Over the last day or so I’ve (@greenm1981) gone back and forth with the Twitter arm of the progressive blog loadedorygun.net, on the subject of deficits and taxes. My original intent was to point out that progressives need to avoid the deficit when speaking about social and economic policy. Public finance is one of the most misunderstood subjects in politics and economics, and the Left is not exempt from that characterization. But, it is my fault for choosing to engage this misunderstanding in a tweet. My bad.
At the same time, we cannot ignore the power of social media in overcoming binding myths and promoting ideas that generate progress. So it is sort of a catch-22. What follows is an attempt to clear the air as to a misunderstanding that has emerged between @loadedorygun and myself.
I hold a lot of respect for the blog loadedorygun.net, and in the past they have been very influential in bringing about my own political awareness. I follow them on twitter so that others might be indirectly exposed to their message. I agree that government should serve to promote equality, well-being and social justice. My disagreement, however, is based upon my understanding of how taxes and deficits work at the federal level.
The left has long embraced the myth that taxes finance government spending, that deficits are inherently bad, and that it makes for sound fiscal policy to pursue balanced budgets. And for good reason, “the deficit” as it stands in the modern political discourse virtually guarantees that any politician with serious ambition, needs to humble before that old time religion. Ironically, Democrats in their desire to show themselves as responsible keepers of the public coffers, amplify the rhetoric of fiscal austerity in a futile attempt to prove they are the not the party of profligate waste.
All of this rhetoric is predicated upon the notion that since the federal government is constrained by what it receives in taxes, or what it can raise by selling bonds, that cutting taxes ties the hands of government to engage in socially useful activities. Cutting taxes, while offering some stimulus in the short run, only reduces the prospect of long term goals such as single-payer health care, clean energy infrastructure projects, full employment policys, etc.
But, government does not spend tax money. Rather, they spend by crediting their reserve account at the Fed, which is then debited by the account of the recipient of federal expenditures, such as veterans on the GI Bill or recipients of Social Security. Further, before dollars can be collected as taxes, they must enter the financial system through federal spending. In essence, the federal government creates money by spending. This ability to spend without prior reserves is common to governments that have sovereign control of their currency. In other words, they issue money that is not pegged to an external currency, and their debts are denominated in their own currency. Countries under these conditions (US, Japan, Australia, Canada, UK, etc.) are never cash constrained; they cannot go insolvent. States within the US, or member countries of the EU, do not enjoy this freedom to spend without constraint. But, the federal government does.
So then what about inflation? Why do pay taxes at all? The conventional wisdom that “printing money” creates inflation is a myth, and is not grounded in theory or experience. Inflation occurs when the price of inputs in the production process (oil, steel, labor, etc.) increase due to efforts to increase corporate profits, or because of some event that restricts their normal production (Hurricane Katrina). Inflation also occurs when the economy comes up against its real limits of production at full employment, in which case it is demand led. In today’s economy inflation is not a real concern; unemployment of both labor and capital is very high!
Taxes serve two functions. First, taxes destroy money. Taxes remove purchasing power from the economy. A progressive tax structure serves to regulate demand in such a way that reduces the tendency for incomes and wealth to flow towards the richest households, leaving the purchasing power of most households intact. Also, a progressive tax structure has what economists call a “countercyclical” effect on the economy: it dampens both booms and busts by removing an increasing amount of purchasing power in the former, and a decreasing amount of purchasing power in the latter. This is especially true if the progressive tax is on incomes.
Second, taxes create demand for the currency. When the federal government levies a tax it gets to choose the terms which serve to settle that tax. In the US taxes are only payable in dollars, therefore we demand dollars so that we can meet our tax liability. This process has been developed by a school of monetary scholars under the banner of Chartalism. This approach contrasts sharply with the conventional, ahistorical story that money emerged from barter. Unfortunately, there is no anthropological evidence for this claim and it only persists out of convention.
Ok, so what? My description of how taxes and spending work at the federal level exposes what has come to be an inversion (or perversion?) of the relation between the deficit and economy. The deficit - the difference between tax revenues and spending - is a means to an end. The end I have in sight, as do Progressives, is full employment and social justice. But in politics, the deficit has become an end in itself. All of our policy goals are subsumed to whether it results in a reduction of the deficit, or at least having a neutral effect. This inversion of means versus ends results in Progressives taking the stance that tax cuts are not good in this economy, or that it will make it impossible to afford larger agendas. This is misguided.
Tax cuts, at the federal level, increase aggregate demand. Surely, cutting top marginal tax rates on high income earners or extending estate tax cuts have a negligible effect compared to direct job creation. But, not all taxes are the same. Payroll taxes - medicare and social security - are regressive taxes on income. They are not necessary to fund those programs and their continued presence shifts the burden of taxation from the rich to the poor. Suspending all payroll taxes immediately would increase purchasing power of all wage earners. And, cutting payroll taxes would reduce the level of wage inequality, immediately. Since payroll taxes are split between the wage earner and the employer, employers would see an immediate relief as well.
To be clear, for the sake of stability and equality the top marginal rates on income need to go back to their post-WWII rates, or at least their post-Kennedy rates. And we need a hefty estate tax so that you can’t create a tendency towards dynastic wealth accumulation. We also need to push for a federal job guarantee program, that places the government as “employer of last resort.” There is no better way of achieving full employment and we can afford it.
But, if the Left wishes to retain any power in government it ought not pursue a tax increase of any kind! Until those that wish to find employment are presented with the opportunity, and until the middle class sees a substantial tax decrease, any attempt to raise the top marginal rates will be used like a weapon. Not seeing any effect on their earnings, middle class voters will accept the lies that the Dems raised their taxes, and they will turn even further to the Right.
If you suspend payroll taxes, create jobs directly, you will see a reduction of the deficit to follow, because more jobs means more tax revenue. Only after that will there be the political capital to pursue more progressive goals.
Curious as to the source of my radical interpretation of public finance? Here are some great sources for a more technical reading: