Wednesday, April 16, 2014

Garth Brazelton — Purpose of Taxation

That may sound odd to people that think that our taxes go directly to 'fund' our federal spending, but that's the way it is. The use of taxes to fund spending is an optical illusion that gets perpetuated in the media - liberal or otherwise.

So what purpose does taxation at the federal level serve? Well, largely it's to modulate private spending demand....
I feel like many of our political disagreements would be better served by understanding these nuances as it relates to taxation. My fear is that the media and political extremists and made it virtually impossible to have an honest examination on the different role of taxes at different entity levels. It's just all black and white to them. Taxes are good or evil depending on the political persuasion, and that unfortunately does nobody an good at the end of the day.
Reviving Economics
Purpose of Taxation
Garth A Brazelton

44 comments:

Anonymous said...

Does Ramanan always have to chime in to no purpose other than to muddy the waters?

Roger Erickson said...

Kevin,
Is sure seems like it. There are always defendants of the status quo, since their income usually depends on it. Safe way to hedge is to seem to criticize the status quo while actually defending it's basic tenets. :(

Charles Hayden said...


He's a troll. He's set up an example where taxes=expenditures, meaning no net-financial $ assets. Private Savers=Private Deficit Spenders.

He's then saying taxes fund the expenditures. That means the entire economy shouldn't exist, as government would have to collect dollars before it spends them into existence.

marris said...

My comment on this post:

> So what purpose does taxation at the federal level serve? Well, largely it's to modulate private spending demand... Because of that, our spending demand shrinks.

By this reasoning, the purpose of the levees in New Orleans is to keep the ocean level higher. After all, without the levees, water would flow into a lower elevation area and the ocean level would be lower than it is now.

It is MMT to confuse effect and purpose.

Any "normal person's" view of the "purpose of taxation" aligns precisely with the *purpose intended by most tax authorizers*:
to fund government spending (to enable it without debt issuance).

Cue the word dump from Tom...

Tom Hickey said...

The issue is the facts in addition to the theory, and both theory and facts are in dispute between the major parties to this controversy, that is, those who specialize in money and banking, finance, and monetary economics. In the economic sphere, it is largely a debate between the Chartalists and those Circuitists that disagree with them.

Historically, it doesn't matter much who is actually correct as much as who is perceived to be correct, since that view dominates the expert universe of discourse and is used in policy formulation. Presently, conventional economics is largely confused about this, while Chartalists and opposing Circuitists at least have consistent narratives.

marris said...

IMHO, if the Chartalists and Circuitists wanted to be less slippery, they would say:

The purpose of taxation in policy *should be* to regulate private demand because of explanatory reasons X, Y, and Z.

Instead, they say:

The purpose of taxation in policy *is* to regulate private demand because of explanatory reasons X, Y, and Z.

Of course, slipperiness is only attributable to the self-proclaimed Chartalists and Circuitists who understanding what they're talking about. It does not apply to the parrots who don't really understand any theory.

Charles Hayden said...

There is nothing slippery about it.

Gov't and/or its designated agents have to spend or lend the $ currency into existence, or $ taxes don't get paid, $ bonds don't get sold, and the $ checks don't clear.

Can you handle that?








marris said...

> Can you handle that?

Sorry Charles, I've already assigned you to the parrot bucket.

In the real world, under the current policy regime, fiscal spending is perfectly balanced with taxation + bond sale proceeds. No new currency enters the system through fiscal policy.

The only way new currency enters the system is through Fed operations.

I don't think I have time to educate you on the MMT category of NFA, which lumps together bonds and currency. This lump *can* be increased through fiscal policy (running a defecit), but bonds cannot be used to pay taxes.

Tom Hickey said...

marris, you are simply echoing one side of the debate. The debate will not be decided by anyone here but rather by the "experts" in the field. That doesn't mean that the correct answer will prevail, of course.

What we are doing here is trying to understand how this works from the perspectives. Since this is an MMT-based blog it is obviously biased toward the MMT view, which we regard as the best explanation to the best of our understanding.

Simply stating one side of the debate more often or more loudly doesn't advance understanding of the issues.

I and others on this side of the debate have argued it with opposing Circuitists, and we disagree about the facts because we construe them differently. When there is disagreement over the facts, the debate grinds to halt until that obstacle is overcome. But facts are often theory-laden, so the disagreement may really be over key assumptions.

It's basically about whether government can change the amount of net financial assets held by non-government in aggregate as the general case, and whether governments do in specific cases, in the US in particular. Most agree over the general case, but differ over the special cases, the US in particular.

Tom Hickey said...

marris "I don't think I have time to educate you on the MMT category of NFA, which lumps together bonds and currency. This lump *can* be increased through fiscal policy (running a defecit), but bonds cannot be used to pay taxes."

This is the nub of it.

Mosler's view, taken over by MMT, is that bonds function simply as a reserve drain rather than a financing vehicle under a non-convertible floating rate system is controversial. Some accept this view and others don't. Some see a huge difference between bonds and currency and between the Treasury and central banks and MMT does not. We are all familiar with the reasons on both side at this point, I assume, and have made our choices.

marris said...

> Mosler's view, taken over by MMT, is that bonds function simply as a reserve drain rather than a financing vehicle under a non-convertible floating rate system is controversial.

Tom, there is no "debate" on what Garth is stating in his post.

He states that the purpose of taxes is to regulate private demand.

His argument is some macro (which I'm not disputing) + an accounting identity.

I'm saying that Garth makes a categorical error (or at least commits categorical sliding). I illustrate this with my levee example.

Either you think that my levee example conforms to the structure of Garth's argument or you don't. If you don't, please explain why *in structural terms*. No MMT word dump is going to do it. A thoughtful counter-argument may.

Kristjan said...

"marris "I don't think I have time to educate you on the MMT category of NFA, which lumps together bonds and currency. This lump *can* be increased through fiscal policy (running a defecit), but bonds cannot be used to pay taxes.""

They can be used as collateral to borrow the funds to pay taxes. It all comes down to the same thing. Bonds versus reserve balances are definitaly not an obstacle to pay taxes.

Greg said...

marris

I think the weakness of your analogy is "where did the ocean come from in the first place" ?

There is no ocean of currency to tax without a currency issuer. Consolidating Treasury and CB you get "the ocean is filled first by the Treasury/CB"

One problem we all have is we are trying to analyze this after the ocean has been filled. The real question is where did the ocean come from? The ocean of dollars came form the USgovt. It has been re-denominated many times through history. The ocean has been given many different values throughout time, but the value today, the value that we all most agree upon, is the value in dollars.

Six said...

The levee performs both functions, usually. It's capable of performing the opposite of its intended purpose, given the right set of circumstances.

Assigning people to the "parrot bucket" does nothing for your argument and makes you look like a d-bag (pardon my coarseness), especially since you are merely parroting a different set of arguments. Nice try, though!

Matt Franko said...

Even in a scenario where we are at LESS than full output/employment, couldnt the govt just spend the same gross amount per year but in the process agree to pay higher unit costs for its provision and cause so-called "inflation"? rsp,

Tom Hickey said...

As I read it, Garth is saying two things. First that taxes don't fund government (said at tax time). This is obvious in a fiat system, with which any person that understands fiat agrees. The question then is whether the US running a pure fiat system and funding itself with currency issuance. He doesn't get into that but assumes it.

Secondly, he takes the Keynesian position (not only MMT) that demand is the key macro variable rather than interest rates.

Taken together this is the position of Abba Lerner's functional finance, in which government spending increases demand and taxes decrease demand. Lerner's first point of FF (my emphasis): "The government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes."

Garth doesn't mention MMT and the position he takes is Keynesian and Lernerian.

Seems pretty clear that regardless of whether government taxes and borrows credit money created by banks or spends by issuing it own currency, it affects demand when it taxes and spends by expanding and contracting the money supply held by the public. When the government net "borrows" — however one interprets that — non-government has more to spend that otherwise, and when government net taxes, the reverse. So when the private sector reduces its borrowing and desires to increase its saving and deleveraging, then demand lags behind output potential. This results in contraction and increased unemployment unless government offsets increased private saving desire.

The argument against this is rather that when government borrows it makes the supply of money more costly by increasing interest rates. That is factually untrue in that it manifestly depends on conditions.

The other aspect of this argument is that government crowds out investment by competing with loanable funds. But even if the loanable funds doctrine were true, this would not be the case in a liquidity trap, as Krugman admits.

The question is really about the fiscal position of the government, as the present political debate over solvency, affordability, and price stability shows.

The question then remains about the present case in the US where government issues bonds through the Treasury and currency through the central bank, and Treasury notes and coin as government assets are marginal (as in the US now). Garth doesn’t get into the operational details but merely states the Chartalist position with respect to fiat being used by government to fund itself. If this is the case, then loanable funds, solvency and affordability collapse. The remaining issue is price stability.

So while Garth's statement is truncated, that's understandable given the scope of his post. I don't see him being wrong in the context of MMT although MMT economists might not chose to put it that way.

Brian Romanchuk said...

I lost the link, but I just read an article by Nick Rowe (I believe) that said that no serious school of thought seriously disagreed with the basic idea of functional finance, but there are disputes about the implications.

It comes down to the intertemporal budget constraint. If you take it seriously, taxes will eventually have to pay for all spending. I do not take it seriously, but that is based on issues with the mathematics. But since the mainstream beleives the budget constraint is correct, they do not appear to accept functional finance.

Arguments over where the money came from originally and/or legalistic disputes over monetary operations do not capture the mainstream argument against functional finance.

marris said...

> The levee performs both functions...

Umm, the dispute here is about purpose, not function. I agree that the levee functionally does both.

> especially since you are merely parroting a different set of arguments. Nice try, though!

The levee argument is my own. I came up with it in response to this post. Nice try, though!

marris said...

> They can be used as collateral to borrow the funds to pay taxes.

The dispute is about taxes and government spending. Since bonds cannot be used to pay taxes, they are distinct for this analysis.

They may be fungible for another analysis (e.g. collateral market).

marris said...

> First that taxes don't fund government (said at tax time). This is obvious in a fiat system, with which any person that understands fiat agrees.

Nope. He is explicitly stating that *the purpose* of taxes (why they were passed) is to regulate aggregate demand.

I made a structurally similar argument about the *purpose* of the levee.

You are saying something like *the levee makes the ocean level higher... anyone who understands the physical properties of water understands that*.

Not a valid counterargument.

marris said...

> Lerner's first point of FF (my emphasis): "The government shall maintain a reasonable level of demand at all times.

Tom, if you want to make your point, find a quote from a current lawmaker (in the current policy regime) who states: "let's raise taxes for the purpose of decreasing aggregate demand."

Tom Hickey said...

Tom, if you want to make your point, find a quote from a current lawmaker (in the current policy regime) who states: "let's raise taxes for the purpose of decreasing aggregate demand."

Anyone who reads this blog must know that our opinion of such lawmakers is that they are either morons or carrying out a hidden agenda that lies beneath the public agenda.

Tom Hickey said...

marris, perhaps I don't get your analogy. Why don't you just say what you mean in economic terms.

Six said...

I'm trying to follow your logic, marris:

Even though you are parroting the widely held, albeit flawed, notion that taxes fund government spending, you yourself are not a parrot because you came up with an original, albeit flawed, analogy. Do I have that right? Would you be willing to let Charles out of the "parrot bucket" if he brought forth a goofy analogy, too?

Tom Hickey said...

He is explicitly stating that *the purpose* of taxes (why they were passed) is to regulate aggregate demand.

If that is what Garth means he is wrong, since almost no lawmakers understand the difference between government finance and non-government finance and act as if the world were still on a gold standard.

It seems clear to me that he is speaking in terms of Lerner, which is the operationally correct view, instead of the prevailing conventional view.

If the prevailing conventional view were correct, why would he even write the post in the first place.

Tom Hickey said...

I should clarify that the way I read Garth he is also implying that this is already the current operational reality rather than a policy prescription to be realized.

I assume that the reason he is writing this is that most economists, policy people, the media and the public is in the dark about this and confuses government finance with private finance, since they are ignorant of the distinction between the government as currency issuer and users of the currency.

Tom Hickey said...

BTW, the only recent lawmaker I know of is Peter Stark, and he lost his last election and is no longer serving.

Is there anyone now in Congress or the executive branch that does understand this? Anyone who understands it a candidate in 2014 or 2016?

Dan Kervick said...

All of this is strikes me as an idle, scholastic head-on-a-pin discussion about ill-defined conceptual distinctions without an important difference.

All that is really important in the end is what kinds of budgetary and policy agendas are viable and desirable within the operational realities of the existing system, and what kinds of policy agendas would require changes to that system.

Whether we call it "funding" expenditures or something different - like "moderating aggregate demand" or "stabilizing prices" - everybody seems to accept that for a given set of decisions on an annual spending program, some corresponding decision must be made on the appropriate levels and kinds of revenues. Everybody also seems to accept that, under current operational practices, revenue shortfalls automatically trigger the sale of government debt instruments, not the emission on non-interest-bearing currency.

As a thought experiment, everybody should imagine that they are called in to testify to an open-minded Congress on the proper conduct of fiscal and monetary policy. You're the czar: it's up to you. You can propose the full slate of spending authorizations. You can propose the full slate of taxes and tax rates. You have to do something concrete; you have to put some numbers on these airy ruminations. What do you recommend? Whatever you recommend, there will be some total level of anticipated spending and some total level of anticipated tax revenue inflow - and thus some anticipated deficit.

Where do you think those numbers should be, given present macroeconomic circumstances? Should the deficit be $1 trillion? $1.5 trillion? $2 trillion? $5 trillion? $10 trillion? If you have no idea what the answer is, and if you don't even know what kinds of analytic tools you would use to come up with a specific proposed answer, then I would submit you don't know much of practical relevance.

I called this kind of endless and degenerating discussion "scholasticism" because that's precisely what it reminds me of. In the late medieval period, just before the rise of modern quantitative science, there were endless discussions of things like the theory of motion. Some though motion was caused by an internal "impetus"; some might have appealed to "natural places"; some might have defended a Democritean atoms-in-a-void account with random "swerves". But what almost none of these scholars could do was provide principled and well-confirmed instructions to a artilleryman as to how much gunpowder he should put in a cannon, at what angle it should be pitched, and what initial velocity of a cannonball would be required to get it to land at some desired spot.

Tom Hickey said...

If we are arguing about the choice of the term "purpose" in the purpose of taxation being demand adjustment rather than government funding, I agree that there is enough ambiguity to call for use of another term. "Purpose" can be construed to mean function, reason, effect, and intention. I was reading in the sense of operational function, but I can see how some might read it as the intention of the lawmakers, but I think that would betray ignorance of the context.

But where ambiguity is possible, it is best avoided by choosing another mode of expression.

So it would be better stated as, the operational function of taxation under the current monetary regime is demand adjustment in order to address price stability rather than to fund government expenditure as is commonly assumed.

Tom Hickey said...

Keynes: Look after the unemployment, and the Budget will look after itself.

From a 1933 radio debate Keynes did with Stamp

Lerner would say, "Look after the unemployment and price stability, and the Budget will look after itself."

Economists do come up with plans for doing things like this. Keynes did during the Great Depression.

More recently, Christina Romer came up with a detailed plan projecting an initial deficit or 1.5 trillion and reduced it under pressure to 1.2 trillion. The final package was 0.850 trillion — about 57% of the initial figure — and the details were altered for political reasons to get the measure passed.

Brian Romanchuk said...

I just put on article on my site (bondeconomics.com) where I discuss this, and I have the link to the excellent Nick Rowe article (title is something like "functional finance and the long run budget constraint").

I use his article to explain why this is not just a semantic debate.

Tom Hickey said...

Thanks, Brian. I already posted it.

Tom Hickey said...

Nice post, btw.

Wrt the IGBC, Scott Fullwiler has written a definitive paper dismissing it an issue.

Interest Rates and Fiscal Sustainability

Anonymous said...

IS is factual
SHOULD BE is political

All political stripes are capable of using MMT

JK said...

MARRIS:
"Umm, the dispute here is about purpose, not function. I agree that the levee functionally does both."

TOM:
"If we are arguing about the choice of the term "purpose" in the purpose of taxation being demand adjustment rather than government funding, I agree that there is enough ambiguity to call for use of another term. "Purpose" can be construed to mean function, reason, effect, and intention. I was reading in the sense of operational function, but I can see how some might read it as the intention of the lawmakers…"

This seems to be the point of disagreement. The way I read the word "purpose" iin "the purpose of taxes" is as "function" i.e. "the function of taxes is to regulate aggregate demand"

I think that anyone who understands MMT understands that it is interpreted in that way. Really, what's the point of talking about "purpose" as a "motive" of those who institute taxes? IMO, "motive" is unimportant in this discussion. It really doesn't matter if lawmakers institute taxes because they think they need to in order to raise revenue in order to spend. Who cares what they think they need to do?

MMT, functional finance, mosler economics, etc. allows us to take a birdseye view of the situation. From a birdseye view, the "purpose" (function) of taxes is nothing more than to remove purchasing power from the private sector in order to make room for government spending without causing inflation.

Auburn Parks said...

To Dan K. specifically and everyone more broadly-

When considering how much private sector net income is too much, we must follow the level of productivity.

If wages keep up with productivity (like they did for decades before 1980) then there isn't much need for a large Govt deficit to increase private incomes.

If real wages stay flat (there could be many reasons for this) than the Govt should focus on increasing private incomes up to some fixed ratio with productivity.

http://upload.wikimedia.org/wikipedia/commons/7/73/US_productivity_and_real_wages.jpg

Brian Romanchuk said...

Tom - thanks for the Fulwiler paper. I may have looked at quickly awhile ago, but I am trying to build up my references for a book on fiscal policy,

Auburn Parks said...

Should have also noted that not running a large trade deficit in the reference time period, also makes it possible to not run large Govt deficits.

Dan Kervick said...

Auburn, what if we were in an economy in which changes in wages were keeping pace with changes productivity, but in which the economy was producing well below capacity?

Also, wouldn't it be possible to have an economy in which changes in wages were not keeping pace with changes in productivity, but in which there was nevertheless high inflation due to in inequitable distribution of income to the upper end of the income scale?

Auburn Parks said...

Dan-

"Auburn, what if we were in an economy in which changes in wages were keeping pace with changes productivity, but in which the economy was producing well below capacity?"

I guess anything is possible but since 1980 real wages only increase as unemployment approaches and then goes below 5%

https://research.stlouisfed.org/fred2/graph/?graph_id=157171&category_id=

There is no one rule or policy that is optimal and predictive for every situation and what if.

So if wages were keeping up with productivity, is inflation high or low? If there is slack capacity and low inflation then we would have room to increase AD in order to make use of the spare capacity.

Auburn Parks said...

"Also, wouldn't it be possible to have an economy in which changes in wages were not keeping pace with changes in productivity, but in which there was nevertheless high inflation due to in inequitable distribution of income to the upper end of the income scale?"

I don't believe thats possible. If tax cuts for the wealthy don't generate broad economic growth, then there is no reason to assume that high inequality would cause inflation.

OF our $17T national income, which scenario would have a higher inflationary bias (assume balanced budgets and no foreign sector)?

1) 1% got $15 T and the 99% $2T

or

2) 1% got $2T and the 99% got $15T

Dan Kervick said...

I don't believe thats possible. If tax cuts for the wealthy don't generate broad economic growth, then there is no reason to assume that high inequality would cause inflation.

What if in some not-to-distant hyperkleptocratic future we have permanent double digit unemployment, with many of the employed working at stagnant serf wages to produce the output that is mostly consumed by the wealthy, but the Fed allows treasury yields to rise to 10% so the non-working, rent-collecting plutocrats get ongoing helicopter drops of free cash from the government, continually eroding lower class purchasing power and real wages. If the Fed is wild enough, you could get inflation even with mass unemployment and stagnant wages. Wages are only one component of income and working people are only one component of the population.

There is no reason to think you can only have inflation with high employment.

Auburn Parks said...

Dan-

I too can construct highly unlikely, irrelevant what if scenarios that have no bearing whatsoever on our converstaion.

What if all the wealthy people decided that they would instead give all their money to poor people, what would happen to inflation then?

You were complaining about how MMTers never have any sort of mathematical framework for how big a deficit is needed.

There is no right size nominal deficit for all seasons, the economy is alive. Its a dynamic adaptive system, so we must use ratios and combinations of metric to make policy.

Its like me asking you how much inflation a $1 trillion deficit would generate?

Garth A Brazelton said...

Thanks for the repost. Perhaps I wasn't clear with the use of my word "purpose." By that I just meant, whether politicians realize it or not, taxes aren't raise for the purpose of 'funding' expenditure. They have other "purposes" or perhaps a better word would be "functions."

The impetus of the post was one of my facebook friends posted that link from New Republic that I put in my post about how everyone should love tax day because it's us funding needed infrastructure, education, etc... and that I annoyed me.