Note: Everything here is from my own personal notes from reading The Deficit Myth by Stephanie Kelton. Reading it dramatically and immediately impacted my understanding of how governments function. It helped me understand things in money that just didn’t make sense to me before, and explained why much of what a government says about its finances doesn’t match with reality.
If you’re not ready to commit to an entire book on monetary theory yet, I can highly recommend following Richard Murphy (also on Twitter) to start with bite sized jewels of information.
This post is UK focused. The principles apply to any country that is the sole source of its currency.
No one needs to pay for the NHS
“The NHS is on the verge of collapse.” We hear this all the time. “The problem is how much it costs to run.” This is something else we hear all the time.
How about this one: “If you want to put more money into the NHS, want to give nurses a pay rise, want to properly fund social care, all of that money has to come from taxes elsewhere.” Whenever an opposition political party puts forward a suggestion for improving healthcare, social care, schooling, public transport, or any other service that would benefit the public, the response from those in power is always the same: “How are you going to pay for it?”
This seems on the surface like a reasonable question. You might even say a responsible and prudent question. But I’ve learnt that it isn’t. It’s a smokescreen first popularised by Thatcher and plays on the idea that if the government wants to fund something, it has to find a way to pay for it, and the only way it can pay for things is by borrowing or raising taxes. This isn’t true. In reality, the government doesn’t pay for anything using taxes or borrowing. Those things serve a purpose, but that purpose is not to pay for public services.
TABS and STAB
This idea that a government has to get money from taxes and borrowing before spending is called TABS. Taxing And Borrowing comes before Spending. On the surface, it makes sense. It’s the same way a traditional family budget works. You have to somehow get ahold of the money (either by earning it or borrowing it) before you can spend it.
This isn’t how government finances work.
If you think about who makes the money in the first place – that is, who actually creates it – it logically can’t be how it works. The UK government controls the creation of British Pounds. It can’t borrow British Pounds or tax people in British Pounds until it first creates some and gives it out to people, i.e., spends it.
How government finances actually work is STAB. That is, spending comes before taxes and borrowing. But we can accept that this might be true, and still expect that a government would want to spend no more than it then eventually receives back through taxes and borrowing. This also isn’t true.
They do WHAT with my taxes??
Here’s something that freaked me out when I first heard it. When you pay tax on something, be that VAT, income tax, National Insurance, you would logically expect that it goes back onto a balance sheet and gets spent on a public service.
Except it doesn’t. It’s taken off your payslip, but it doesn’t go anywhere. It’s just gone. It’s not spent, it’s not collected by the government, it’s just deducted from your income. It’s nothing more than a reduction in what ends up in your personal bank account.
But surely the government needs that money in order to function. That’s the entire point. We get taxed so that there is money to spend on public services. But in reality, the government doesn’t need in our money.
I’m going to use the same analogy from the book, because it explains why this is the case. It explains why the government has no want or need for our tax money, and yet in what seems like a contradiction, why it needs you to pay it.
Chores and taxes
You have two kids and want them to start doing chores around the house. You assign each chore a value, which you pay out in your own business cards. So maybe emptying the dishwasher is worth three business cards, tidying their room is worth five business cards. You send them off at the beginning of the week, with a stack of old business cards ready to hand out.
The end of the week comes around, and you still have a full stack of business cards, and the house is a mess. You ask the kids why they didn’t collect any cards. “What’s the point?” they ask. “They’re not worth anything.”
As the creator of our own new money (business cards), how do we solve this problem? We can buy another stack of 500 from the printer, but if the kids don’t put any value in them, then they’re not going to want to collect them, and they therefore have no value. How do you make the business cards valuable? You introduce a tax.
You change the rules. The chores stay the same, and the number of business cards they can collect for each task stays the same. But now, you tell the kids that if they don’t pay you 30 business cards at the end of the week, they will lose some of their privileges.
A new week starts, and now chores are getting done, and business cards are being collected. At the end of the week, the house is tidy and each of them pays you 30 business cards. You’ve introduced a tax, with a punishment for not paying, and now your money (business cards) have value.
And when the kids hand you their 30 business cards each, what do you do with the cards they hand back? Nothing. You don’t need them. In reality, you’d probably hold onto them to hand back out the next week, but only for the sake of efficiency. You can always just get more printed. It’s not like you don’t have to do chores yourself to get more. You just put another order in with the printer.
This is how a country that is the sole issuer of its own currency works.
Constraints and the The Magic Money Tree
When governments talk about balancing the books, or irresponsible borrowing, they are talking in language that we are used to. We’re all familiar with having to balance our own budget. We have to receive or borrow money before we can spend it. But this isn’t how government finances work.
Because countries are the sole issuer of their own currency, the government never needs to “balance the books” in order to spend money.
The magic money tree really does exist. In fact, not only does it exist, it’s the way governments pay for everything.
Of course, there are constraints, but they are not governed by what we think of as a traditional personal budget. The evidence of a government spending too much is not a budget deficit. Countries that issue their own currency almost universally generate a deficit, that is, they spend more than the receive. And operating in this way is typically good for an economy.
The real constraint is inflation. If there is too much money in an economy, then its value can decrease, reducing the spending power of the citizens. If spending power is decreased too much, then people reduce their spending, which ultimately reduces a country’s productivity.
Productivity is what actually matters. And if a government spends money in the right ways and in the right places, that benefit the population and spur productivity, then spending more is a good thing. Government spending should be used to achieve policy objectives, and it is.
If a government isn’t pursuing particular policy objectives, then hiding behind “responsible budgeting” and “deficit reduction” is a useful smokescreen. It sounds reasonable, but is not a true constraint. We should be questioning the real reason why so many of our public services are chronically underfunded to the point of collapse.