Friday, May 30, 2014

Randy Wray — Taxes and the Public Purpose

In previous instalments we have established that “taxes drive money”. What we mean by that is that sovereign government chooses a money of account (Dollar in the USA), imposes obligations in that unit (taxes, fees, fines, tithes, tolls, or tribute), and issues the currency that can be used to “redeem” oneself in payments to the government. Currency is like the “Get Out of Jail Free” card in the game of Monopoly.
Taxes create a demand for “that which is necessary to pay taxes” (and other obligations to the state), which allows the government to purchase resources to pursue the public purpose by spending the currency.
Warren Mosler puts it this way: the purpose of the tax is to create unemployment. That might sound a bit strange, but if we define unemployment as a situation in which job seekers want to work for money wages, then government can hire them by offering its currency. The tax frees resources from private use so that government can employ them in public use.
To greatly simplify, money is a measuring unit, originally created by rulers to value the fees, fines, and taxes owed.
By putting the subjects or citizens into debt, real resources could be moved to serve the public purpose. Taxes drive money.
So, money was created to give government command over socially created resources.
New Economic Perspectives
Taxes and the Public Purpose
L. Randall Wray | Professor of Economics, University of Missouri at Kansas City


Ralph Musgrave said...

If taxes are necessary in order to give money its value (“taxes drive money”, as Randy puts it), how come Bitcoins have value despite the fact that those running the Bitcoin system don’t collect taxes? Reason is that while Randy’s ideas on tax certainly contain some truth and explain why various forms of government money past and present have value, it is also true that people will use ANY FORM OF MONEY as long as it is competently managed.

Matt Franko said...

Bitcoin is a libertarian idea of a currency Ralph....

libertarians don't want our govt institutions to be driving anything I can tell you that....

so bitcoin might actually work BETTER for the libertarians so you see some use of it and the associated chaos around it... it "works" for them... we have an s-load of libertarians at least over here Ralph....


Anonymous said...

Taxes drive state money Ralph.. people can trade in Bitcoins, corn, navel lint, or anything else they want to without taxes.

Anonymous said...

Of course if you do trade in navel lint... the sales tax is still due in dollars.

Tom Hickey said...

Ralph, governments have ruled that privately created digital currencies are property not currency and therefore subject to property law and taxes pertaining to property. Digital currencies are ersatz precious metals but function more like clamshells in tribes where clamshells were a scarce novelty.

Trading with Bitcoin is bartering stuff for Bitcoin that has no intrinsic value. See The Fair Price of a Bitcoin is Zero by Eric Tymoigne.

Money is a legal construct in a modern economy. It's what the law says it is. See Christine Desan on this.

Money as a Legal Institution by Christine A. Desan
Harvard Law School, September 5, 2013

Tom Hickey said...

"Of course if you do trade in navel lint... the sales tax is still due in dollars."

Gains are also taxed as what the government approves as the nominal value in the unit of account and payable in the unit of account.

There is no contradiction in using barter, free banking, digital currencies etc in finance and commerce along with state currencies, but taxes are levied and payable in the government's unit of account.

As Minsky said, anyone can create IOUs the trick is getting them accepted. Non-government media of exchange are dependent on custom, while government currency is created and determined institutionally by law.

Most economists ignore or are unaware of the role of law in a modern monetary economy based on exchange of property (transfer of property rights). The entire market economy is chiefly a complex web of law, regs, and legal institutions determined by the legislative and regulatory processes, which are themselves determined by law, which is interpreted by the judiciary and conflicts adjudicated by courts. Without this structure modern capitalism is hobbled if not impossible and it is one of the chief hurdles in emerging countries and their economies.

Ralph Musgrave said...

Money is defined by economists as something like “anything widely accepted in payment for goods and services”. So, re Tom’s point that “Money is a legal construct..”, government can pass laws saying that taxes must be paid in the government’s money, but that doesn’t stop other types of money being genuine money, as per economists’ definition.

“Trading with Bitcoin is bartering stuff for Bitcoin that has no intrinsic value.” Same goes for trading with US dollars, doesn’t it? I.e. a $100 bill has no intrinsic value.

But to repeat, I’m not contradicting Randy. I’m just saying that in addition to his explanation for dollars having value, there is a second reason, namely that money is useful stuff, thus anyone who creates a well managed form of money will find it being used. In fact that’s what commercial banks do: they’ll credit your account with any amount of their home made money you like as long as to deposit enough collateral. But commercial banks’ “dollars” are not real US government dollars. They’re simply a promise by the commercial bank to convert their dollars to government dollars if that’s what you want.

Tom Hickey said...

Randy has emphasized that taxes are a sufficient reason to drive demand for money, not a necessary reason. For example, if banks issued their own notes and loans were contracted in their IOUs, then the borrower would have to obtain the bank's IOUs to service the loans if the bank only accepted its own IOUs in payment.

MMT economists acknowledge that money existed as debt prior to the issuance of state money, as well as money emerged from creditary relationships, as David Graeber recounts the anthropology of.

The MMT claim is that "modern money" is state money and that state money or chartal is tax-driven.

But it is also the case now that the state has huge power over exchange, especially monetary and financial exchange, as a matter of national security and an orderly society.

Since the proliferation of organized crime, and now terrorism, states are using this power in ways they haven't previously or at least not as obviously, as well as cooperating with each other to do so.

Tom Hickey said...

In spite of that, I think that "digital currencies" have a future as payments system, especially internationally, at least until the present system decides to compete with them by offering a better deal. Right now, the rents are a cash cow for them, and digital currencies are going after that inefficiency rent by eliminating intermediaries.

The Rombach Report said...

I see a conundrum with regard to a tax driven currency. MMT orthodoxy asserts that increasing or decreasing the SUPPLY of currency by lowering or raising the tax rate is sufficient to create the desired value for a fiat currency.

This makes sense but I think it only tells half the story. Meanwhile, the Supply Side model argues that cutting the appropriate taxes can increase the DEMAND for currency. In this contest, if taxes are raised, currency SUPPLY is reduced, but if that reduced SUPPLY is matched by reduced DEMAND for the currency there may be no net effect.

To take it a step further it is quite conceivable that higher taxes could reduce DEMAND for the currency even more than the reduction in currency SUPPLY to the extent that it weakens the value of the currency.

I think that depending on circumstances one model or the other may have more influence than the other on the value of the currency. It seems to me to be very much a game of 3 dimensional chess.

Tom Hickey said...

MMT doesn't hold that taxes determine the value of the currency. What MMT says is that taxes drive state money by creating a demand for it.

The higher the tax rate or the less available the currency, the more pressing the demand to obtain it to satisfy obligations to the state. If the state would not require obligations to it to be meet only in its currency, then there would potentially be no demand for the currency. But the currency would still have its nominal value even though no one might accept it in exchange.

In a floating rate system, currencies have relative value wrt to each other. In their own currency zone, they have varying levels of purchasing power. Both of these depend on a variety of factors. A lot of finance has to do with anticipating fluctuations based on changing conditions that influence a myriad of factors affecting relative value.

According to MMT, the value of the currency is determined by the prices that government sets as monopolist. One price is the price of credit terms of the own rate that government sets for its currency. The other prices are goods prices — what government offers in markets to transfer private resources to public use.

Fiscal policy addresses effective demand in the marketplace, not demand for currency. If effective demand outpaces productive capacity to meet it, then according to functional finance government should dampen consumption demand by withdrawing currency by decreasing spending or increasing taxation.

Decreasing the availability of funds increases demand for credit and government can control this either through making credit more expensive by increasing the policy rate or less available by tightening bank requirements for collateral and credit standards.

Anonymous said...


"if taxes are raised, currency SUPPLY is reduced, but if that reduced SUPPLY is matched by reduced DEMAND for the currency there may be no net effect."

you appear to be saying that raising taxes could lead to more spending overall, and higher inflation (more effective demand for goods and services).

The Rombach Report said...

"you appear to be saying that raising taxes could lead to more spending overall, and higher inflation (more effective demand for goods and services)."

y - Not saying that raising taxes could lead to more private sector spending. Conceivably higher taxes could increase inflation if it resulted in reduced borrowing demand for the currency. If taxes are raised to put the brakes on inflation currency supply will go down. However, if that reduced currency supply is matched by reduced demand for the currency because the after tax return on capital has gone down, the policy action may not quell inflation. Instead, the result may end up being stagflation.

It's kind of ironic that the MMT model focuses on tax driven policy to create value for the currency from the supply side. By contrast the SUPPLY SIDE model is also in part a tax driven policy that creates value for the currency but from the demand side. For example the late Jude Wanniski would argue that the tax cuts of the 1980s created DEMAND for the dollar because the after tax return on capital had gone up.

Note that even though nominal treasury yields fell sharply in the 1980s, real inflation adjusted yields rose as inflation fell and the US$ appreciated sharply. All this happened amid historically large deficits at the time.