In a previous post, it was explained that enforcement of taxes (or some other financial obligation to the state) that can only be extinguished (i.e. finally settled) with money issued by the government is fundamental to the viability of a national currency. Without such an obligation, widespread acceptance of the currency would not be assured. The currency might cease to serve as an effective mechanism for public provision of adequate infrastructure, education, health care, social security and much more.
But there is something interesting about this. If we think about the initial introduction of the currency, the government could not have simply imposed a tax on us and then sat around waiting for us to pay. Where would we have got the currency from to pay the tax?
Clearly, the currency originally has to come from the government (meaning the consolidated government sector). The government can issue its currency in one of two ways, either by spending or lending.
The obligations of non-government to the state, however, can only be extinguished once the government has spent the currency into existence. Government lending creates an obligation on non-government to repay the loan, and so a government loan to non-government to finance a tax payment does not enable non-government – considered as a whole – to extinguish its obligations to the state.
The above considerations lead us to two basic points. Guaranteed viability of a national currency requires that:
- The imposition of a tax obligation precedes government spending.
- Government spending logically precedes tax payments and tax revenue.
The logical sequence is clear: (i) government imposes taxes; (ii) government issues the currency; (iii) we use the currency to pay taxes as well as for other purposes.
Strictly speaking, point 1 is sufficient rather than necessary. That is, it is perhaps conceivable that a national currency could gain acceptance without being backed by taxes but the effective enforcement of a tax obligation guarantees acceptance of the currency, at least to the extent necessary to satisfy tax requirements. Only a very brave (or foolish) government would attempt to operate a national currency without a tax basis.
Point 2 always holds. Government spending must already have occurred before non-government financial obligations to the state can be extinguished.
Clearly, then, government does not need our tax payments in order to spend. What it needs is our readiness to accept its currency. It guarantees this by imposing a tax obligation. But in order for us to pay our taxes, government must first spend the currency into existence.
Reflecting on this for a moment exposes as silly a lot of what we hear from the media and politicians when it comes to fiscal policy. We are frequently asked to believe that the government cannot afford to provide adequate infrastructure and social services because it has supposedly “run out of money”. Yet, the only entity for which it is impossible to run out of the currency is government – the currency issuer. The rest of us can run out of money. But the currency issuer cannot.
For this reason, the true measure of fiscal “affordability” should never be framed in terms of money, but rather real resources.
If there is a shortage of trained doctors and nurses, it will not be possible to expand hospital care until some more have been trained. If there is a shortage of teachers, educational services will be similarly constrained. A shortage of engineers, trades people and raw materials will impact on the provision of infrastructure. And so on.
Lack of money, however, is never a legitimate excuse for government. It can always spend sufficiently to ensure full employment of workers and real resources.
The above is intended as an introductory post and does not touch on the details of current monetary and fiscal operations. In practice, governments typically follow a rather convoluted series of steps when they spend. None of that changes the basic point that government spending must precede tax payments. For further details see: