Modern Monetary Theory

[Elvis]

In the paper, Kelton argues that when money is spent by Treasury, it's considered a debit; when some of the money is repaid in taxes, that's considered a credit. It balances to zero—*poof*—like repaying a loan principal.

Or like redeeming one of Krugman's babysitting coupons: the coupon can't be used again.

The argument is debatable if only because some others will dispute it, but so far it seems correct to me.

[JackRiddler]

This is what occurred to me. The accounting and the legal appropriation (spending) of money and issuance of bonds count more than the imagined location of a particular unit that was income, became taxes, and landed in a treasury account. In the accounting, when it goes out of the federal government or central bank, it is issued as money in the economy. When it comes in, it is removed. I like my preferred words for this, issued and removed, better than those used by economists and most of the time MMTers', by the way. Create and destroy makes it seem more material than it is.

PS - Moderate headache today, I feel like telling the world here. Damn it.

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[JackRiddler]

So since you were reading a scholarly piece about the history of TT&Ls, why do they exist? Or what is the official reasoning for having originated this practice, historically? Let me be lazy. You can just explain what you found out. (I'm guessing it's a kind of counterbalance to avoid a capsizing shock to bank reserves every April when a lot of money gets shifted around?)

Banks are not intermediaries of loanable funds - facts, theory and evidence
Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.

Published on 26 October 2018
Staff Working Paper No. 761
By Zoltan Jakab and Michael Kumhof

In the loanable funds model that dominates the literature, banks are nonfinancial warehouses that receive physical commodity deposits from savers before lending the commodities to borrowers. In the financing model of this paper, banks are financial institutions whose loans create ledger-entry deposits that are essential in commodities exchange among nonbanks. This model predicts larger and faster changes in bank lending and greater real effects of financial shocks. Aggregate bank balance sheets exhibit very high volatility, as predicted by financing models. Alternative explanations of volatility in physical savings, net securities purchases or asset valuations have very little support in the data.

https://www.bankofengland.co.uk/working ... d-evidence

Technology as integrated into institutions: expanding the list of actors affecting institutional conditions of cooperation
Authors: Per Forsberg
Abstract
This study seeks to overcome the gap between institutions and technology in the literature of the commons. It emphasises the importance of inviting and testing different technologies as actors that are of importance for resolving social dilemmas. In this study, a test is carried out to see if a certain accounting technology mediates factors that facilitate the sustainable management of commons. The technology that is tested in this study regards ‘notched sticks’ that were used as accounting in self-governed farming villages during the seventeenth and eighteenth centuries, especially in upper Dalarna, Sweden, when organising ‘new urban commons’. The findings are that the notched sticks did function as mediators, connected in a network that did affect several factors, or conditions, for sustainable management of commons. As such, the technology of sticks was an actor that served in mediating relations, decision-making and transparency. For example, as accounting technology the sticks did change situations with possible individual bounded rationality through the construction of social entities and methods for balancing rights and obligations. Considering how accounting technology can be integrated into institutions, this implies that awareness is needed when changing and implementing technological solutions.

Keywords: Self-governed organizations, critical accounting, performativity of accounting, actor-network theory, cooperation
DOI: http://doi.org/10.18352/ijc.784

I pick up some of this stuff at an FB group you, Elvis, will probably want to join:
https://www.facebook.com/groups/964571730266588/

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[JackRiddler]

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So Wray talking about it inspired me to look up colonial money. Honestly, I found the burning part a bit hard to believe. I read a couple of scholarly papers but I didn't keep the links to post here. Here is what I learned:

Authors all say colonial moneys were the first paper currency not backed by any other commodity, the first true fiat for exchange in consumer markets. They were first issued to finance colonial militias to fight against Indians and French, by Massachusetts in 1690 and then on a much larger scale in the 1750s forward, in that period by most colonies. The rationale was always that these currency issues were "borrowed" against future taxes. As Wray maintained, the currency issues were always accompanied by new tax measures meant to collect an amount equivalent to the currency issue in stages, and thus to "repay" or "redeem" the issuance that was called a loan.

By the way, colonial taxes were mostly capitation or head taxes, meaning uniform charges per adult head. These were "progressive" insofar as slaveholders were taxed for each slave they owned, male or female. White females and children generally were not taxed, except for women who were heads of household, for example as widows.

Since the future taxes were payable in the paper currency, in practice this meant that the "loan" to the colonial government allowing it to issue paper money was "repaid" in the paper money it had issued, a kind of financial tautology or reversal of the actual sequence. (On issuing, the government isn't borrowing from the people, it's dispensing to them; when it collects back, it's not repaying them, it's inducing payment from them.) Once the paper money issue had been collected back in taxes and thus "repaid," it was considered to be "redeemed." Redemption was completed by burning the re-collected money. Redemption through burning, wow. There's your religious angle again.

This worked. Surviving accountings suggest that around 98% of such moneys were eventually collected and burned (and 2% if anything sounds like a low loss rate). There were a series of issues as needed to fund spending, so it got complicated. Whatever the language deployed, given that this form of money was previously unknown and unprecedented, it's pretty obvious that taxing it back was what "drove" it to be adopted as currency. That was why people treated it so universally, because it was good for paying a tax they had to pay. So the colonial governments issuing these moneys understood this principle of MMT.

The moneys were inflationary, at least insofar as each issue (depending on its issue date) fell against the Spanish and English currencies. This is hard to assess now. There were competing imperial currencies claiming metallic backing, which you don't have in the U.S. today. Also, macroeconomics didn't exist, so it's also hard to assess the impact of the currency issues in terms of employment, wages, households' ability to purchase a given basket of goods, standard of living, etc., on just the evidence of personal accounts. It is clear (and hardly surprising) that the Seven Years War meant a lot of jobs and capacity growth in manufacturing centers like New York. I didn't find anything about what farmers thought about paper money, whether they supported it like the Populists demanding greenbacks after the Civil War, or eschewed it for taxing them (and thus forcing them further out of self-sufficiency and into market dependency).

After the Seven Years War, the British clamped down on colonial scrip in 1764, presumably to avoid having a separate economy in colonial money out of their control, just as they wanted to raise taxes in the colonies. In the standard history, Parliament pushed to impose taxation on the colonists so as to raise revenues, so that they would finally repay "their" share for defense against the now-defeated French. I don't know if anyone has written a reverse of this, in which the British motivation was not so much raising revenues (which proved a failure in practice) as reestablishing a monopoly for the pound.

Fascinating how we're not taught any of this stuff in school. I don't think it would be taken as boring if done right. Kids are usually fascinated with money. The burning would be an attractive point.

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[JackRiddler]

Here is one about how the story then continued with the Continental currency during the independence war, which eventually came to be seen as a disaster in the 1780s. By the end, the Federalists were able to impose a system of higher taxation than the British had managed, to impose it with far more effective force, and to claim this was now all good since there was representation. Grubb seems about to argue that the Continental Congress also sabotaged the currency to help set off the crisis of the 1780s. I haven't had a chance to read it, however, but here's the links and teasers. Yeah, I realize I may have to email it or something if you don't have JSTOR access.

Farley Grubb. "State Redemption of the Continental Dollar, 1779–90" The William and Mary Quarterly, Vol. 69, No. 1 (January 2012), pp. 147-180.
Published by: Omohundro Institute of Early American History and Culture
DOI: 10.5309/willmaryquar.69.1.0147
https://www.jstor.org/stable/10.5309/wi ... .69.1.0147
Page Count: 34
Topics: Paper money, Continental congresses, Currency, Congressional resolutions, Currency swaps, United States history, Economic history, Taxes, Pollutant emissions, National treasuries

Abstract
From 1775 through 1779 Congress financed the War for Independence (1775–83) largely by issuing paper money—the Continental dollar. A lot of dollars were issued and inflation ensued. In 1779 Congress discontinued emissions and shortly thereafter abandoned paper money. In 1780 Congress recommended that the states revoke the Continental dollar’s legal tender status, which the states quickly did. In 1781 Continental dollars ceased to circulate as a currency and markets for trading them soon disappeared. They were supposedly trashed and forgotten. “Not worth a Continental” became a common derogatory phrase. The history of the Continental dollar is important for understanding the financial development of the early Republic. If nothing else, that history shaped the debates and decisions at the 1787 Constitutional Convention regarding how monetary powers would be changed in the new U.S. Constitution. This essay examines yearly remittances of Continental dollars to the U.S. treasury by each state from 1779 through 1789. The states met their requirements after 1780 by significantly raising taxes and by taking Continental dollars at substantially depreciated rates. These actions helped destroy the usefulness of Continental dollars as a money.

Author Information
Farley Grubb
Farley Grubb is a professor of economics and NBER Research Associate in the Economics Department at the University of Delaware (e-mail: grubbf@udel.edu; Web site: http://myprofile.cos.com.ezproxy.gc.cuny.edu/grubbf16). Preliminary versions of this article were presented at Binghamton University, State University of New York, and the 2008 American Economic Association annual meeting, Jan. 4–6, New Orleans. The author thanks the participants at these presentations and Christopher Hanes and Peter Rousseau for helpful comments. He also thanks Nayla Dahan, Kelly Lynn Perkins, Nathan Richwine, and Zachary Rose for research assistance and Tracy McQueen for editorial assistance.

Federalist anti–paper money rhetoric is well known and well documented, but the actual redemption history of the Continental dollar post-1778 is not.8 Sorting out this history by compiling the quantitative evidence on state compliance with congressional resolutions regarding the redemption of Continental dollars will contribute to identifying where the problems with the Continental dollar resided, to assessing the veracity of Federalist anti–paper money rhetoric, and to understanding the role played by the Continental dollar in the constitutional restructuring of monetary powers in the early Republic.

When Congress emitted Continental dollars, it also established procedures for their final redemption and removal from circulation. For the first emission of three million—those with the date May 10, 1775, printed on the bills—Congress passed remittance instructions on July 29, 1775. States were to remit set quotas of Continental dollars to the Continental treasury to be burned. Each state’s quota was roughly proportional to its population share in the Union, and Congress left each state free to decide how best to redeem Continental dollars from the citizens within its jurisdiction...

[Elvis]

So since you were reading a scholarly piece about the history of TT&Ls, why do they exist? Or what is the official reasoning for having originated this practice, historically? Let me be lazy. You can just explain what you found out. (I'm guessing it's a kind of counterbalance to avoid a capsizing shock to bank reserves every April when a lot of money gets shifted around?)

It's late and I'm feeling lazy, too, so I'll paste from the 1979 St. Louis Fed paper about TT&Ls I posted earlier. Part of the original idea was to encourage people to spend less, that is, consume fewer resources needed for the war. The paper is about a 1978 change in TT&Ls when Treasury introduced "Investment Accounts" attached to the TT&Ls (to further stabilize reserves), and they provide an illuminating history of the accounts:

TT&L Note Accounts and the Money Supply Process
RICHARD W. LANG

[snip]

TREASURY BALANCES AT BANKS

Background

Originally, TTL accounts at commercial banks were called Liberty Loan accounts. Created by Congress
in 1917 in the Liberty Loan Act, these accounts facilitated the issuance of Treasury securities (Liberty
bonds) to finance government expenditures during World War L1 Proceeds of the sale of Liberty bonds
were deposited in Liberty Loan accounts at commercial banks instead of in the Treasury’s account at the
Federal Reserve Banks. Thus, the deposits used to pay for the bonds remained in the banking system until
spent by the government. The Liberty Loan accounts avoided an increase in the volatility of deposit and
bank reserve flows which could have resulted from the war-financing effort. Moreover, this system also
encouraged banks to purchase Liberty bonds for their own accounts and to act as underwriters of these
Treasury issues in selling them to the public.2

In 1918, the Treasury extended the provisions governing the use of Liberty Loan accounts, allowing federal
income and excess profits taxes to be deposited in them. The accounts were renamed War Loan
Deposit accounts, and banks were required to pay interest on the funds in these accounts at the rate of
2 percent per annum. These balances were essentially interest-earning demand deposits.

When the Banking Act of 1933 prohibited the payment of interest on demand deposits, interest payments
on War Loan Deposit accounts were also eliminated. Furthermore, the Banking Act of 1935 made
these accounts at member banks subject to the same reserve requirements as those placed on private demand
deposits.

Balances in War Loan Deposit accounts increased rapidly during World War II with the increased issuance
of government debt to finance the war. After the war, Congress continued to broaden the use of
these accounts to include deposits of more types of tax receipts, including withheld income taxes and
Social Security payroll taxes. In 1950, the accounts were renamed Tax and Loan accounts.

Currently, TTL accounts continue to serve as deposit accounts for the proceeds from the sale of U.S.
government securities (particularly savings bonds), as well as for such varied tax receipts as withheld income
taxes, corporate income taxes, excise taxes, employer and employee Social Security taxes, federal
unemployment taxes, and taxes under the Railroad Retirement Act of 1951.

Treasury Management of TTL Accounts

One of the main objectives of establishing the original Liberty Loan accounts was to minimize fluctuations
in the aggregate levels of bank deposits and reserves that can result from sales of government
bonds. This objective later was extended to include minimizing fluctuations in deposits and reserves that
can result from tax payments. If the Treasury had no accounts with commercial banks, proceeds of bond
sales and tax payments would be deposited in the Treasury’s account at Federal Reserve Banks. Deposits
thus would be transferred out of the banking system, and bank reserves would decline. These funds
would be returned to the banking system only when the Treasury issued checks drawn upon its account
to make purchases or transfer payments.3

The Federal Reserve can use open market operalions to offset such fluctuations in bank reserves.
The Open Market Desk can purchase government securities (which increases bank reserves and deposits)
when the Treasury’s balance at the Fed increases, and can sell government securities when the Treasury’s
balance at the Fed declines. Such “defensive” open market operations effectively neutralize the effect that
shifts in Treasury balances between commercial banks and the Fed have on bank reserves.

Prior to 1974, the Treasury tended to minimize fluctuations in its balances at the Fed by maintaining
funds at commercial banks until they were disbursed. Consequently, the Fed had only to make relatively
small defensive open market operations to smooth out changes in bank reserves associated with the Treasury’s
cash management.4

Although the Treasury earned no interest on these commercial bank accounts after 1933, it generally felt
that various services provided by banks (without charge) compensated for the lack of explicit interest
earnings. Such services included the sale and redemption of savings bonds, collection of taxes, and handling
of Treasury checks and other Treasury securities. Two Treasury studies of TTL accounts, one
in 1960 and another in 1964, found that these accounts were not a source of profit to banks; the cost of providing
services to the Treasury was generally greater than the value of the TTL accounts to the banks. A
similar study in 1974, however, found the reverse, primarily because of increased market interest rates and
the exclusion of certain items that were previously counted as costs of providing bank services to the
Treasury.5

In order to increase its return from TTL accounts, the Treasury proposed in 1974 that Congress permit
TTL balances to earn explicit interest. While Congress debated the Treasury’s proposal, the Treasury changed
its cash management procedures to reduce its balances at commercial banks (chart 1). The Treasury began
to quickly shift funds deposited into TTL accounts to its account at the Fed. Average Treasury balances at
the Fed and their volatility increased substantially after 1974 (chart 2). Swings in the weekly Treasury
balance at the Fed, which averaged $533 million in 1974, more than doubled in 1975 to an average of
$1,388 million (table 1).

The Treasury viewed its increased balances at the Fed as a way to earn implicit interest on its funds. The
Fed would offset the decline in bank reserves result ing from such a shift of Treasury balances by increasing
its portfolio of government securities (to stabilize either the federal funds rate or the level of bank
reserves). With a larger portfolio of interest-earning assets, Federal Reserve income would rise. Since the
Federal Reserve turns over its earnings after expenses to the Treasury as “interest” on the issuance of Federal
Reserve notes (currency), the Treasury expected its Income” from the Federal Reserve to increase
under this system.

This approach to managing the Treasury’s balances increased defensive open market operations and complicated
both the management of bank reserves and the short-run stabilization of the federal funds rate.7 As
weekly swings in Treasury balances at the Fed became larger, weekly swings in Federal Reserve holdings
of government securities (the major source of bank reserves and the monetary base) also increased
(table 1). The increased volatility of the Treasury’s balance at the Fed made the prediction of its effect
on bank reserves more difficult. At times the Fed requested that the Treasury redeposit funds into TTL
accounts, so that the Fed could avoid making direct purchases of securities to maintain its desired level of
bank reserves in the face of these shifts.8

[more] https://files.stlouisfed.org/files/htdo ... ct1979.pdf

Here's a chart from the paper. I wonder what accounted for the mid-'70s dip? Post-Vietnam "peace dividend"? Seems that either fewer taxes were being paid, or Treasury was pulling funds out at a higher rate (or both).

TT&L Averages 1950-79.jpg

The Social Security Trust Fund is another ball of wax, but related...

Currently, TTL accounts continue to serve as deposit accounts for the proceeds from the sale of U.S.
government securities (particularly savings bonds), as well as for such varied tax receipts as withheld income
taxes, corporate income taxes, excise taxes, employer and employee Social Security taxes, federal
unemployment taxes, and taxes under the Railroad Retirement Act of 1951.

Amounts equalling the FICA (Social Security) taxes are (eventually?) used to buy the non-tradable U.S. bonds that make up the Social Security Trust Fund. Note that here the government is buying bonds from itself. As I understand it, at the end of the fiscal year, the bonds are sold back to the Treasury. At this moment I think the FICA tax money probably ceases to exist; a deposit to the Treasury General Account might be recorded on the books, but by now we know that the whole budget as revenues vs. outlays is a constraining accounting chimera (metaphor check). Warren Mosler would say it's functionally no different than if the Treasury never sold the bonds to the Trust Fund in the first place. It's a never-ending mindbender!


I have JSTOR but can't find the log-in info. It's easy to register as an "independent researcher" so I can just join again or I find the old registration email. I saw some other macroeconomic things there I'd like to read.

[Elvis]

If anyone questions the fact that federal budget deficit produces a private-sphere surplus (and vice-versa), just show them these charts (they're roughly the same but the first one includes the foreign sector, also interesting to track):

Sector Balances.jpg

Deficit - Surplus.jpg

Particularly notice the flatline domestic economy right after the vaunted Clinton federal surplus and the massive dip in non-government savings/wealth—starting well before Sept 11, 2001.

Warren Mosler addresses this relationship in "Seven Deadly Frauds" (omitting the "but Innocent" part), with this funny story:

In July 1999, the front page of the Wall Street Journal
had two headlines. Towards the left was a headline praising
President Clinton and the record government budget surplus,
and explaining how well fiscal policy was working.

On the right margin was a headline stating that Americans weren’t
saving enough and we would have to work harder to save
more.

Then a few pages later, there was a graph with one line
showing the surplus going up, and another line showing savings
going down. They were nearly identical, but going in opposite
directions, and clearly showing the gains in the government
surplus roughly equaled the losses in private savings.

To some extent the mainstream state of denial must be massive, deliberate fraud. And as I'll show later, it's a political "no-go."

[Elvis]

Note that amounts in the TT&L accounts are not "money"—thus they're not included in any aggregate such as M1, M2 etc. Nor are Treasury bonds considered "money," not even in M4, the aggregate of T-bills. T-bills are short-term (less than a year), bonds are long-term (20-30 years); T-bills are more liquid, but neither T-bonds or T-bills are included in any of the "M" money supply measurements.

Here's a handy chart from Wikipedia, explaining the various M's etc.:

Money Supply M nos.jpg

https://en.wikipedia.org/wiki/Money_supply

Below are the types of aggregates used in the U.S.:

United States

The Federal Reserve previously published data on three monetary aggregates, but on November 10, 2005 announced that as of March 23, 2006 it would cease publication of M3.[15] Since the spring of 2006 the Federal Reserve has only published data on two of these aggregates. The first, M1, is made up of types of money commonly used for payment, basically currency outside banks and checking account balances. The second, M2, includes M1 plus balances that generally are similar to transaction accounts and that, for the most part, can be converted fairly readily to M1 with little or no loss of principal. The M2 measure is thought to be held primarily by households. As mentioned, the third aggregate, M3 is no longer published. Prior to this discontinuation, M3 had included M2 plus certain accounts that are held by entities other than individuals and are issued by banks and thrift institutions to augment M2-type balances in meeting credit demands; it had also included balances in money market mutual funds held by institutional investors. The aggregates have had different roles in monetary policy as their reliability as guides has changed. The following details their principal components:[28]

M0: The total of all physical currency including coinage. M0 = Federal Reserve Notes + US Notes + Coins. It is not relevant whether the currency is held inside or outside of the private banking system as reserves.

MB: The total of all physical currency plus Federal Reserve Deposits (special deposits that only banks can have at the Fed). MB = Coins + US Notes + Federal Reserve Notes + Federal Reserve Deposits

M1: The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits

M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).

MZM: 'Money Zero Maturity' is one of the most popular aggregates in use by the Fed because its velocity has historically been the most accurate predictor of inflation. It is M2 – time deposits + money market funds

M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.

M4-: M3 + Commercial Paper

M4: M4- + T-Bills (or M3 + Commercial Paper + T-Bills)

L: The broadest measure of liquidity, that the Federal Reserve no longer tracks. L is very close to M4 + Bankers' Acceptance

Money Multiplier: M1 / MB. As of December 3, 2015 it was 0.756.[29] While a multiplier under one is historically an oddity, this is a reflection of the popularity of M2 over M1 and the massive amount of MB the government has created since 2008.


Although the Treasury can and does hold cash and a special deposit account at the Fed (fed funds), these assets do not count in any of the aggregates. So in essence, money paid in taxes paid to the Federal Government (Treasury) is excluded from the money supply. To counter this, the government created the Treasury Tax and Loan (TT&L) program in which any receipts above a certain threshold are redeposited in private banks. The idea is that tax receipts won't decrease the amount of reserves in the banking system. The TT&L accounts, while demand deposits, do not count toward M1 or any other aggregate either.

Mulling the significance of taxes being excluded from the money supply. Seems like TT&L amounts become "money" when commercial banks with TT&L "note options" accounts are investing or lending it. (About two thirds of tax payments are put into the "note option" accounts.) Any time it's "the government's money," say when it's eventually put into a Treasury bond (which is not "money"), then I suppose it wouldn't be liquid "money" until the government spends it (which would be "never"?)


I watched Ron Paul grilling Bernanke about gold: "Is gold money?"
Bernanke: "No."
This infuriated Paul, he couldn't believe anyone could be so stupid.
Bernanke added, "Are Treasury bonds money?—I don't think they are."
Ron Paul just kept yelling, "For thousands of years, gold blah blah blah!...."

Interesting, though, when Paul asked Bernanke, 'Why then, does the Fed hold gold reserves?'
Bernanke didn't know what to say, then shrugged and said, "Tradition."

(Bernanke quit the Republican party when he "lost patience with Republicans' susceptibility to the know-nothing-ism of the far right.")


Also see: https://en.wikipedia.org/wiki/United_St ... asury_bill

[Elvis]

"I understand, but I can't go there."

Many public person deficit hawks of any stripe seem to understand that a federal deficit equals a private surplus, but it's political suicide to say so. Randall Wray says, "Policy makers probably don't want to understand it." For some deficit decriers, it's pretty clear they understand the principle very well, but they don't want it to become general knowledge (e.g. Laffer?).

Warren Mosler says in a 2012 lecture: "Anyone who's not for deficit reduction gets laughed off the stage."

https://www.youtube.com/watch?v=ba8XdDqZ-Jg (Mosler and Kelton together, addressing Columbia pre-law students; 2 hours inc. Q&A)

Al Gore understands it, says Mosler. Mosler gets around! Another kicker from Seven Deadly Frauds (2009):

(p.44)
Al Gore

Early in 2000, in a private home in Boca Raton, FL, I was seated next to then-Presidential Candidate Al Gore at a fundraiser/dinner to discuss the economy. The first thing he asked was how I thought the next president should spend the coming $5.6 trillion surplus that was forecasted for the next 10 years. I explained that there wasn’t going to be a $5.6 trillion surplus, because that would mean a $5.6 trillion drop in nongovernment savings of financial assets, which was a ridiculous proposition. At the time, the private sector didn’t even have that much in savings to be taxed away by the government, and the latest surplus of several hundred billion dollars had already removed more than enough private savings to turn the Clinton boom into the soon-to-come bust.

I pointed out to Candidate Gore that the last six periods of surplus in our more than two hundred-year history had been followed by the only six depressions in our history. Also, I mentioned that the coming bust would be due to allowing the budget to go into surplus and drain our savings, resulting in a recession that would not end until the deficit got high enough to add back our lost income and savings and deliver the aggregate demand needed to restore output and employment. I suggested that the $5.6 trillion surplus which was forecasted for the next decade would more likely be a $5.6 trillion deficit, as normal savings desires are likely to average 5% of GDP over that period of time.

That is pretty much what happened. The economy fell apart, and President Bush temporarily reversed it with his massive deficit spending in 2003. But after that, and before we had had enough deficit spending to replace the financial assets lost to the Clinton surplus years (a budget surplus takes away exactly that much savings from the rest of us), we let the deficit get too small again. And after the sub-prime debt-driven bubble burst, we again fell apart due to a deficit that was and remains far too small for the circumstances.

For the current level of government spending, we are being over-taxed and we don’t have enough after-tax income to buy what’s for sale in that big department store called the economy.

Anyway, Al was a good student, went over all the details, agreeing that it made sense and was indeed what might happen. However, he said he couldn’t “go there.”

I told him that I understood the political realities, as he got up and gave his talk about how he was going to spend the coming surpluses.

A good laugh line in the Mosler lecture linked above is the upshot of his meeting with Sen. Fritz Hollings of Gramm–Rudman–Hollings infamy. Hollings, like Gore, listened carefully to Mosler's argument and had to agree that large deficits were actually good. But it didn't sink in; he says to Mosler,

"Well, it's a pretty large number and I think we need to do something about it."

[Elvis]

Trying to understand the effect of the foreign trade imbalance, particularly with China, and China consequently parking its ample dollar reserves in the form of long-term Treasury bonds in savings accounts at the Federal Reserve. This technical term for this is, "OMG WE ARE BORROWING OUR CHILDREN'S FUTURE FROM CHINA!!"

From everything I've seen, China's dollars don't fund or finance anything; they sit in Fed accounts, earning a modest interest rate. If China "wants its money back," the Fed would essentially just move the amounts from China's savings account to China's "checking account" from where they could spend or withdraw it at any time.

Mosler says the trade imbalance with China and Japan is a net gain for the U.S., since Americans get the goods they want at the lowest price, while not exporting American resources which are better used at home. If the U.S. exported a similar amount of goods back to China, Americans would lose those real resources while getting what?—the same dollars back.

I heard someone on the radio explain how, for Americans, exporting to China is great at the microeconomic level: if I have a neat product that sells in China, good for me! Selling stuff to the Chinese is a good thing for individuals, families, businesses etc., and dollars don't come easy at that level. At the macreconomic scale, however, sending too many real, limited resources out of the country is a net loss when all the U.S. gets is some lousy dollars, which do come easy at the macro level.


So many dopey financial sites (investopedia e.g.) and MSM news outlets (not to mention uninformed brainiacs on Quora) confidently state that the federal government sells Treasury bonds as an alternate source of revenue to taxation. Even treasurydirect.gov tosses out the usual "the U.S. Department of the Treasury issues securities to raise the money needed to operate the federal government."

Here's a Reuters example:

https://www.reuters.com/article/us-usa- ... SKCN1HB34M
China, holding Treasuries, keeps 'nuclear option' in U.S. trade war
Trevor Hunnicutt, Kate Duguid

NEW YORK (Reuters) - It took China just 11 hours to retaliate against the United States for proposing tariffs on some 1,300 Chinese products, but Chinese officials are holding back on taking aim at their largest American import: government debt.

In a tit-for-tat response to the Trump administration’s plan for 25 percent duties on $50 billion of Chinese imports, China hit back with its own list of similar duties on key American imports including soybeans, planes, cars, beef and chemicals. But officials signaled no interest for now in bringing their vast holdings of U.S. Treasuries to the fight.

China held around $1.17 trillion of Treasuries as of the end of January, making it the largest of America's foreign creditors and the No. 2 overall owner of U.S. government bonds after the Federal Reserve. Any move by China to chop its Treasury portfolio could inflict significant harm on U.S. finances and global investors, driving bond yields higher and making it more costly to finance the federal government.

Despite the totally-wrong "common knowledge" about it, even as a beginning student of this stuff I can confidently state that the U.S. does not sell Treasury bonds for revenue. Take a look at these breakdowns of federal revenues, particularly Table 2.1 - Receipts by Source: 1934–2022.

https://www.gpo.gov/fdsys/search/pagede ... rowse=true

No bond revenue anywhere. Zoom in on the "Other" category, no amounts from bond sales in there (though that's where the profits that the Fed returns to Treasury are listed).


I think a lot of the problem is havng to explain to the average Joe Taxpayer, "We use your tax payments and savings bond purchases in a complicated macroeconomic scheme to stabilize bank reserves and control inflation and the money supply."

Sensble sounding explanation here:

https://www.nakedcapitalism.com/2010/08 ... ficit.html
Why Treasury Bonds Do Not Fund Our Federal Deficit
Posted on August 20, 2010 by Yves Smith

This is a particularly clear and succinct explanation of the role of Treasury auctions in monetary operations at Pragmatic Capitalism (hat tip BondSquawk), in a post I urge you to read in its entirety, “The Myth of the Great Bond “Bubble.”

The government bond market is merely a monetary tool that the central bank utilizes to control the cost (or supply) of money by controlling the level of reserves in the system. So, when the government auctions bonds they are merely targeting reserves in the system. This action is mandated by Congress as an accounting tool and so is seen as a source of funding, however, in reality the Central Bank is merely draining reserves that the Treasury already spent into existence – reserves that were deposited at various banks (read this process in greater detail here). Therefore, it’s incorrect to argue that there won’t be buyers of U.S. bonds – with the banks earning 0.25% on their reserves and the government offering anything above that (depending on duration) the trade is a no-brainer for the banks who hold these reserves. The government is basically offering them free money and the Central Bank keeps control of the money supply in exchange (at least in theory). What is not occurring is some sort of funding mechanism. The Fed could care less if the auctions are 2X, 3X or 4X oversubscribed. They don’t get extra money when this occurs. They don’t get a gold coin that can then be spent. So long as they meet the 1:1 bid to cover the auction is a huge success because they drained their targeted reserves and convinced Congress that we aren’t going bankrupt.

Yves here. This is the part most people don’t appreciate: the Federal government spent PRIOR to the bond auction by crediting bank accounts. The government does not fund its spending via bond auctions.

Also: I ran across this CSIS section about China ("ChinaPower Project - Unpacking the complexity of China's rise"), they seem pretty level-headed and this article about China and U.S. debt was helpful: https://chinapower.csis.org/us-debt/

[Elvis]

As an English duchess is reported to have said when being told of Darwin’s theories of human descent: “Let us hope it is not true, but if it is true, let us hope it does not become widely known.”

[JackRiddler]

How Federal Reserve notes came to be the main currency, in a history by the Federal Reserve. Interesting mix of very important moments (1933!) with relative trivia:

https://insidefraser.stlouisfed.org/2018/10/federal-reserve-notes/

Dismal Facts: Federal Reserve Notes
Posted on October 25, 2018

The Federal Reserve has the power and authority to use the words “Federal Reserve note” to turn paper into money.[1] That power is part of the original functioning of the Fed and is enshrined in the Federal Reserve Act of 1913. Specifically, the Act ordered the production of $5, $10, $20, $50, and $100 (but not $1) Federal Reserve notes.

[...]

[JackRiddler]

.

I've met Nathan, he's kind of a boy genius.

https://daily.jstor.org/paper-money-rebellion/

TREASURY NOTES

Paper Money Rebellion

The Currency Act of 1764 returned the restrictions of 1751: banning colonists from printing their own legal tender bills.


The English lion dismember'd or the voice of the public for an enquiry into the public expenditure. By BPL [CC BY 2.0], via Wikimedia Commons

Nathan Tankus December 29, 2015

In France, a far-right party, the National Front has been on the rise. A year ago, the far left party Syriza won in Greece. These European political developments, and many others, have been driven by popular anger over the euro. Both the far left and the far right pillory “the Troika”—a concise name for the European Central Bank, the European Commission, and the International Monetary Fund, the institutions making monetary policy—for being powerful, yet unelected, bureaucrats. People are angry about not having democratic input into decisions about their own currency. Citizens gather in the streets holding signs that read “Troika Go Home!” or “People United Against the Troika.” All this is strikingly reminiscent of American colonial politics in the 1760s.

Throughout the 18th century, the question of who had the power to issue legal tender, or currency, was a contentious one between the British Parliament and American colonial governments. According to the law, debts could be paid with legal tender at the legal tender’s face value. Recall from the second Treasury Notes column that American colonial money was like a savings bond, so its present value was lower than its face value. Thus, British merchants expecting to be paid in sterling were paid in bills worth much less. Imagine expecting to be paid $100 and instead being forced by a court to accept 100 pesos—it’s understandable that the British merchants were upset.

The difficulty for the British Parliament was that these same paper monies were being used by colonies to pay for manpower and supplies needed to fight various wars. In 1751 Parliament passed an act restricting colonial money. However, a mere three years later, the French and Indian War (also known as the Seven Years’ War) forced the British to loosen those restrictions. The colonies were expected to provide soldiers and supplies to that war effort, and the only way to do this was to print paper money. According to historian Joseph Ernst’s classic account, the Currency Act of 1764 passed precisely because the war was over. Now that they no longer needed the colonies to use paper money to fight the war, British policymakers were most concerned with the interests of the British merchants who were owed debts by colonists. The Currency Act of 1764 returned the restrictions of 1751: banning colonists from printing their own legal tender bills. But, adding insult to injury for the colonists, it also placed new limits on their currency, requiring prior approval of any nonlegal tender bills by the Privy Council, a formal body of royal advisers. Nonlegal tender bills could still be useful because though colonists couldn’t force British merchants (or any private creditor) to accept them, the colonial governments would still accept them in payment of taxes or repayment of land bank mortgages.

In 1770 the Privy Council shocked colonial governments by vetoing multiple bills allowing colonies to print nonlegal tender paper money. In a letter to Benjamin Franklin, Joseph Galloway explained why this ruling was so shocking and outrageous to the American colonists:

I am greatly Surprized at the Conduct of Administration in Relation to the New York and New Jersey Paper Money Bills. The Reason assigned for their Rejections are really rediculous—And can be accounted for on no other Ground, than that they are determined, the Americans shall not have any Paper Medium at all….But How is their Conduct on this Occasion to be reconciled with what has passed heretofore?

Distant bureaucrats were applying inconsistent and economically unworkable rules on a population who had no say in making those rules. These restrictions caused considerable hardship in the colonies and, therefore, revolts, just like in today’s Europe. The most famous revolt related to the 1764 currency act was in North Carolina, where rebels called themselves “regulators” because they were attempting to ensure that the agents of the government themselves followed the law. A combination of local corruption and inability to print money worsened and accelerated a wave of foreclosures. When local courts and the North Carolina legislature brought them no relief, they closed those courts to stop the foreclosures, threatened the corrupt agents of the government, and began arming themselves.

Herman Husband was widely seen as a representative of the North Carolina regulators and explained the revolt this way:

This is a grievous burden on the poor, as matters have been carried on, for money is not to be had: And when a poor man’s goods is distrained [foreclosed on], the practice has been to take double, treble, yes ten times the value has sometimes been taken away. —And if they complain, they are not heard; if they resist, they are belabored like asses.

Merciful Lord, would any people rise in mobs to disturb a peaceable nation if they could help it! Who is more ready than the poor to venture their lives in time of war for the safety of the nation! Nay it is pinching hunger and cold, brought on them by abuse of officers, that is the cause.

Husband’s solution to the shortage of paper money was for people to pay taxes directly in whatever they produced. This was not unprecedented; items such as wheat and tobacco had been used to pay taxes in some colonies.

Ultimately the regulators were crushed—fittingly by soldiers paid in newly printed paper money. Their political legacy, however, lived on, and some historians argue the pressure they and other social movements put on colonial elites helped move their fellow colonists closer to breaking with the British Empire.

The Troika could learn something from early American history: when decisions about currency are made by unelected, distant elites, outrage and revolt is not usually far behind.

[Elvis]

https://www.nakedcapitalism.com/2010/08 ... ficit.html
Why Treasury Bonds Do Not Fund Our Federal Deficit
Posted on August 20, 2010 by Yves Smith

This is a particularly clear and succinct explanation of the role of Treasury auctions in monetary operations at Pragmatic Capitalism (hat tip BondSquawk), in a post I urge you to read in its entirety, “The Myth of the Great Bond “Bubble.”

The government bond market is merely a monetary tool that the central bank utilizes to control the cost (or supply) of money by controlling the level of reserves in the system. So, when the government auctions bonds they are merely targeting reserves in the system. This action is mandated by Congress as an accounting tool and so is seen as a source of funding, however, in reality the Central Bank is merely draining reserves that the Treasury already spent into existence – reserves that were deposited at various banks (read this process in greater detail here). Therefore, it’s incorrect to argue that there won’t be buyers of U.S. bonds – with the banks earning 0.25% on their reserves and the government offering anything above that (depending on duration) the trade is a no-brainer for the banks who hold these reserves. The government is basically offering them free money and the Central Bank keeps control of the money supply in exchange (at least in theory). What is not occurring is some sort of funding mechanism. The Fed could care less if the auctions are 2X, 3X or 4X oversubscribed. They don’t get extra money when this occurs. They don’t get a gold coin that can then be spent. So long as they meet the 1:1 bid to cover the auction is a huge success because they drained their targeted reserves and convinced Congress that we aren’t going bankrupt.


Yves here. This is the part most people don’t appreciate: the Federal government spent PRIOR to the bond auction by crediting bank accounts. The government does not fund its spending via bond auctions.

I forgot to mention that the (mile-long) comments following the post are again helpful; replies to skeptics of MMT hammering at one detail or another flesh out nuance and bring various perspectives. Here's one that suggests the present arrangement is not synonymous with what MMT calls 'the way money works' in the U.S.:

COMMENTS


anon
August 20, 2010 at 7:44 am

The article is incorrect in many ways. MMT has a lot of useful things to say, but it misrepresents the dynamics of treasury borrowing at the operational level.

In fact, the government is constrained (i.e. constrains itself) to a banking arrangement with the central bank whereby overdrafts are prohibited. This means that it is impossible for the government to spend beyond the level of current cash in its operating account, since to do so would mean incurring an overdraft position.

The only thing that MMT can reasonably say is that an alternative operational arrangement would be quite possible, whereby the government would in fact spend before borrowing, if such an overdraft limitation were lifted.

The government rules out such an alternative arrangement (i.e. constrains itself) due to the perceived risk that limitless overdrafts would invite continuous monetization of government expenditures without any borrowing at all. The substance of that risk is very debatable, and should be debated, and has been debated in the MMT context. But at the same time, MMT misrepresents this operational alternative as if it were the substance of existing operational arrangements, which it is not.

This may be helpful in understanding how things work presently to obscure the potential of the fiat money system.

[Elvis]

Stephanie Kelton and other MMT advocates often cite a 1946 article by Beardsley Ruml, then Chairman of the New York Fed. (I believe the article is quoted in this thread's OP, or at least first page.) I'll post it in full below, since it unambiguously explains why federal taxes are no longer needed for revenue (since 1933) and succinctly describes some basic emphases of MMT—all straight from the belly of the beast more than 70 years ago.

Its evident focus on corporate income tax is unsurprising considering the source (Wall Street)—but—Ruml does make good points as to why it's an odious tax. Randall Wray argues, just as Ruml does below, that if the aim of the corporate income tax is to reduce income inequality, it's much better to tax the owners, as opposed to the entire enterprise, where it adversely affects employment and prices (lose/lose). Ruml points out the problem of the owners shielding their investment incomes from income taxes.

A major current obstacle in the U.S., Wray notes, is that the corporate income tax is the progressive-liberal-leftist's most treasured and favoritest tax of all time, and any talk of abolishing or even cutting it elicits kneejerk reactions against the idea. We Lefties looove that corporate income tax!—and in a true "revenues pay for spending" regime, it would make some sense (though either way, taxing the owners should come first). Accordingly, it's safe to say that Ruml and today's MMT agree that in a fiat money system the corporate income tax is counterproductive.

Ruml seems to get a couple of things wrong, but hard to say whether that's because of 'knowing' the wrong thing or masking something else. To me, the main thing he gets wrong is in the fourth purpose of taxation, to isolate and assess directly the costs of certain national benefits, such as highways and social security. We know that Social Security benefits are paid directly with new money issued by Treasury when it writes the check or credits the recipient's account—and not paid from the Trust Fund (except by an accounting charade). Roosevelt conceded this much in 1936 and agreed the FICA tax served no economic purpose. This was as true in 1946 as it was in 1935, and is still true today. (I agree with Wray that the FICA tax should be abolished immediately.)

All that said, Ruml does write plainly: The public purpose which is served should never be obscured in a tax program under the mask of raising revenue. (There's that word mask again.)

Highway taxes and other federal excise taxes are likewise not, as far as I can determine, funded from revenues, but that might have been different in 1946 (I doubt it). Minor points, perhaps, or not, considering the size of Social Security outlays today—anyway I'm pretty sure he's mistaken on both counts. (As New York Fed Chairman, Ruml may not have had an intimate understanding of SSA payouts, just as Larry Summers, a Harvard economist, doesn't "really understand" reserve balance sheets.)

In the editor's introduction, note how he can't quite grasp the implications of what Ruml is saying—either that or he sees the implications and is trying to confuse the reader. This recalls the question of why the the solid benefits of fiat money and deficit-based fiscal policies have been resisted and attacked for so long. Another reason occurs to me: if everyone is meaningfully employed earning high wages and enjoying financial security, say goodbye to predatory lending—Timothy Geithner's new gig—except in the classic case of the gambling addict who racks up impossible debts. Geithner's mob would be out of the business, since a first-rate healthcare system would be treating gambling addictions.

At the time in '46 and ever since, the article provoked little or no discussion among mainstream economists (heh wonder why). But its persuasive arguments, stated in clear language, makes it good background material in understanding and disseminating the MMT perspective.

My only added emphasis is the bolded bit in the Editor's introduction. The smiley is mine.

American Affairs
A Quarterly Journal of Free Opinion
January 1946

[pp35-39]

TAXES FOR REVENUE ARE OBSOLETE

by Beardsley Ruml,
Chairman of the Federal Reserve Bank of New York.

Mr. Ruml read this paper before the American Bar Association during the last year of the war [World War II]. It attracted then less attention than it deserved and is even more timely now, with the tax structure undergoing change for peacetime. His thesis is that given (1) control of a central banking system and (2) an inconvertible currency, a sovereign national government is finally free of money worries and need no longer levy taxes for the purpose of providing itself with revenue. All taxation, therefore, should be regarded from the point of view of social and economic consequences. The paragraph that embodies this idea will be found italicized in the text. Mr. Ruml does not say precisely how in that case the government would pay its own bills. One may assume that it would either shave its expenses out of the proceeds of taxes levied for social and economic ends or print the money it needs. The point may be academic. The latter end of his paper is devoted to an argument against taxing corporation profits. — Editor.

The superior position of public government over private business is nowhere more clearly evident than in government's power to tax business. Business gets its many rule-making powers from public government. Public government sets the limits to the exercise of these rule-making powers of business, and protects the freedom of business operations within this area of authority. Taxation is one of the limitations placed by government on the power of business to do what it pleases.

There is nothing reprehensible about this procedure. The business that is taxed is not a creature of flesh and blood, it is not a citizen. It has no voice in how it shall be governed — nor should it. The issues in the taxation of business are not moral issues, but are questions of practical effect: What will get the best results? How should business be taxed so that business will make its greatest contribution to the common good?

It is sometimes instructive when faced with alternatives to ask the underlying question. If we are to understand the problems involved in the taxation of business, we must first ask: "Why does the government need to tax at all?" This seems to be a simple question, but, as is the case with simple questions, the obvious answer is likely to be a superficial one. The obvious answer is, of course, that taxes provide the revenue which the government needs in order to pay its bills.


It Happened

If we look at the financial history of recent years it is apparent that nations have been able to pay their bills even though their tax revenues fell short of expenses. These countries whose expenses were greater than their receipts from taxes paid their bills by borrowing the necessary money. The borrowing of money, therefore, is an alternative which governments use to supplement the revenues from taxation in order to obtain the necessary means for the payment of their bills.

A government which depends on loans and on the refunding of its loans to get the money it requires for its operations is necessarily dependent on the sources from which the money can be obtained. In the past, if a government persisted in borrowing heavily to cover its expenditures, interest rates would get higher and higher, and greater and greater inducements would have to be offered by the government to the lenders. These governments finally found that the only way they could maintain both their sovereign independence and their solvency was to tax heavily enough to meet a substantial part of their financial needs, and to be prepared — if placed under undue pressure — to tax to meet them all.

The necessity for a government to tax in order to maintain both its independence and its solvency is true for state and local governments, but it is not true for a national government. Two changes of the greatest consequence have occurred in the last twenty-five years which have substantially altered the position of the national state with respect to the financing of its current requirements.

- The first of these changes is the gaining of vast new experience in the management of central banks.

- The second change is the elimination, for domestic purposes, of the convertibility of the currency into gold.


Free of the Money Market

Final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity.

The United States is a national state which has a central banking system, the Federal Reserve System, and whose currency, for domestic purposes, is not convertible into any commodity. It follows that our Federal Government has final freedom from the money market in meeting its financial requirements. Accordingly, the inevitable social and economic consequences of any and all taxes have now become the prime consideration in the imposition of taxes. In general, it may be said that since all taxes have consequences of a social and economic character, the government should look to these consequences in formulating its tax policy. All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.


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.

Among the policy questions with which we have to deal are these:

- Do we want a dollar with reasonably stable purchasing power over the years?

- Do we want greater equality of wealth and of income than would result from economic forces working alone?

- Do we want to subsidize certain industries and certain economic groups?

- Do we want the beneficiaries of certain federal activities to be aware of what they cost?

These questions are not tax questions; they are questions as to the kind of country we want and the kind of life we want to lead. The tax program should be a means to an agreed end. The tax program should be devised as an instrument, and it should be judged by how well it serves its purpose.

By all odds, the most important single purpose to be served by the imposition of federal taxes is the maintenance of a dollar which has stable purchasing power over the years. Sometimes this purpose is stated as "the avoidance of inflation"; and without the use of federal taxation all other means of stabilization, such as monetary policy and price controls and subsidies, are unavailing. All other means, in any case, must be integrated with federal tax policy if we are to have tomorrow a dollar which has a value near to what it has today.

The war has taught the government, and the government has taught the people, that federal taxation has much to do with inflation and deflation, with the prices which have to be paid for the things that are bought and sold. If federal taxes are insufficient or of the wrong kind, the purchasing power in the hands of the public is likely to be greater than the output of goods and services with which this purchasing demand can be satisfied. If the demand becomes too great, the result will be a rise in prices, and there will be no proportionate increase in the quantity of things for sale. This will mean that the dollar is worth less than it was before — that is inflation. On the other hand, if federal taxes are too heavy or are of the wrong kind, effective purchasing power in the hands of the public will be insufficient to take from the producers of goods and services all the things these producers would like to make. This will mean widespread unemployment.

The dollars the government spends become purchasing power in the hands of the people who have received them. The dollars the government takes by taxes cannot be spent by the people, and, therefore, these dollars can no longer be used to acquire the things which are available for sale. Taxation is, therefore, an instrument of the first importance in the administration of any fiscal and monetary policy.


To Distribute the Wealth

The second principal purpose of federal taxes is to attain more equality of wealth and of income than would result from economic forces working alone. The taxes which are effective for this purpose are the progressive individual income tax, the progressive estate tax, and the gift tax. What these taxes should be depends on public policy with respect to the distribution of wealth and of income. It is important, here, to note that the estate and gift taxes have little or no significance, as tax measures, for stabilizing the value of the dollar. Their purpose is the social purpose of preventing what otherwise would be high concentration of wealth and income at a few points, as a result of investment and reinvestment of income not expended in meeting day-to-day consumption requirements. These taxes should be defended and attacked it terms of their effects on the character of American life, not as revenue measures.

The third reason for federal taxes is to provide a subsidy for some industrial or economic interest. The most conspicuous example of these taxes is the tariffs on imports. Originally, taxes of this type were imposed to serve a double purpose since, a century and a half ago, the national government required revenues in order to pay its bills. Today, tariffs on imports are no longer needed for revenue. These taxes are nothing more than devices to provide subsidies to selected industries; their social purpose is to provide a price floor above which a domestic industry can compete with goods which can be produced abroad and sold in this country more cheaply except for the tariff protection. The subsidy is paid, not at the port of entry where the imported goods are taxed, but in the higher price level for all goods of the same type produced and sold at home.

The fourth purpose served by federal taxes is to assess, directly and visibly, the costs of certain benefits. Such taxation is highly desirable in order to limit the benefits to amounts which the people who benefit are willing to pay. The most conspicuous examples of such measures are the social security benefits, old-age and unemployment insurance. The social purposes of giving such benefits and of assessing specific taxes to meet the costs are obvious. Unfortunately and unnecessarily, in both cases, the programs have involved staggering deflationary consequences as a result of the excess of current receipts over current disbursements.


The Bad Tax

The federal tax on corporate profits is the tax which is most important in its effect on business operations. There are other taxes which are of great concern to special classes of business. There are many problems of state and local taxation of business which become extremely urgent, particularly when a corporation has no profits at all. However, we shall confine our discussion to the federal corporation income tax, since it is in this way that business is principally taxed. We shall also confine our considerations to the problems of ordinary peacetime taxation since, during wartime, many tax measures, such as the excess-profits tax, have a special justification.

Taxes on corporation profits have three principal consequences — all of them bad. Briefly, the three bad effects of the corporation income tax are:

1. The money which is taken from the corporation in taxes must come in one of three ways. It must come from the people, in the higher prices they pay for the things they buy; from the corporation's own employees in wages that are lower than they otherwise would be; or from the corporation's stockholders, in lower rate of return on their investment. No matter from which sources it comes, or in what proportion, this tax is harmful to production, to purchasing power, and to investment.

2. The tax on corporation profits is a distorting factor in managerial judgment, a factor which is prejudicial to clear engineering and economic analysis of what will be best for the production and distribution of things for use. And, the larger the tax, the greater the distortion.

3. The corporation income tax is the cause of double taxation. The individual taxpayer is taxed once when his profit is earned by the corporation, and once again when he receives the profit as a dividend. This double taxation makes it more difficult to get people to invest their savings in business than if the profits of business were only taxed once. Furthermore, stockholders with small incomes bear as heavy a burden under the corporation income tax as do stockholders with large incomes.


Analysis

Let us examine these three bad effects of the tax on corporation profits more closely. The first effect we observed was that the corporation income tax results in either higher prices, lower wages, reduced return on investment, or all three in combination. When the corporation income tax was first imposed it may have been believed by some that an impersonal levy could be placed on the profits of a soulless corporation, a levy which would be neither a sales tax, a tax on wages, or a double tax on the stockholder. Obviously, this is impossible in any real sense. A corporation is nothing but a method of doing business which is embodied in words inscribed on a piece of paper. The tax must be paid by one or more of the people who are parties at interest in the business, either as customer, as employee, or as stockholder.

It is impossible to know exactly who pays how much of the tax on corporation profits. The stockholder pays some of it, to the extent that the return on his investment is less than it would be if there were no tax. But, it is equally certain that the stockholder does not pay all of the tax on corporate income — indeed, he may pay very little of it. After a period of time, the corporation income tax is figured as one of the costs of production and it gets passed on in higher prices charged for the company's goods and services, and in lower wages, including conditions of work which are inferior to what they otherwise might be.

The reasons why the corporation income tax is passed on, in some measure, must be clearly understood. In the operations of a company, the management of the business, directed by the profit motive, keeps its eyes on what is left over as profit for the stockholders. Since the corporation must pay its federal income taxes before it can pay dividends, the taxes are thought of — the same as any other uncontrollable expense — as an outlay to be covered by higher prices or lower costs, of which the principal cost is wages. Since all competition in the same line of business is thinking the same way, prices and costs will tend to stabilize at a point which will produce a profit, after taxes, sufficient to give the industry access to new capital at a reasonable price. When this finally happens, as it must if the industry is to hold its own, the federal income tax on corporations will have been largely absorbed in higher prices and in lower wages. The effect of the corporation income tax is, therefore, to raise prices blindly and to lower wages by an undeterminable amount. Both tendencies are in the wrong direction and are harmful to the public welfare.


Where Would the Money Go?

Suppose the corporation income tax were removed, where would the money go that is now paid in taxes? That depends. If the industry is highly competitive, as is the case with retailing, a large share would go in lower prices, and a smaller share would go in higher wages and in higher yield on savings invested in the industry. If labor in the industry is strongly organized, as in the railroad, steel, and automotive industries, the share going in higher wages would tend to increase. If the industry is neither competitive nor organized nor regulated — of which industries there are very few — a large share would go to the stockholders. In so far as the elimination of the present corporation income tax would result in lower prices, it would raise the standard of living for everyone.

The second bad effect of the corporation income tax is that it is a distorting factor in management judgment, entering into every decision, and causing actions to be taken which would not have been taken on business grounds alone. The tax consequences of every important commitment have to be appraised. Sometimes, some action which ought to be taken cannot be taken because the tax results make the transaction valueless, or worse. Sometimes, apparently senseless actions are fully warranted because of tax benefits. The results of this tax thinking is to destroy the integrity of business judgment, and to set up a business structure and tradition which does not hang together in terms of the compulsion of inner economic or engineering efficiency.


Premium on Debt

The most conspicuous illustration of the bad effect of tax consideration on business judgment is seen in the preferred position that debt financing has over equity financing. This preferred position is due to the fact that interest and rents, paid on capital used in business, are deductible as expense; whereas dividends paid are not. The result weighs the scales always in favor of debt financing, since no income tax is paid on the deductible costs of this form of capital. This tendency goes on, although it is universally agreed that business and the country generally would be in a stronger position if a much larger proportion of all investment were in common stocks and equities, and a smaller proportion in mortgages and bonds.

It must be conceded that, in many cases, a high corporation income tax induces management to make expenditures which prudent judgment would avoid. This is particularly true if a long-term benefit may result, a benefit which cannot or need not be capitalized. The long-term expense is shared involuntarily by government with business, and, under these circumstances, a long chance is often well worth taking. Scientific research and institutional advertising are favorite vehicles for the use of these cheap dollars. Since these expenses reduce profits, they reduce taxes at the same time; and the cost to the business is only the margin of the expenditure that would have remained after the taxes had been paid — the government pays the rest. Admitting that a certain amount of venturesome expenditure does result from this tax inducement, it is an unhealthy form of unregulated subsidy which, in the end, will soften the fibre of management and will result in excess timidity when the risk must be carried by the business alone.

The third unfortunate consequence of the corporation income tax is that the same earnings are taxed twice, once when they are earned and once when they are distributed. This double taxation causes the original profit margin to carry a tremendous burden of tax, making it difficult to justify equity investment in a new and growing business. It also works contrary to the principles of the progressive income tax, since the small stockholder, with a small income, pays the same rate of corporation tax on his share of the earnings as does the stockholder whose total income falls in the highest brackets. This defect of double taxation is serious, both as it affects equity in the total tax structure, and as a handicap to the investment of savings in business.


Shortly, an Evil

Any one of these three bad effects of the corporation income tax would be enough to put it severely on the defensive. The three effects, taken together, make an overwhelming case against this tax. The corporation income tax is an evil tax and it should be abolished.

The corporation income tax cannot be abolished until some method is found to keep the corporate form from being used as a refuge from the individual income tax and as a means of accumulating unneeded, uninvested surpluses. Some way must be devised whereby the corporation earnings, which inure to the individual stockholders, are adequately taxed as income of these individuals.

The weaknesses and dangers of the corporation income tax have been known for years, and an ill-fated attempt to abolish it was made in 1936 in a proposed undistributed profits tax. This tax, as it was imposed by Congress, had four weaknesses which soon drove it from the books. First, the income tax on corporations was not eliminated in the final legislation, but the undistributed profits tax was added on top of it. Second, it was never made absolutely clear, by regulation or by statute, just what form of distributed capitalization of withheld and reinvested earnings would be taxable to the stockholders and not to the corporation. Third, the Securities and Exchange Commission did not set forth special and simple regulations covering securities issued to capitalize withheld earnings. Fourth, the earnings of a corporation were frozen to a particular fiscal year, with none of the flexibility of the carry-forward, carry-back provisions of the present law.

Granted that the corporation income tax must go, it will not be easy to devise protective measures which will be entirely satisfactory. The difficulties are not merely difficulties of technique and of avoiding the pitfalls of a perfect solution impossible to administer, but are questions of principle that raise issues as to the proper locus of power over new capital investment.

Can the government afford to give up the corporation income tax? This really is not the question. The question is this: Is it a favorable way of assessing taxes on the people — on the consumer, the workers and investors — who after all are the only real taxpayers? It is clear from any point of view that the effects of the corporation income tax are bad effects. The public purposes to be served by taxation are not thereby well served. The tax is uncertain in its effect with respect to the stabilization of the dollar, and it is inequitable as part of a progressive levy on individual income. It tends to raise the prices of goods and services. It tends to keep wages lower than they otherwise might be. It reduces the yield on investment and obstructs the flow of savings into business enterprise.

The journal pages are reproduced here for those who prefer the real thing in blotchy PDF:
http://bilbo.economicoutlook.net/blog/w ... solete.pdf




Beardsley Ruml