Thursday, August 21, 2014

A Government is Not a Household

In 1996, economist Paul Krugman wrote an article titled “A Country is Not a Company.”  The article argued that many people don’t seem to understand that the macroeconomic issues facing a nation are often distinct from the issues facing companies—so different, Krugman contended, that “business leaders who have been promoted to economic advisers are no more likely to be great economists than military experts.” 

By the same token, many people don’t seem to understand that a government is not a household, and it’s common for politicians to take advantage of this fact: “Government needs to tighten its belt,” we’re told, “just like families sitting around the kitchen table have to do to put food on the table.”  But does the U.S. government, operationally speaking, really have to either tax or borrow before it can spend, just like any household has to have enough income or borrow money before it can purchase goods and services?  The answer, perhaps surprisingly, is no, because the government is the monopoly issuer of the currency.

What do I mean by that?

The economist Warren Mosler explains it this way: Consider how the government collects taxes.  When you pay taxes, the government adjusts the number in your checking account downward to reflect the amount paid.  If you had $1,000 in your checking account and paid $200 in taxes, the government just changes the $1,000 to an $800.  Notice that the government doesn’t actually collect anything real from you—it’s not as if you’ve handed over a sack of gold bars to the government to drop into its coffers.  All the government did was change numbers in your bank account; nothing “went” anywhere.

Alternatively, you might choose to pay your taxes by mailing a check or physically delivering cash to the IRS—not advisable, but some people do it.  What does the IRS do with this cash?  It doesn’t add it to a pile of money stored in its basement, waiting to be handed over to the Treasury.  It throws it away.  So if the government throws away your money when you pay your taxes, how do your taxes “pay” for government spending?  In a literal sense, they don’t.

Now, some of you are saying, “Wait a minute.  If the government doesn’t ‘get’ anything from taxes that it can later ‘use’, then how does the government spend?”

Suppose that when you filed your tax return this year, it turned out that the government actually owed you money--$200 to be exact.  If you had $1,000 in your checking account on Monday morning, but received your tax return from the government Monday afternoon, your account would then show that you had a balance of $1,200.  How did the government do this?  It changed one of the zeroes in your bank account to a two.  It didn’t mail you a $200 gold bar, all it did was credit your account by making data entries onto an electronic spreadsheet.  Yes, modern money is a spreadsheet.

To see this more clearly, imagine you are the scorekeeper of a card game, with the power to add and subtract points from all the players’ scorecards subject to the outcome of the game.  When you exercise this power, no one asks you where you got those points to add to the scorecard.  That is, no one wonders whether you have a hoard of points stashed away somewhere to ensure you have enough to add to each player’s scorecard.  You are the monopoly issuer of points! Similarly, when you subtract points from a player’s scorecard, it doesn’t “add” to the mound of points you have to give out.  As the economist Cullen Roche likes to say, the government neither has nor doesn’t have any money. 

In the United States, the government, working through the Federal Reserve Bank and the Treasury, is the scorekeeper, and we are the players.  That’s the difference between the government and a household.  What that means for all of us is that the U.S. government can literally never run out of money because it is the issuer of money, just like the scorekeeper can never run out of points.  Asking questions like, “Where does government get the money?” like David did in an earlier post, literally makes no sense.  But people, of course, can run out of money.  

There was a time when this wasn’t true, when the government really was revenue constrained, particularly when the value of the dollar was tied to gold.  But the way many people think about economics is still clouded by this era of money, even though the U.S. closed the gold window in 1971.  It’s true that there are legal constraints regarding how much the government can spend—e.g., the debt ceiling—but those are self-imposed constraints that have nothing to do with how the monetary system functions.  So why do governments tax or “borrow” at all?  More on that in another post.

No comments:

Post a Comment