Blog\/2025\/10\/30\/where-does-the-money-go-when-the-government-spends-and-when-it-taxes\/","title":{"rendered":"Where does the money go when the government spends \u2014 and when it taxes?"},"content":{"rendered":"

A reader here has written<\/a> in response to recent posts on how government spending works<\/a>:<\/p>\n

\u201cThanks, Richard, for the patient and insightful explanation. In my mind it leaves a question that keeps bugging me: when commercial banks make a loan, and the borrower spends it, it puts money into the economy. As the loan gets repaid, that money disappears from the accounts.<\/p><\/blockquote>\n

When a government spends, it seems, the money is taken out of circulation by tax.<\/p><\/blockquote>\n

BUT, is that money taken off the accounts by a similar process? It looks from your explanation that the money sloshes around in the central bank reserve account and can be put into circulation again by public spending?<\/p><\/blockquote>\n

I\u2019d love to know which account actually cancels the spending, or to know that government spending increases the amount of money in the system perpetually.\u201d<\/p><\/blockquote>\n

That's a good question, and it goes to the heart of why the government\u2019s money is not like bank money. Let me break this down.<\/p>\n

First<\/span>, when commercial banks lend, they create new money, but only temporarily. A bank loan creates a bank deposit out of thin air, and then the moment the loan is repaid, that deposit vanishes again. Bank money is inherently self-cancelling.<\/p>\n

Second<\/span>, government-created money, or base money, is not of that kind. When a currency-issuing government spends, the Bank of England simply marks up the central bank reserve account of the bank that receives the payment. What appears is new net financial wealth<\/span> for the private sector. In other words, someone's bank balance has been increased by the government making a payment, with that deposit being backed by their bank's reserves at the Bank of England.<\/p>\n

Third<\/span>, taxation reverses that process. It does not fund the government; instead, it erodes the purchasing power that the government previously created by spending new money into existence. When tax is paid, a commercial bank instructs the Bank of England to mark down<\/span> its reserve balance. The commercial bank then reduces the taxpayer\u2019s deposit accordingly. That money is gone. It does not sit in a pot. It does not fund the next round of spending. It is eliminated.<\/p>\n

So yes, tax cancels government money \u2014 just as a loan repayment cancels bank money \u2014 but with one crucial difference. Government spending creates money that is not automatically cancelled again. <\/b>It only disappears if and when tax is charged.<\/p>\n

Fourth<\/span>, the amount of money left in the economy after tax is a policy choice:<\/p>\n