Why are there taxes?

Great Debates
41

Faith in the mathematical security of its algorithm.

I didn’t see anybody say it was a good way of managing the economy.

Of course, it would not be.

This is absolutely true.

But it also absolutely depends on how the economy is doing, and that is also not all that in doubt among actual economists. A Keynesian economist would say, for example, that increasing the budget deficit by 100 billion dollars a year right now (like the current tax plan is slated to do) is a fucking crazy policy. It’s a fundamental Keynesian idea that recessions are when the deficit should be expanded to stimulate the economy, and expansions are when the multiplicative effect disappears and when deficits need to be reduced.

A more monetarist economist (like myself) would not deny the potential multiplicative effect of the desirability of “stimulative” policy during downturns. But again, we’re not in the downturn.

It’s not particularly controversial when you look at the data.

The 1980s are the most notable US example. Reagan deficits didn’t increase demand. Inflation dropped, even while military spending and government deficits exploded, because Volcker was tightening money at the same time. Monetary policy outweighed fiscal policy in determining aggregate demand in the economy.

What’s legitimately controversial today, among actual economists, is whether that remains true when interest rates hit zero. A New Keynesian-leaning economist (and I would guess this represents the majority of macroeconomists) would suggest that spending is appropriate in the particular situation of zero interest. A more monetarist-leaning economist (in the minority, such as myself) would suggest that monetary policy is still dominant in that case.

It’s sensible for policy-makers to defer to the majority of opinion.

But I still think it’s wrong.

The official unemployment rate is down to 4%.

The U-6 underemployment rate (which includes part-time workers who want more work, and people who claim to want to job but are not currently looking for work) is down to 8% which is where it was before the Great Recession.

Wage growth is (finally!) seeming to pick up a bit of steam.

And most important of all, the federal funds rate has been above 0% for the last two years. The entire reason the Fed is raising interest rates is to cool down the economy to prevent inflationary overheating.

More demand can’t do anything more here. The slack is gone.

You can’t double people’s nominal incomes and expect them to be able to buy more if the prices of everything are double, too.

The same principle applies to smaller increases as well. A 5% increase in nominal income will not help anyone, if prices increase 5%.

Underemployment is back to where it was before the Great Recession.

Labor force participation is still down, but that is probably the new normal from here.

The entire point of the Great Moderation that started under Volcker is that monetary economists believed they finally had the whole demand thing under control, which was to say that demand was finally calibrated to where it needed to be to maximize production while stabilizing inflation. There was an issue when we hit zero percent in 2008, but for most the period between the early 1980s until 2008, monetary economists thought they’d found an optimal rule (variants of the Taylor rule) that put aggregate demand exactly where it needed to be.

This is just standard New Keynesian (interest-rate based) macroeconomics. You push aggregate demand up to where it should be, and then you stop pushing.

There is obviously a potential for good government spending.

That would be because the particular projects are good and well-chosen. It wouldn’t be from any demand-based multipliers from that spending. Those are gone now. Demand is not currently a problem – altho it could become a problem again during the next recession if rates drop back to zero.

If someone says I want to tax the rich and give to the poor because the poor need it more! then that can be a sensible comment. It’s at least theoretically possible to build a coherent tax policy out of that idea. But if someone says I want the rich and give to the poor to increase economic productivity right now! then that is completely absurd at the current moment. Production comes from factories, hospitals, schools, shops, farms, etc. If we want more production, we need more real resources. We need to focus on increasing the supply of those real resources. Obviously policy makers should maintain strong aggregate demand, but we’re past the point where more demand is going to help.

Money sitting in bank vaults is not real resources. Factories and farms are real resources.

42

I’m not assuming anything about you.

As to builder and farmer, they’re my scenarios so I get to decide what they want to do!

I have them reflecting what I see as the most usual setup in modern societies–to work to provide at least a certain bare minimum of existence even for those who don’t contribute. If you need a more direct motivation, let’s say the hippy becomes a raving lunatic and kills people before starving to death, but aside from that, does nothing offensive, just lays about. So they figure it’s better for their consciences and their lives that they just hand him a free apple each day.

43

A poor faith to have, as much as it has been hacked. Again, just yesterday in fact.

I thought you meant it as a demonstration that a money supply does not need to be govt backed in order to be useful to an economy.

I absolutely agree that increasing the deficit to cutt taxes in our current economy is unwise on several levels.

I don’t know that cutting taxes on the lower classes is bad idea though. Cutting taxes on the upper middle to wealthy and ultra wealthy, definatly a bad idea. IMHO, of course.

I think we are heading towards one here pretty soon. If consumer demand falters for even a little bit, I see waves crashing down on the economy.

I disagree with this. I run a business, I could use a bit more demand. All my business owning peers would love to see an increase in demand for their products and services.

You can’t double everyone’s income and not expect prices to double, sure, but you don’t need to double everyone’s income, just the people that aren’t making much (and I don’t know if double is necessary.)

Same here, if you only increase say 15% of people’s wages by 5%, then prices will not go up by 5%

You get both, you get a well chosen good project, and you get money in the pockets of the people who work on it. They spend the money in the economy, increasing demand.

What if I say both? I do think that for ethical reasons, the poor should be given money, as they do need it more than the wealthy, but I also come from the pragmatic sense that it is better for the economy as well. The wealthy will get that money back when the poor person spends it, and it works its way back up to the top.

Money sitting anywhere is not a real resource, it is only an account of what proportion of resources our economy produces the holder of that money can command. Humans producing things are also real resources.

44

In order to have a callus system of economics that allows people to die from a lack of ability to participate in the economy, you have to make the assumption that those people will lay down and die quietly.

45

A country that has taxes will be able to raise a more powerful military and annex countries that don’t have taxes.

46

In fact the government only gets to spend a fraction of the oil taxes. All of the oil money goes into the Sovereign Wealth Fund (currently valued at a trillion USD) and the government can only spend up to 4% of the yield to balance the budget. (Until parliament decides otherwise of course.)

47

Money has two purposes, one is as a medium of exchange, and the second is as a store of value. The medium of exchange function is the easiest to understand. If the sculptor wants to buy apples he has to wait until the farmer wants a sculpture or use an IOU so that the farmer can exchange the IOU for sculpture later. The IOU is the money and one IOU equals one statue.
The store of value is the part you are not getting. If the farmer takes the IOU to a copier and creates a new fiat IOU, then the farmer is not richer. He takes it to the sculptor who says he can only produce one sculpture a week so the price of a sculpture is now 2 IOUs instead of one. If the farmer uses the copier enough then it becomes pointless to have the IOUs and the economy reverts back to the sculptor only getting apples when the farmer wants a sculpture.
In the real world there is a demand for money like every other good. If the amount of money created exceeds the demand then the money loses its value. If it loses enough value then it loses usefulness as a medium of exchange.

48

It’s confusing when you talk about apples as currency.

Yes, you can create a piece of paper that says “IOU one apple”. That’s a fiat apple, or an apple standard currency. It creates paper money backed by apples. It can be created by fiat, because I can write that IOU even if I don’t have any apples in my apple barrel. But that piece of paper is not an apple. It’s a piece of paper that can be exchanged for an apple.

But it can only actually be exchanged for an apple if you bring it to someone who has an apple they are willing to give you in exchange for your paper. Like, if they had a bunch of apples, and they promised you one and gave you paper yesterday, and you show up today with the IOU and ask for your apple. Then they’d honor their promise and give you an apple. Or maybe they wouldn’t. You could just tell you to fuck off. They’d have tricked you.

Or, I could be a hippy with no apples, and I wrote up an IOU for one apple and gave it to you yesterday in exchange for your organic hemp milk. You come to me today asking for your apple, and I don’t have one. I don’t want to tell you to fuck off, but I just don’t have an apple. Maybe I had one yesterday when I wrote the note, but the apple is gone today for some reason. Let’s even say that I didn’t eat the apple myself, a raccoon broke into my kitchen and ate the apple I was going to give to you.

Anyway, I created a fiat apple yesterday, but today there is no way for me to redeem my IOU. I can create an IOU by fiat just by writing a note, but I can’t create an apple by fiat, I have to plant an apple tree and wait 10 years and harvest and store apples if I want to create apples.

So what happens if tomorrow I present you with another apple IOU. You remember last time how you tried to get an apple from me but couldn’t. So do you accept that apple IOU at face value? Or do you demand a premium? “Remember how last time you screwed me over? What if that happens again? So I need not just one apple IOU for a pint of hemp milk, I need one and a quarter.”

If I just create apple IOUs by fiat whenever I like, but never actually hand out any apples, people are going to demand a higher and higher premium for accepting apple IOUs. This is also known as inflation. Whoa, the price of everything is going up! But it’s easier to think of it that the value of the money is going down. Pretty quick people stop acceptig my IOUs because they don’t believe my lies anymore, and the value of my IOUs drops to zero. They don’t accept any amount of apple IOUs for any amount of hemp milk, not even at millions to one.

The difference between a crunchy old hippy hand scrawling IOUs and a government issuing fiat money is that the government has soldiers and cops and judges and prison guards. They can MAKE you accept IOUs, and if you don’t like it, too bad. But notice that if the government makes you accept their money, and accepts your money for tax payments, that worthless IOU actually has value. That makes a government controlled hyperinflated currency collapse a lot more slowly than one issued by one dude who lives in a cardboard box. An IOU from some random guy will go from face value to zero pretty quickly. It can take years to happen with government currencies, because there’s usually some way to use them.

The point is, an apple backed currency doesn’t create more apples, unless the apple growers see a larger market for apples under the new scheme and grow more. Lots of people spent a lot of time digging gold and silver out of the ground back when precious metals were used as money. More money can increase economic activity by facilitating exchange. If the economy grows at about the same rate as the amount of money in circulation then there’s no inflation. If the economy grows faster, then you have deflation. If it grows more slowly you have inflation. But this requires the money to actually be used. If I write up 10,000,000 notes that say IOU one apple and then lock them up in a safe, those IOUs aren’t money. They only become money when I offer one to someone and they accept.

And so you have the spectacle of the Federal Reserve creating a metric fuckton of money during the financial crisis, and the economy not growing by much, but still having low inflation. That money has to circulate to create inflation, and that new money mostly didn’t.

49

My definition is non-standard, but I think it has utility.

For clarity please indicate in four scenarios whether “fiat money” has been created and, if so, who created it.
(a) Acme Widgets borrows $X from Wells Fargo and gets money added to its checking account.
(b) U.S. Treasury sells $X of notes to Wells Fargo and gets money added to its checking account.
(c) Wells Fargo sells the Treasury notes it got in (b) to the FRB.
(d) Acme decides it wants in $X in cash; so Wells Fargo sends an armored truck to pick up the banknotes and delivers them to Acme.

50

Are this $X tied to a fixed amount of some commodity? No? Then they are fiat money.

51

He asked when it was created and by whom, not which is or is not fiat.

52

So, any debt instrument in a country not on a gold (or similar) standard, is “fiat money”? (And what about U.S. Civil War greenbacks? They were promises to, eventually, pay gold.)

I’m very curious what Hellestal will answer. I like the distinction I made between “fiat money” and “debt marker” but I can’t compare it with the standard definition of “fiat money” until I know what that is.

53

On vacation. My internet access will likely be spotty for the next week or so.

Your deeper point here is totally true, that newfangled electronic assets are not necessary safe.

But Bitcoin has not been hacked, or its value would already be zero.

An exchange was hacked. Exchanges have been hacked before. People seem to have been unwise to put their faith in those exchanges, and they might also be unwise to put any faith in Bitcoin itself. Nevertheless, the algorithm’s encryption has held so far, and faith in that encryption – regardless of how wise that faith is – remains a necessary condition for Bitcoin to have any value at all.

I did mean that.

But there is a difference between “useful” and “ideal”. Volatile assets can still have their uses, even if they fall short of an ideal.

A recession will eventually happen. When it happens, it is extremely likely that interest rates will go back to zero, and at time we’re going to return to earnest discussions of whether more-spending vs more-money is the most appropriate tool. Or honestly, more-spending vs. more-money vs. do-nothing. There are prominent economists, even to this day, who believe that insufficient aggregate demand is not a thing that can happen.

Not everyone in the profession actually cares about looking at the evidence.

That is true for practically all businesses, in all time periods, eternally. Even in boom times, countless businesses fail from lack of individual demand for their particular service, and many very successful businesses would like to be even more successful. The difference between a recession and a boom is not just businesses failing from lack of demand for their particular stuff, but also how many new businesses spring into life to take advantage of the apparent opportunities. A boom is still characterized by bankruptcies and job loss. It’s just that the gains outweigh the losses.

More broadly here: individual demand for any particular business’s good is a “real” variable.

“Aggregate demand” is nominal.

The two concepts, despite the similar name, are extremely different. Aggregate demand is literally the flow of money in an economy, regardless of what is being bought. A business owner nearly always thinks “I’d like more demand for my product”, but higher aggregate demand when the economy as already at capacity will mean that all costs increase roughly proportionally at roughly the same time. You could charge twice as much for your stuff, and yet have twice the costs for any employees (or the electric bill, rent, etc. if you have no employees), and then see twice the price at the grocery store when you’re going shopping.

You would not be any better off if costs increase proportionally with business revenues. This is the entire idea behind aggregate demand.

When the economy is not at its productive capacity, then there is every reason to believe that more aggregate demand will result, in most increases, with increases in revenues for businesses outpacing increases in costs for those businesses. But after the economy has approached its productive capacity, that is no longer the case. You get the costs of inflation, without any benefit to business or workers.

This is why the Fed is raising rates right now. The engine is already beginning to run hot now.

If people in general needed more “money”, the Fed could push some push buttons on a computer and cut them a check.

Everyone understands the extreme example of this. The government could give every single one of us a trillion dollars. But that would make no one rich. It would make us poor. People don’t need “money”, they need the real stuff that the money is intended to purchase. There is a certain point out there where more “money” no longer helps more than it hurts.

We are at that point.

This is the reason why the Fed is raising rates right now, to cool down the economy. Jobs are already there. More spending right now is not likely to create more jobs, it’s just going to push up prices. I have already cited the data on this, but maybe it’s worth reviewing: the U3 official unemployment rate is near 4%. The U6 underemployment rate is down to where it was before the Great Recession. Wage gains finally seem to be showing up. (We’ve probably reached the NAIRU: the non-accelerating inflation rate of unemployment.) Not mentioned earlier, but also true: capacity utilization is back around where it was in the naughties. It’s a fact that giving a trillion dollars to everyone is not going to help anyone. That’s easy to understand. But a corollary to that is that there is some point at which new money hurts, instead of helping, where more aggregate demand causes price increases rather than job creation.

Again: the Fed is increasing rates. Right now. They’ve been doing it for the last two years.

They are doing this to slow down aggregate demand. They are doing this to decrease spending in the economy, relative to where the spending would be if they didn’t act. Those two previous sentences mean the same thing. They think they’ve already reached that point. If the government hires a bunch of people in order to “increase demand”, the Fed is just going to increase interest rates, more quickly, to decrease demand until it’s back at the level that they want it to be to avoid the inflationary pressure that would happen otherwise.

This is literally their job. Again, this is just plain Keynesian economics. This is the entire reason why those interest rates go up and down. Fed policy-makers believe that more spending will only result in higher prices, not a net increase in jobs. Giving money to particular people will, of course, help those particular people but it’s going to come at some cost to other people.

What if an economist says that money doesn’t matter?

Then they’re wrong. They are indifferent to actual evidence.

What if someone says that there is more room for more aggregate demand between where we’re standing now, and giving everyone a trillion dollars (which is obviously excessive)? Well, clearly that’s a big window there. It’s a spectrum, not the binary case of those “money doesn’t matter” economists who are flatly incorrect. It’s at least a possibility that the Fed is tightening prematurely.

But given the previously mentioned evidence: if they’re wrong, they’re not wrong by much.

We’re living right now in the aftermath of a massive demand failure, and some people are pushing for any error to be in the opposite direction: missing by too much demand, rather than too little. People of that belief tend to believe that the Fed should be doing more, but not because it’s certain that there is more slack in the economy but because the cost of missing in that direction is assumed to be less than the cost of missing in the other direction of too little demand. That’s not necessarily a safe assumption. 2008 was a shitshow, yes, but too much demand is also a problem. It’s still destructive, just in a different way.

It seems more sensible to me to just aim for the right level of demand.

Absolutely true.

54

Fiat money is a currency without intrinsic value established as money by government regulation. So what’s currency? Currency circulates as a means of exchange or storage of value.

Currency backed by a valuable commodity – like gold certificates – is called “representative money,” and is technically a kind of fiat money, but usually the term is reserved for currency that is backed by nothing but the government that issues it.

So distinguishing between “debt markers” and fiat money fails, because the value of the “marker” is established by government regulation to be exactly the same as an engraved portrait of a dead president. As for your examples:

(a) Acme Widgets borrows $X from Wells Fargo and gets money added to its checking account.
Assuming that the loan is made from a pool of demand deposits that is not diminished by the loan, this creates $X.

(b) U.S. Treasury sells $X of notes to Wells Fargo and gets money added to its checking account.
© Wells Fargo sells the Treasury notes it got in (b) to the FRB.
These things don’t happen. The U.S. Treasury distributes notes to the Federal Reserve banks, who distribute them to private banks. The banks have accounts with the Federal Reserve, and it’s these accounts that are used when banks borrow (create) money or pay it back (destroy money). Each Federal Reserve bank, by law, holds collateral (mostly T-bills, but also bills of exchange or promissory notes) that equals at least the value of the currency it issues.

(d) Acme decides it wants in $X in cash; so Wells Fargo sends an armored truck to pick up the banknotes and delivers them to Acme.
This is just a change from the demand deposit account to banknotes – nothing is created.

55

He did so as part of a discussion on whether a debt marker is fiat money or not. But my answer was obviously inadequate to get my point across.

56

Debt instruments increase the money supply of the currency they are denominated in. If I write you an IOU for 100 USD and the market considers that debt so solid others will buy it off you for 100 USD, then it can be used as money and there is 100 USD more in the money supply. (Or one of the supplies, there is a ladder of definitions.)

Doesn’t matter if we’re talking 1812 or 1989, gold standard or not, trading the debt marker as dollars increases the supply of dollars and if I suddenly go bankrupt the money supply shrinks. What we consider part of the money supply is to a large degree independent of whether the currency is commodity backed or not.

57

Fiat money has no “intrinsic value”, no value in itself but only derived value from what can be acquired or purchased with it. Having a credit entry in the liabilities column of some institution’s accounting ledger – whether it be a government bank, a private bank, or even a retail business – is not valuable in and of itself. Nobody collects credit entries in institutional liabilities, solely for the purpose of having credit entries. They will, eventually, want to tap those entries for the actual things that they want to have.

The ledger entry is not valuable in and of itself, nor is it pegged today at a fixed exchange rate to any commodity that has intrinsic value, which can be called “representative money”. (I see this has already been noted.)

This is money created by Wells Fargo.

This is part of the “broad” money supply, not the monetary base which is created the central bank.

If the US Treasury kept accounts like this at private banks (which it does not, tho it did in the past), then Wells Fargo would have created the liability and that would be part of the “broad” money supply.

But today the government has its own bank, the Federal Reserve, and Treasury uses their account at the Fed for their securities sales. They no longer use private banks for these sorts of transactions.

When a financial institution sells its Treasuries to the Fed, the institution receives a credit entry in the liabilities column of the Federal Reserve’s ledger.

Acme possess cash with no intrinsic value.

The cash was previously recorded as a credit liability in the accounting ledgers of the Fed. (Acme’s decision to withdraw money from their Wells account dissolved the equivalent value of the liability Wells had to them, while the withdrawal also increased the amount of currency in circulation outside of bank vaults.)

Not “any debt instrument”.

You can get into debt with me and carry around an IOU that I personally wrote. That will be a debt instrument, but it will not be money because it won’t be accepted by anyone as money. The particular debt of banks, however, is very often spendable just as easily as cash – or in some cases, even more easily than cash. It’s a debt instrument that acts as a medium of exchange, where my hand-written IOU would not.

There is no distinction here.

All modern fiat money is recorded as a liability entry in some institution’s ledgers. Today it’s “debt markers” all the way down. That doesn’t mean all debt instruments are money, but it does mean that all fiat money is a debt instrument of some kind, at least according to the accountants.

Central bank liabilities legally work very differently from private bank liabilities, but the accountants record them all in exactly the same way. It’s impossible to draw a distinction between “fiat money” and “debt markers” when all fiat money is a debt marker – not without drawing some sort of fine, idiosyncratic distinction that no one else will understand or recognize.

58

The U.S. government does not create money “by fiat” the way the government of Zimbabwe once did. If the U.S. government’s spending exceeds its income it must sell debt to the credit markets at a (long-term) interest rate set by private lenders. (There was some talk a few years ago of bypassing this by creating a trillion-dollar coin “by fiat.”)

The distinction seems meaningful to me, although I understand that the complexities of money will render the distinction less important than many other factors.

Yes, when the central bank buys trillions of dollars of government debt, the credit markets are, in effect, bypassed and my distinction may seem particularly pointless. (OTOH, I think the FRB is now hoping to begin selling its stockpile of Treasury debt.)

59

What the OP proposes is to run a really, really large budget deficit. Call it “Expansionary fiscal policy”.

If the Fed keeps interest rates at a level consistent with ordinary monetary policy, we’d expect a lot of inflation. Because the government is buying lots of military hardware, while the populace continues to merrily spend funds on hookers and beer volcanoes with their gargantuan tax cut. Or on books and computers. It doesn’t matter: there’s a ton of aggregate demand.

But the Fed could also have really tight monetary policy, choking off investment and consumption fueled by credit cards. Then inflation could be contained.

Maybe. It’s possible that maximum monetary policy tightness can’t overcome maximum fiscal looseness. I’m pretty sure it could when national investment exceeded the federal spending as a share of GDP as it did in the 1920s. Today, it’s less clear.

But c’mon. If the Fed raises reserve requirements sufficiently so that there is 0.1% as much money in the economy as there used to be, it’s hard to imagine that inflation wouldn’t be kept under control.

60

Yet the US government still creates money by fiat. The Fed is itself a government agency, and its powers are from an act of Congress.

Even governments that are hyperinflating can still practice the fiction that the government is selling to the public, and then the central bank just “happens” immediately afterward to buy all of the available debt, in order to finance that spending with money.

The legal requirement to sell to the public markets first is a fig leaf.

Regardless of any ostensible “independence”, central banks are (in most places) national banks that will ultimately follow the the political winds, and the dictates of the people in power in that nation. If the people in power are spending irresponsibly, the government bank will facilitate that irresponsibility by financing that spending with new money creation. If the US Treasury had trouble at its auctions, the Fed would indirectly support those auctions. Extensive spending will result in extensive money creation. Direct vs indirect financing of government debt is not a distinction that has ever mattered.