Whenever I write anything about public expenditure and taxation, I’m likely to get someone commenting that Modern Monetary Theory has shown that a government with its own currency does not need taxation to finance public expenditure. I’ve tried a couple of responses to this, but now I think I can explain better why this argument is
(a) wrong in terms of (what I understand to be) the central claims of MMT
(b) regressive in terms of taxation policy
(c) politically pernicious
Starting at the beginning, as I read the central argument of MMT on fiscal policy, it is based on the idea of functional finance. The idea is that governments should first decide on the appropriate level of public expenditure, that is on the allocation of resources between public and private consumption and investment. Next, they should consider the requirements of macroeconomic policy to determine appropriate levels of money creation and issue of public debt. Finally, they should set the desired level of taxation as residual, to balance the sum of total income (seignorage+net debt+ tax revenue) and total expenditure.
That’s one way of looking at things, and useful in a lot of ways. But now consider what happens to this story if governments decide that an increase in public expenditure is warranted. Assuming that levels of money creation and debt issue were already set appropriately in terms of macroeconomic policy, there is no obvious reason for them to change. But then the identity between income and expenditure implies that the increase in public expenditure must translate, dollar for dollar into an increase in tax revenue. Perhaps there is an explanation for why an increase in desired public spending would change the settings of macro policy in the direction of more money creation, but if so, I haven’t seen it. If the increase in public expenditure is only temporary (on a war, for example), it might make sense to run up public debt. But because this debt has to be serviced, it implies the need for lower spending or higher taxes in the future.
To turn this around, suppose you think, as most MMTers do, that the stance of macroeconomic policy is almost invariably too contractionary. Then, you would advocate more money creation and larger deficits. That implies lower taxation but, on the functional finance view, no increase in public expenditure. And, again, if you don’t accept that inference and say that higher public expenditure should be part of the fiscal policy mix that in turn implies that the level of taxes must be correspondingly higher than if public expenditure did not increase.
Turning to regressiveness, if the economy is fully employed (more precisely, if an expansion in public consumption and investment will take up resources that would others be used for private consumption and purposes) then any expansion of the money supply is effectively an inflationary tax on money balances – it must be, or else no resources would be transferred from private to public use. Considered as a tax, inflation is similar to a consumption tax (since money balances are used to provide liquidity for consumption) but more regressive, since high income households are likely to hold less of their assets in cash or near-cash forms. Either way, inflation is regressive when compared to an income tax with a progressive scale, or even a threshold.
Finally, the claim that government expenditure does not require taxation is politically pernicious. Even if it is true in some limited cases (I don’t think it is), the way it is made leads people to dodge the issue that taxation is the price of civilisation. One way or another we have to pay for what we consume, and it’s silly to try and dodge this. It’s particularly damaging to the extent that MMT is associated with the left. The last thing the left needs is to be portrayed as offering a deceptive ‘free lunch’, which is exactly what the misreading of MMT discussed here would seem to be.