Fairy Tales of Coming State of the Union: Raise Money By Taxing/Borrowing

In "All Together Now: There Is No Deficit/Debt Problem,” I warned against the message calling for deficit reduction that the President will probably deliver in his State of the Union Address next month. I view the coming narrative as very likely to be composed of a number of fairy tales. I've already examined the fairy tale that the Government of the United States can involuntarily run out of money, or is in the process of involuntarily running out of money. This post examines the second fairy tale in the narrative, namely the idea that the Government can only raise money to spend by either taxing or borrowing.

How many times have we heard that the Government can only get US Dollars to spend by either taxing or borrowing. We must hear this from Cable News outlets and in the Washington Post and the New York Times at least a number of times every single day. Then we also hear it from hundreds of blogs across the country and from such Peter G. Peterson outlets as The Fiscal Times, and AmericaSpeaks. Based on these outlets one can't help wondering whether some transformation has taken place since the Founding of the Republic providing for US currency created by the private sector, and that it is private-origin currency that the Government must have in order to spend for its programs. Of course, this isn't true. The Constitution authorizes the Government alone to create United States Dollars. The Government has since delegated the task of printing money to the Federal Reserve Bank which prints the Federal Reserve Notes now in circulation, but, nevertheless the authority for such issuance comes from the Government and it still retains the authority to print Treasury Notes and to create money in other ways.

If you think about it further, the Government's creation of US Dollars is logically prior to either taxing or borrowing, since to either borrow US Dollars or get dollars through taxation, those dollars have to have been created by the Government at some time in the past. So, the notion that the Government can get money by either taxing or borrowing, and only in these ways, is a pretty obvious untruth, told by people who either don't understand where money comes from, or who want other people to believe that money for spending can only come from these two sources.

The truth is that the Federal Government doesn't need to, and also doesn't, raise its spending money from taxing and borrowing. The Federal Government doesn't even “fund” its expenditures as the users of its currency have to “fund” theirs. Most often these days, the Government spends money by marking up accounts in the private sector. The Government also spends by marking up State Government accounts, and by issuing checks to some people, and even by printing a relatively small amount of currency, and coining an even smaller amount of money. But, again, the Government, mostly uses its spending authority to mark up accounts, and it doesn't use the money it collects in taxes, or the money it has raised from borrowing, in its spending process.

There's only one main reason why the Government borrows money when it wants to deficit spend, and that's because Congress requires that it do that, not because the Government either needs or uses the money borrowed in order to spend. The rule that it must issue debt in these circumstances is a hangover from gold standard days.

Congresspeople probably believe that issuing debt when the Government deficit spends prevents or moderates inflation because borrowing removes cash from the economy that Government spending injects into it. It's true that it removes cash from the economy, but whether or not debt is issued to match Government spending, that spending still adds net financial assets to the private sector economy, and the fact that the net addition is a bond and not cash is no less, and may be more inflationary because bonds can be leveraged to a greater degree than cash deposits, and also command interest income. Government deficit spending still adds net financial assets (savings) to the private economy dollar for dollar, and that spending has nothing operationally to do with whether or not money is borrowed to correspond with the spending.

The requirement mandating such a correspondence has nothing to with the function of spending. Though it has everything to do with causing interest to be paid to foreign Governments and wealthy individuals -- “welfare” that the US need not pay them if it doesn't continue to practice debt issuance.

Government doesn't use money raised through taxation to spend, either. In fact, taxing actually destroys both private sector money and Government money. This becomes quite clear when you know what the Government does when it receives payment of taxes in cash. After the tax payer leaves the tax office, the cash paid is shredded by the government official.

So, if the Government doesn't spend the taxes it collects, but destroys the money, then why must it tax. In my view taxes have three functions. First, if the Government did not tax and also require citizens to pay their taxes with Government currency, then that currency would have no value. So Government taxes to establish and validate the value of its fiat money.

Second, Government also may tax to drain aggregate demand from the economy. When the economy is overheated, the best way to avoid inflation is to increase taxes.

And third, Government also needs to tax to re-distribute wealth in a democratic society. Mal-distribution of wealth is a great danger to democracy, as we are seeing in the United States today. One of the chief means of restoring a greater measure of economic inequality to the United States would be a reformed and much more progressive taxation system.

Lastly, not only is it true that the Federal Government raises money through means other than taxing or borrowing all the time, because it creates that money in the act of spending. It's also true that the money it spends is not the money it collects through taxing or borrowing. So, the idea that we must raise money by taxing or borrowing in order to fund our spending is a fairy tale.

On the other hand there is a kernel of truth to the tale, in the sense that Congress mandates that deficit spending cannot occur unless the Government issues debt. But this doesn't mean that the Government has the capability to spend only by raising money through taxing or borrowing. Instead, it means that Congress, itself has mandated a need for borrowing to accompany deficit spending. Therefore in place of the fairy tale, the Administration will tell, we see the real truth – namely that it is the fault of Congress that the Executive must borrow and incur new debt in order to deficit spend, and, consequently, also that it is the fault of Congress that we have a national debt today at all.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

Views expressed on this page are those of the authors and not necessarily those of Campaign for America's Future or Institute for America's Future