If the government can “print” all the money it needs to pay for its activities, why do we need taxation? Eliminating taxes would surely be a campaign platform that everyone would love to vote for. Unfortunately, except for libertarians who view all taxation as theft, no one believes it is possible to eliminate taxes. Even Modern Monetary Theory includes a strange justification for taxes. 

Modern Monetary Theory justifies taxes as a way to create a demand for government currency as though the only reason people will accept the legitimacy of currency issued by the government is if they are required to pay taxes with that currency. Surely people accept the legitimacy of government currency because it is regarded as legal tender for all debts and there are laws enforcing its use.

What Modern Monetary Theory is really trying to do is reframe the functional analysis of taxation in a system based on a fiat currency that has no “intrinsic” value and to underscore the ability of a government to pay for things by “printing” money. It even defines fiat currency as “a tax credit not backed by any tangible asset.” [see Warren B. Mosler “Soft Currency Economics”]

The key insight of Modern Monetary Theory is that the government of a nation with its own currency is a unique economic entity and should not be viewed like a household or a business in terms of its income and expenses. It does not need income in order to pay expenses, but it does need a form of money which will be accepted as payment for goods and services.

In 1946 Beardsley Ruml, who was chairman of the Federal Reserve Bank of New York, published an article called “Taxes For Revenue Are Obsolete” in which he attempted to explain the real purpose of taxation:

What Taxes Are Really For

Federal taxes can be made to serve four principal purposes of a social and economic character. These purposes are:

1. As an instrument of fiscal policy to help stabilize the purchasing power of the dollar;

2. To express public policy in the distribution of wealth and of income, as in the case of the progressive income and estate taxes;

3. To express public policy in subsidizing or in penalizing various industries and economic groups;

4. To isolate and assess directly the costs of certain national benefits, such as highways and social security.

In the recent past, we have used our federal tax program consciously for each of these purposes. In serving these purposes, the tax program is a means to an end. The purposes themselves are matters of basic national policy which should be established, in the first instance, independently of any national tax program.

Mainstream economics does not regard taxation as an effective means of controlling inflation because raising taxes is politically difficult, and it thinks inflation can be controlled by monetary policy. Nonetheless the most immediate objection to a simplified notion of Modern Monetary Theory is that “printing money” is a surefire way to undermine the value of the currency and put us on the road to hyperinflation. Inflation prevention is surely the principal justification for taxation in Modern Monetary Theory and is the main caveat overlooked by many critics of the theory. What is involved is a shift in focus from deficit or surplus in the federal budget to inflation or deflation caused by direct changes in the amount of money circulating in the economy.

The use of taxation to redistribute wealth or income and its use as a form of behavior control are both political hot potatoes that many economists shy away from. They are clearly derived from policies that are beyond the scope of economics as such to evaluate – although some economists would argue that the accumulation of wealth in the hands of a minority is a way to promote growth. Taxing capital gains may serve another economic purpose in addition to redistributing wealth. It can be argued that the “creation” of wealth by appreciation in the value of assets like securities, commodities, collectibles or even real estate causes speculative bubbles which produce financial crises. Taxing capital gains more heavily might dampen this tendency.

Excise taxes such as taxes on alcohol or tobacco have been justified by cost benefit analyses given the effect they have on healthcare costs, but I suspect PR campaigns about the dangers posed by both have been more effective in curtailing their use than the economic disincentives represented by a slightly higher cost to the consumer. A more relevant example might be the proposal for a carbon tax as a way to fight climate change.

The textbook explanation of taxation is a bit broader or more generaI:

In taxing, government is in reality deciding how to draw the required resources from the nation’s households and businesses for public purposes. The money raised through taxation is the vehicle by which real resources are transferred from private goods to collective goods. [Samuelson/Nordhaus p.312]

This explanation is, of course, based on the assumption that the government must have revenue from taxes or loans in order to have money to spend in the acquisition of goods. The transfer of resources from private to public (collective) occurs when the government spends the money regardless of whether it is fresh off the printing presses or existing money raised by loans or taxation.

It must be emphasized that Modern Monetary Theory applies only to sovereign currency. State and local governments that do not generate their own currency must raise money the old fashioned way i.e. by taxes or loans. One implication of this may be that it would make sense to have state and even local currencies in addition to the national currency. To some extent the introduction of the Euro has backfired because it has become more difficult for countries in the European Union to deal with their own domestic fiscal issues even though the Euro has streamlined international trade within the union.

Taxation is not the only tool for preventing inflation. If money is created by credit extended then the amount of new credit extended to companies or individuals can be tailored to prevent excess money in circulation. Control over money creation is probably a more immediate and effective method for preventing inflation caused by excess money in circulation. It is the equivalent of the monetary policies currently used, but it has the advantage of being a more direct control over the amount of credit available. There is no “pushing on a rope” with lower interest rates.

Relying primarily on money creation rather than taxation to prevent inflation would probably mean that the main justification for taxation is the redistribution of wealth or income. Everyone decries the outrageous imbalance in the distribution of wealth in the US, but few seem to want to vote for a level of taxation that would seriously alter it. Eliminating interest-bearing loans and stock market speculation might go a long way towards reducing income inequality, but it may only be through radical changes in income tax rates and estate taxes that the distribution of wealth can be restored to anything like a reasonable level. Before any of this could happen, though, we need a fundamental change in our understanding of money and finance.

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