Series on tax: Part 1 – why?

Huzzah, I am writing about tax on Rates Blog.  In Part 1 I ask “why do we tax“.

I get onto other issues later – in fact, this will be a five article series.  Here all I do is combine the idea of “government spending” and “paying for government spending”, and give a little wink to ideas such as equity and tax incidence.  They will play a more central role in the next article, when I discuss tax systems that seem ideal … but that we don’t use for often good reasons.

  • Jahid

    Nice article, Matt Nolan. Thanks for sharing

  • rndtechnologies786

    Nice blog.

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  • NicTheNZer .

    I have an answer to your question here Matt, but somehow its different to yours,
    http://wwaet.blogspot.co.uk/2013/07/why-do-we-tax.html

    • Hola Nic,

      I am discussing tax in reference to the redistribution and movement in goods and services – not the allocation of fiat money. They are related undeniably, but what we ultimately care about is the distribution of goods and services not the numeraire we use as a unit of account! (Note: Relative prices adjust as the distribution of fiat money changes across the income scale!)

      Once I get to the article on “inflation tax” this is one of the areas I will cover off – namely as long as the monetary authority sufficiently manages demand (which I’ll agree has had issues in some places!) government spending works by shifting the relative demand for resources in the economy – it is redistributional. Using its own fiat currency to do this IS a form of tax in exactly the same way!

      I have more here:

      http://www.tvhe.co.nz/?s=%22series+on+tax%22&submit=Search

      And when thinking about this issue we have this:

      http://www.tvhe.co.nz/2013/05/20/series-on-tax-part-2b-lets-experiment-with-explanations/

      I’d also note the idea a government can spend “as much as they want without limit” ignores the supply constraints of the economy, and the fact their choice is a distributional one! My chats to some MMT people suggest they do not hold such an extreme view and recognise this, they just differ about how they see the supply side and how they see fiat money printing as a form of “taxation”/”redistribution”.

      Also the “they don’t tax before they spending, they can spend before they tax” distinction has no real meaning here – it is more semantic than having anything to do with the distinction being discussed 🙂

      • NicTheNZer .

        I still disagree about the appropriate framework for this discussion, you also said,

        “However, talking about all these things in terms of money is misleading. In truth, the government is taxing and spending in order to change the allocation of goods and services.”

        that’s another way of saying we don’t care about the numeraire we use as a unit of account?

        Its actually more miss-leading not to talk about a unit of account, and to talk about the abstract allocation of goods and services. Unbelievably there are examples of Central Banks running models (DSGE Models, and others) which model a barter economy without any money, that has been miss-leading them in fact! Anyway a simple example?

        “I’d also note the idea a government can spend ‘as much as they want without limit’ ignores the supply constraints of the economy”

        Yes, there are things that are not for sale, there are also things which can’t be acquired for love or money (in fact I discussed one constraint imposed by a gold standard, not enough gold to support the standard). But its not that clear how you explain that trivial concept without money.

        • “Unbelievably there are examples of Central Banks running models (DSGE
          Models, and others) which model a barter economy without any money, that
          has been mis-leading them in fact!”

          This is not a fair way of viewing “moneyless models”. Money is a veil.

          http://www.ecb.int/events/pdf/conferences/cbc4/Woodford.pdf

          Any “model” (like DSGE models) that has active monetary policy admits that there is something special going on with money, and that it has impacts on the general economy – this is the entire justification for having central banks adjust policy rates in the way they do! If they didn’t, then governments could do the same by adjusting deficits – this is broadly accepted.

          I agree with you, and MMT people, and the economics profession, when we say money is special and government can print money to finance things – but the production of goods and services has to come from inputs, and the way money financing deficits works to get that process going is what should be of interest!

          “Yes, there are things that are not for sale, there are also things which
          can’t be acquired for love or money (in fact I discussed one constraint
          imposed by a gold standard, not enough gold to support the standard).
          But its not that clear how you explain that trivial concept without
          money.”

          No this isn’t it. We have technology, land, capital, and labour which can be utilised to make goods and services – it is this process that provides the constraint on what can be provided. Government is an institution that has social authority to adjust this distribution, but we are still limited by land, capital, labour, and technology!

      • NicTheNZer .

        Additionally,

        “Also the “they don’t tax before they spending, they can spend before they tax” distinction has no real meaning here- it is more semantic than having anything to do with the distinction being discussed”

        This distinction had/has more than semantic relevance to countries joining the Euro (obviously).

      • NicTheNZer .

        Finally,

        “I’d also note the idea a government can spend “as much as they want without limit” ignores the supply constraints of the economy, and the fact their choice is a distributional one! My chats to some MMT people suggest they do not hold such an extreme view and recognise this, they just differ about how they see the supply side and how they see fiat money printing as a form of “taxation”/”redistribution”.”

        Note I said without limit, not without consequences. The reason they don’t hold such an extreme view is this view is not extreme, its simply a factual statement about how sovereign finance works. I think before talking about ‘inflation tax’ I think economics should probably get its terminology straight and try to come up with a list of things which are not to be described as ‘taxes’. The Friedmanesque notion that everything can be described as a tax is rather confusing.

        Here is my list of ‘taxes’,

        Taxes = that’s a Tax (on tax payers).

        Inflation = that’s a Tax (on savers).

        Relative price hikes = that’s a Tax (on consumers).

        Welfare cuts = that’s a Tax (on beneficiaries).

        Government spending = that’s a Tax (on the private sector).

        Regulation = that’s a Tax (on efficiency).

        Deregulation = that’s a Tax (on the honest).

        People writing nonsense on the internet = that’s a Tax (on my mental abilities).

        you can probably think of others…

        • Your starting to get abrasive in your comments here – try to be civil, or I’ll just assume you have no interest in trying to figure out what disagreement, if any, we have 😉

          “Note I said without limit, not without consequences. The reason they
          don’t hold such an extreme view is this view is not extreme, its simply a
          factual statement about how sovereign finance works”

          Ok, so they can print and use as much of the fiat currency as they want. No economist would disagree with this – it is completely trivial! Talking about matters in terms of the distribution of goods and services forces us to actually think about the trade-offs associated with changes and where the burden of distributional changes falls.

          The reason economists went quite against money financed deficits was because the burden would fall on those unable to protect themselves from inflation, or the change the price they charge for goods and services. In this context, the burden falls mainly on the poor – the reason economists went against money financed deficits (in most, not all circumstances) was because it seemed regressive!

          “The Friedmanesque notion that everything can be described as a tax is rather confusing.”

          Your list says some things that don’t really work. The idea is that unpriced government intervention works to change the distribution of goods and services is central to everything though, and the method of decomposing it into winners and losers helps us think about burden. It isn’t confused, it is honest 🙂

          • NicTheNZer .

            http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf

            Obviously you should read all of this, but if you start at page 52 with the section ‘Italian Epiphany’ you can probably see why solvency risk should be understood in simple factual terms. In the early 1990’s economists at the IMF didn’t apparently understand the notion of no solvency risk!

            • Do you actually have a point in this – or are you just trying to “win an argument” that you are making up?

              My god, my articles on tax are about helping total non-economists understand that there are distributional consequences from government spending and funding choices INSTEAD of acting like it is a simple issue with a block of tax and a block of spending.

              I’m not defending things the IMF has done in the past – and I would note that a lot of economists would view a drop in the exchange rate when debt is denominated in local currency as a form of default against foreigner lenders. We all just need to be careful putting out our assumptions and discussing these idea

              If you are going to switch your tone to being more civil my man I will as well – but you aren’t giving me room to just have a conversation with you here!

              • NicTheNZer .

                Ok, in baby steps.

                You said,
                “Ok, so they can print and use as much of the fiat currency as they want. No economist would disagree with this – it is completely trivial!”

                I pointed out contrary to this,
                “In the early 1990’s economists at the IMF didn’t apparently understand the notion of no solvency risk!”

                Obviously its worse in politics and the general public than this where there is literal deficit hysteria from many people. This example is a microcosm of the point I was making in writing my own post. The framework which says ‘there are distributional consequences from government spending and funding choices’ is pretty meaningless to reality. It is confusing.

                You are also confused by the notion ‘Money is a veil over barter’, this is factually incorrect and miss-leading, but I didn’t reply there because I didn’t want to get off topic.

                “I’m not defending things the IMF has done in the past – and I would note that a lot of economists would view a drop in the exchange rate when debt is denominated in local currency as a form of default against foreigner lenders.”

                Earlier I made a comical point of the mistaken notion that, taxes effect distribution therefore anything which effects distribution is a tax (wrong). Nope, falling exchange rates are still not a default. If you are gambling on exchange rates not falling that is something you do at your risk (and its your responsibility if you get that wrong, not the governments responsibility). Another confusion of the framework which talks about distributional consequences.

                • Look, I don’t appreciate your tone – and you have no intention of trying to read what I was saying charitably. From what I can say, all of your points are trivial and miss the question of what I was answering with my article in order to make a point you want to make – I tried to discuss it with you, but I can’t be bothered dealing with someone who just wants to sit there writing demeaning things. “Baby steps” – really stop talking to me like I’m an idiot, all I hear from that is a massive ego.

                  And when I said money was a veil I was not confused – it is a long-run veil, but in the short-term has real consequences (long run neutrality and short run non-neutrality of money). It is true that it is accepted as a unit of account, but its relative value between private agents depends on expectations around value, underlying relative values, and the current state of prices – implying short-run consequences of active monetary policy.

                  In a separate attempt to rescue to civility, I will turn straight to your post and ignore where this has gone – the rest of my comment is going to ignore this series of comments ever happened.

                  In terms of your post, I don’t disagree with much of what you’ve said there. I also agree that having a government monopoly gives it special benefits (although we have to look at those of the value of real goods and services, and in terms of the expectations of private agents about the relative value of fiat currency to goods).

                  But your discussion doesn’t give us any way to understand the consequences of long run government spending and financing decisions in terms of the distribution of goods and services. The entire series is involves thinking about distribution in a long-run sense.

                  The idea that there is land, labour, capital, and technology gives us a base to understand how government functions as an institution and can use some of this stock of land, labour, and capital to create goods. Essentially the idea of “taxing” and “spending” is one of changing this distribution – and when I say they want to do this in the “cheapest possible way” I am talking about finding ways to redistribute goods and services with the smallest cost to the efficiency of their utilization. Later on this comes up in the idea of price wedges between social and private value.

                  Discussing this in terms of the short-term management of a fiat currency doesn’t add any “value” to the specific types of questions I’m addressing here, and actually doesn’t provide a framework for discussing how government’s choices aid in influencing the distribution of resources and relative prices. If you can think of a neat way it can do that I’d be glad to hear it 🙂

                • NicTheNZer .

                  Well for the record I don’t think your an idiot, Matt.

                  But the IMF is hardly an irrelevant financial institution, so when you say that every economist understands ‘no default risk’, and I point out that this has quite recently been untrue (even for IMF economists not the general public) you do seem to be missing the point. If that’s your defence of explaining things in ‘distributional terms’ rather than explaining how money functions, then I still conclude that explaining things in distributional terms is miss-leading, especially for non-economists!

                  As to how you go from the system of fiat currency, to how that affects the economy, I think you can and intend to discuss this in further posts. I think that to do that however you need to drop the assumption that ‘Money is a veil over barter’ even in the long run (I don’t see any way to derive this, so it’s an assumption). At minimum this has been debate able for a very, very long time, but the implications seem to be things like the economy would function broadly the same without sovereign money being used and with similar levels of economic activity (obviously I think that’s unlikely).

                  I also think that the concept ‘cheapest possible way’ is a form of assumption, (the assumption being that this is desire-able), this is not the same thing as the basic social purpose of why we let the government impose a sovereign currency. In fact if you recognise that money is a token and is no object, then you can immediately see that the ‘cheapest possible way’ could be quite miss-leading. Certainly in financial terms finding the cheapest possible way, money is no object, who cares? Even, “smallest cost to the efficiency of their utilization”, so does this mean that we want to use all the stuff now? That’s definitely relevant and highly debatable.

                  I don’t think I imposed similar assumptions on the discussion in my first post (except I assume that the sovereign currency is imposed by a democracy so I have some say over this and there are alternatives). If I did, then please do point them out, and that’s one reason I think the sovereign currency framework is better for discussion.

                • Hola,

                  Very good, thanks for the comment. Ok I’ll see what I can add here 🙂

                  ” If that’s your defence of explaining things in ‘distributional terms’
                  rather than explaining how money functions, then I still conclude that explaining things in distributional terms is miss-leading, especially for non-economists!”

                  I understand where you are coming from – and there is always a concern that people will take this sort of stuff I’ve written about tax and apply it to thoughts about the economic cycle, which they shouldn’t! The special nature of monetary policy and having a govt with monopoly printing rights does allow us to smooth cycle by using money/interest rates – I’ve always seen the key difference between MMT as being whether govt should do it through an independent authority with a rule (central bank) or through active policy (cyclical taxing).

                  ” I think that to do that however you need to drop the assumption that ‘Money is a veil over barter’ even in the long run (I don’t see any way to derive this, so it’s an assumption).”

                  Over the 1980s and early 1990s this was an assumption that was highly debated – in the end the trend stationarity of GDP convinced people it was reasonable.

                  There are two things here.

                  1) I’m not dropping the assumption, it is indeed part of the “core” of how I work through these arguments. As a result, this is an area where we will have to agree to disagree – and try to find empirical evidence in order to persuade others 🙂 – this is cool!

                  2) I respect the fact that people may not believe in long-term non-neutrality – in fact I often see good “heterodox” arguments as boiling down to that.

                  Just as a note though, the discipline recognises this and has debated it heavily – in monetary policy arguments I explicitly note this assumption, in order to try to avoid misleading!

                  Furthermore, when it comes to non-neutrality what matters again is cyclical deficits etc. Often economists will write “get rid of the deficit” rather than “hit a debt to GDP ratio” – I did the second purposefully to push people away from thinking too heavily from targeting deficits, as a way of trying to steer away from a debate that it different from the “distribution/social contract” idea of what is fair government spending. My apologises if this wasn’t clear enough – when I get to the monetary policy related article, I will try to flesh it out.

                  Note: Long-run neutrality isn’t an argument about money not mattering at all in the long run – the existence of money reduce transactions costs and keeps trade higher as a result. It is an argument that all the relative price levels, and corresponding stock of activity, adjust to changes in the stock of money or credit in the long-run!

                  “In fact if you recognise that money is a token and is no object, then you can immediately see that the ‘cheapest possible way’ could be quite miss-leading. Certainly in financial terms finding the cheapest possible way, money is no object, who cares? Even, “smallest cost to the efficiency of their utilization”, so does this mean that we want to use all the stuff now? That’s definitely relevant and highly debatable.”

                  Hmmm, I see things a touch differently. Say that the government prints currency to fund an increase in spending AND assume this leads to no change in the expectations of private agents about the value of fiat currency relative to goods and services! This is a strong assumption – but it works in the direction of what you are after here, so it may help me illustrate my case.

                  Give that, individuals and institutions will be trying to use land, labour, capital, and technology to make goods and services but the government will have increased their claim on these inputs. As a result, the fact we have more tokens does not change the fact that the underlying inputs are limited, and that the larger use of inputs by government will “crowd out” domestic spending.

                  Now I don’t like the term crowd out too much – as it gets confused with the ideological usage of it, when people want to avoid active monetary policy – and for people trying to argue against government spending (which I am not). When there are underutilised resources, or failures of co-ordination active monetary policy does help out! The MMT guys note this by stating inflation is caused by too much government spending with money financing – a pretty similar view to other schools of economics, and based on this underlying “input-production function” idea.

                  The inability to aggregate, or say we have “stocks” of these specific things, and the fact there are many outputs, makes this a lot more complicated – and can be used as an argument for both sides (saying that resources are utilised more quickly than governments think OR saying that co-ordination failures are more endemic). These are important questions – and making sure we set policy right given all this does matter.

                  Now the efficiency argument isn’t even the crowding out one – not at all. It is the change in the gap between the value of the seller and the value of the buyer in markets – my goal is to run through a series of taxes, and talk about how they work differently in doing this! Having the inputs style approach is pretty essential for this from what I can tell 🙂

                  But this is the thing, with the framework you gave me in the post I’m not sure how I get across the production to distribution issue that is so important to discuss when thinking about the long-term.