A Meme For Money, Part 4: The Alternative Tax Meme

By L. Randall Wray

Let us continue to develop an alternative frame for money. As you know, MMT says that “taxes drive money”. Let’s develop that further.

According to the orthodox meme, taxes are bad—the far right views them as outright theft—so the lower they are, the better. Most view taxes as necessary to “pay for” government spending, but again since in the conservative framing, government does next to nothing that is useful this represents a redistribution from productive, private, use to public waste. Hence, again, it is best to keep taxes as low as possible to “starve the beast” and to keep the private sector humming along.

Yet, from the state money view, the monetary system that we’ve actually inherited is a state money system. And from that framing, the most important purpose of taxes is to create a demand for the state’s money (specifically, for its currency). Further, as we’ll see, the state really does not need tax revenue to spend and in fact really cannot spend tax revenue. Our meme: taxes create a demand for the currency, ensuring willing sellers of goods and services for money.

Taxes serve two other important purposes, too. They can be used to regulate demand—by increasing costs and reducing net income. This is especially important as the economy reaches full employment; if the government continues to increase its resource intake it will drive up prices unless it reduces nongovernment use of resources. And sin taxes are used to reduce socially undesirable behavior (or tax credits are used to reward good behavior).

Another use of taxes is to prevent accumulation of wealth over generations—the so-called “death tax”—although it is doubtful that in practice inheritance taxes are very effective (at least in the US where tax rates have fallen and most wealth is excluded thanks to exemptions, evasion, and legally-sanctioned avoidance). However, Jamie Galbraith has argued that inheritance taxes do drive charitable contributions—including university endowments—which supports a large non-profit sector serving the public interest alongside government. So, to some degree, inheritance taxes can be used to drive resources to the charities.

So in addition to driving money, taxes can be used to further the public purpose.

We can examine in some detail three examples of use of taxes to further the public purpose: favorable tax treatment of mortgage interest, tax advantaged saving, and payroll taxes to “finance” social security.

All of these have unintended and perhaps undesired consequences, and may not actually be in the public interest. The mortgage interest deduction is widely believed to increase house prices. By lowering net after tax monthly payments, it allows owners to take on more debt and thereby pay higher prices. The deduction might also increase the demand for housing, which if supply constrained also pushes up prices. Home ownership is also believed to be socially beneficial (promoting stable communities and providing a secure asset against which families can borrow to finance education, or expensive healthcare). However, once home ownership is widely established as a nearly universal goal of households in a nation, it probably does not require a tax advantage—which may be more than offset by higher real estate prices, anyway. There is also the question about equity since homeownership and the benefits of the deduction are skewed to higher income families. For these reasons, it is not clear that the deduction is in the public interest.

Favorable tax treatment of saving—whether in individual retirement accounts or in pension funds—increases individual desire to save. However, as we know from Keynes that leads to the paradox of thrift: increased propensity to save reduces aggregate demand and thus income so that saving actually does not increase. While thrift is a private virtue, it is a public vice.

Nor is it even possible to provision for future retirement through financial means—as J. Fagg Foster (following Keynes) put it so clearly.^[1] Financial saving cannot transfer aggregate purchasing power from the present to the future. The financial “sinking fund” can actually make it more difficult to provision in the future, by depressing demand and thus investment in capacity today. Only investment, today, in productive capacity can actually help to provision for the future.

And, as Keynes insisted, saving does not “finance” investment—indeed it is better to see investment as “financing” saving in the sense that the income to be saved is generated by the investment spending. Again, Foster’s take on this is informative: saving is the pecuniary accounting of the investment. It looks like this is another poorly designed feature of the tax system.

With that in mind, let us look at the third example: imposing payroll taxes to “pay for” social security retirement. While the US Social Security program began as “paygo” (revenues set to more or less match benefit payments through time), after 1983 it became “advanced funded” with taxes set high enough to accumulate a “trust fund” (sinking fund) to be drawn down in the future. We won’t go into all the problems here, but let us focus on three topics: the undesired consequences of taxing wages and salaries, the accumulation of trust funds, and the belief that taxes “pay for” benefits.

The US payroll tax as designed is flat up to a base income after which it drops to zero. Hence overall it is a regressive tax. It is applied only to income derived from work, and taxes both employees and employers. Hence, as supply siders would say, it drives a “wedge” between the cost of labor and take home pay. It reduces both the incentive to work and to hire labor. To the degree that this actually does reduce employment and output, the payroll tax makes it harder to provision for retirees in real terms—both today and into the future if investment is thereby reduced.

In spite of what my teenage son thinks, work is not a sin that we want to reduce, so why tax it? Obviously, reduced employment is counter-productive to the purposes of the social security program—supporting retirees with real goods and services. For the reasons discussed previously, a sinking fund makes this even worse. So accumulation of a trust fund not only cannot add to “national savings” that can be drawn down in the future to support aged persons, but it might even reduce national saving through the paradox of thrift’s effects on investment.

And finally we turn to the main conventional “tax meme”, the notion that taxes are needed to “pay for” government provision of services and “entitlements” like Social Security. This meme is adopted by both conservatives and liberals, but it suits only the purposes of the conservatives. It is a disaster for progressives. And it is wrong.

Conservatives have used this meme to great advantage since the early 1970s, as they successfully changed the framing of taxes from “the price we pay for civilization” to something closer to “fee for service” payments to government made by “stakeholders”. This was important in the US for the “devolution of government” in which primary responsibility for many government services was moved from the federal to state and local governments. (In the US, since 1960 the federal government has not grown relative to GDP, while state and local governments grew rapidly until around 1980, to become approximately two-thirds the size of federal government—reflecting the devolution trend.)^[2]

In many cases, these extra responsibilities were imposed on state and local governments without federal funding—“unfunded mandates”. That necessitated local tax increases that were sold on the basis that they would pay for enhanced services—which were typically targeted to middle class homeowners.

And that promoted the view that taxes are paid in exchange for government-provided services, some of which are targeted to the “stakeholders” (suburban homeowners) who paid the taxes.

At the same time, social welfare “entitlement” spending grew (some due to “unfunded mandates”). Aided and abetted by Daniel Patrick Moynihan’s “culture of poverty” thesis, the taxpaying stakeholders grew increasingly angry that “their” taxes were being used to pay welfare to the “undeserving”. Problems were compounded by white flight from cities to suburbs and from public to private school. Parents of children in private schools objected to “their” taxes going to support public schools attended by the children of “others” (often of other racial or ethnic backgrounds).

Candidate Romney’s candid dismissal of the “47% who don’t pay taxes” reflects the orthodox tax meme: “those” people are not worthy of our attention because they are not stakeholders in our society.^[3] President Reagan successfully framed the social safety net as supporting “welfare moms driving Cadillacs”, while President Clinton “ended welfare as we know it” by setting lifetime limits on support for poor families with children in order to wean them from the public teats.

The point is this: if taxes are seen to “pay for” government, then the stakeholders who pay more ought to get more from government. Progressives cannot win within this frame.

Everyone knows what “pay for” means—we all go to the shopping mall, and we pull out our wallets to “pay for” the Gucci handbag. You do not grab the bag and look around for someone else to pay. “Hey bro’, I’m a bit short today; can you spare a few hundred to buy this for me?”

No, if you cannot afford the Gucci you buy the Wal-Mart store brand made in China.

It does little good to argue that those who can “afford” to pay taxes ought to do so for the benefit of those who need welfare. That is what the charity meme is for. Of course we all ought to give to charity—from each according to ability to each according to need. If the tax system comes down to charitable contributions, then it should be based on voluntary contributions. Good luck with that! The mixing of these memes will at best lead to confusion, but more predictably it will lead to tax revolt and social spending cuts. (Ex post predictions are relatively easy to make—that is precisely what happened after 1980. Liberals are still struggling to come up with a response.)

We need new tax and spending frames.

Part 5 and the rest of the series follows along next week.