Economic neo-liberals tend to think that having a balanced budget, or a much reduced deficit, is easy enough, at least in principle. Just reduce government spending and increase taxation. Deficits will fall and the financial markets will react by rewarding a ‘prudent’ government. Right? Well, no. That’s where they always get it wrong and they never learn from their mistake. That kind of austerity economics is always just going to send the economy into a downward spiral of recession and increased unemployment as we’ve seen happen in the Eurozone. Governments there have sought, in vain, to balance their budgets in accordance with EU rules. They are actually ‘allowed’ a 3% GDP maximum deficit.
When sovereign governments spend they simply credit bank accounts as we know from MMT. Much of their spending is on wages and salaries. Straightaway about 30% or so comes back in tax and other Government deductions, like National insurance in the UK. The remainder gets spent and respent. After a few respendings there’s not much left after the government has taken its cut at each stage. 20% VAT, fuel duty, corporation tax etc etc and yet more income tax. So, it’s important for Governments to recognise that the level of taxes overall doesn’t have a 1:1 level on the tax take or anything like it. But the level of spending does have close to a 1:1 effect. Of course, raising one tax will increase the revenue raised by that particular tax but reduce the revenue raised by other taxes, simply because once money is removed from the economy, by one tax, it becomes unavailable to be removed by a subsequent tax. Eventually nearly all spending goes back to government as taxes regardless of the level at which they are set, providing they are finite. It just takes longer if taxes are lower.
Just think of it as water being pumped from a bucket and returned to the same bucket via a hosepipe. Once the system has settled down the amount of water returning to the bucket will be same as the amount leaving regardless of the time it takes to complete its journey, which is determined by the length of the hosepipe.
Warren Mosler likes to make the point that all money to pay taxes, and buy government securities, comes from Government spending. We can go further and say that all money to pay taxes (inc buying government securities) and to support the profits, wages and salaries of the private sector comes from Government spending. The lower the level of taxes, the longer the money stays in the economy to benefit the private sector, but it doesn’t just magically appear from nowhere as the more vitriolic of libertarians tend to suggest when they attack all government spending as wasteful.
There are two exceptions to the rule that issued money always comes back to government. Money which is saved by individuals and private companies, and money which is net spent on imports. The taxman can’t get that back. That is the source of the deficit. So, we can say:
Government Deficit = Savings of the Private Domestic Sector + External Deficit
This equation can easily be shown from a consideration of sectoral balances too.
So, if government, in its wisdom (or folly?), does decide the deficit needs to be cut in a recessionary period, it should forget about spending cuts and tax rises. What needs to happen is for saving to be discouraged and, of course, having interest rates very low helps do that. Then imports have to be cut and/or exports increased as well. Of course that’s very difficult to do in a free society where individuals wish to purchase goods and services from anywhere in the world and save money in whatever is their currency of choice. However, if neo-liberals argue this is impossible they must also necessarily concede that running a government surplus, or even a reduced deficit, is sometimes impossible too.
So, is there any truth at all in the conventional wisdom that cutting spending and raising taxes is the way to reduce a government’s deficit? Just a grain! It could send the economy into such a downward spiral that everyone becomes so poor they can neither afford to save nor buy imported goods from abroad. But, if that is the plan, then politicians arguing for a balanced budget should say so in advance to give us the chance of voting for someone else.
Modern Monetary Theory: Real Economics 
Eventually nearly all spending goes back to government as taxes regardless of the level at which they are set, providing they are finite. It just takes longer if taxes are lower
Neil Wilson put it even more emphatically saying something (lost the link) like “in the limit, every cent gets taxed back and destroyed”.
It’s a terrific way to look at things because it renders the battle cry of the neo-libs, “Taxpayers Money”, total gibberish.
But, if that is the plan, then politicians arguing for a balanced budget should say so in advance to give us the chance of voting for someone else.
Yeah, good one Peter! Unfortunately even the Greens in this country (Aust) are besotted with neo-liberal ideology, rendering their progressive social and environmental agenda moot.
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Government spending causes an equivalent amount of taxation. Each time, every time.
And the only thing that stops taxation being equal to government spending *within any particular time period*, is that people have decided to save some of the money they received.
So if you want things to be equal within a time period, you have to reduce the amount of overall saving within that time period. But why would you want to stop people saving or force them to take on more debt?
Government spending causes an equivalent amount of taxation. Each time, every time.
Another great, and succinct, insight. Thanks again Neil.
I’ve read this with some scepticism having just stumbled on the site and my first reaction was this must be a load of twaddle. However, when I set out to write a rebuttal I could not find any flaw in the logic. So to say I am perplexed is an more than an understatement. If Mr Martin is correct how can it be that all the world’s highly paid financial experts can be so wrong?
If Mr Martin is correct how can it be that all the world’s highly paid financial experts can be so wrong?
Try self interest, ignorance, or so much intellectual capital invested that the pain of “writing it off” is too much to bear.
If more folk had some understanding of national accounting and central bank operations the neo-liberals would be laughed out of town, along with the naked emperor.
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The truth is that most experts were educated under a gold standard and have little, if any, expertise with a true fiat money system. That and the fact that MMT would get them fired or laughed out of town….
Molon labe
“Warren Mosler likes to make the point that all money to pay taxes, and buy government securities, comes from Government spending.”
What about the 97% of money in the UK which was created by commercial banks issuing loans?
Ah, I see from some of your other posts that you differentiate commercial deposits as commerical IOUs rather than currency per se.
Yes. The Positive money group like to latch on to this 97% figure, Its calculated assuming that Govt bonds aren’t money BTW. I’ve just argued in my recent post that they are.
Commercial bank money is the IOU of the bank. They create asset /liability pairs just like anyone else can. They no different from the chips that are issued by a casino except they are digital. Those chips could, in principle, be used as money outside of the casino if everyone was confident of the casino’s financial viability.
But just as you can’t pay your taxes with casino chips, neither can you pay them with commercial bank money. The bank has to cough up BoE issued money from its reserves whenever one of its customers writes out a cheque to government.