It's NOT our money.(The gov't doesn't need our taxes to spend)

One of the biggest misconceptions I come across everyday is the idea that the government must collect taxes or borrow in order to have the funds to spend and invest. This idea probably comes from most peoples’ self-centered view of finance. They view the government like they view themselves, in that, it is impossible to spend unless you have the funds in hand first.

This does not apply in this case because the government uses its “own” money, which it can create in limitless quantities. The money is essentially IOU’s, which can take the form of Treasuries, printed bills or simply, bank reserves (mere credits to the banking system).

Moreover, there is no constraint to how many of these IOU’s the government can issue, as stated above. Constraints can only be self-imposed, like when there is a desire to achieve “balanced” budgets or, when policymakers feel that too much spending is creating inflation. At that point they might decide to slow spending. However, these constraints are political in nature, not operational constraints.

The government can spend all it wants of its own currency and usually does so even before one cent in taxes is ever collected or before a single security is ever sold. Indeed, that is the only way that deficits can exist in the first place: the spending is done first and in greater quantities than what comes in, hence, the deficit.

Think about it: If the government first collected taxes and sold securities, there would be no deficit because it could be said to be operating on a “pay as you go” system.

Why, then, does the government need to collect taxes and sell securities if it can spend all it wants of its own money? Because doing so would quickly lead to hyperinflation. Government spending, if left unchecked would swell bank reserves beyond the Fed’s control and cause money supply to grow very rapidly. In order to prevent this, the government collects taxes and sells securities as a means of draining off some of the excess liquidity pumped in by all of the spending.

Therefore, we can correctly state that “the money to pay taxes and sell securities comes from government spending.” It’s not the other way around.

Next post: Enforcing the collection of taxes as a means to give the government’s money value.