By Michal Lerner
To win the next general election, Labour must give bold answers to the question ‘How will you pay for it?’. Let us therefore imagine an interview between an interviewer (I) and a member of the Shadow Cabinet (L) and suggest how the dreaded question should be dealt with in the context of Universal Credit:
I: Labour say that it was wrong to end the £20 rise in Universal Credit. How would Labour have found the money to pay the £6 billion it would have cost to retain the payment?
L: A Labour government would have paid for it in the way British governments pay for everything that has been approved by parliament. It would have instructed the Bank of England to mark up the bank accounts of those entitled to the payment.
I: But what happens if there is not sufficient money in the government’s account?
L: There will always be sufficient money in the government’s account because the Bank of England will simply expand its balance sheet and loan the government whatever funds have been approved by Parliament.
I: But the Bank of England is an independent institution. It might decide not to do that.
L: It is exactly the job of the Bank of England to finance whatever debts the government issues which have been approved by Parliament. By law it has to do so. As Neil Wilson et al make clear in their detailed account of the UK Exchequer:
“Once Parliament has authorised Supply there is no mechanism within the UK monetary system to stop that spending happening. The Bank has no power to refuse and there is no legal mechanism by which a balance has to be checked for available funds. The Bank accommodates the expenditure by balance sheet expansion … Parliament effectively legislates money into existence.” An Accounting Model of the UK Exchequer, Andrew Berkeley, Richard Tye & Neil Wilson p116.
I: So the government is printing money?
L: Printing money is a rather outdated phrase. The government, for the most part, just increases the balance in people’s bank accounts. Creating money might be a more appropriate description.
I: Either way, printing or creating money, it is increasing the national debt. That cannot be a good thing.
L: Why is it not a good thing? It will take a lot of stress off some 5 million people on Universal Credit.
I: But it’s increasing the national debt which our children will have to pay off.
L: It’s true that the government is spending money that has been not been matched by an increase in taxation. But it has been loaned the money by the Bank of England. And the Bank of England is owned by the Treasury. So really the government is just borrowing from itself. And therefore never has to pay it back. Our children and grandchildren will have nothing to worry about. In the national accounts is will be shown as an increase in national debt. But it is certainly open to question if it makes any sense to call borrowing from oneself ‘debt’.
I: But this is madness. Why does the government not therefore increase Universal Credit by £1,000 per week.
L: The government can certainly do that. In fact it did something like that very recently. During the pandemic some 20% of the population were put on Furlough. Furlough was a nice way of saying they were made unemployed by law. The government decided to pay them 80% of their previous earnings. It instructed the Bank of England to mark up the accounts of those on Furlough with the appropriate amount. The Bank of England did what it was legally required to do. There was no issue about the government finding the money. It should also be noted that the creation of all this money and the huge increase in the national debt did not cause inflation and left everyone in a much better position to deal with the pandemic.
I: But did the government not issue bonds to cover the debt, did it not borrow the money from the non-government sector?
L: The government does, as a matter of course, issue bonds equal to the difference between what it spends and levies in taxation. It has no need to do this. In fact issuing bonds is really just a gift to those who don’t want to spend all their income. It allows them to put what they don’t spend into a riskless, interest earning asset. Issuing bonds is really just a hangover from the days when money was based on gold. Some 75% of the bonds issued by the government during the pandemic were bought by the Bank of England. So the government owes that money to itself – since the Treasury owns the Bank of England.
I: But why does the government not just spend money without limit?
L: Because it doesn’t have resources without limit. Government spending of money into the economy when there aren’t things to buy will just push prices up. That’s a major cause of inflation. The government should only spend when the effect on the society is good. Creating and spending more money during the pandemic, than had ever been created and spent outside of a war situation, was good for the society. The same applies to taxation and borrowing; if it’s good for the society then it should tax and borrow. How the spending, taxation and borrowing affect the national debt is a matter of no relevance which is not even worth recording.
I: How does a government decide whether its spending will have a good effect on society?
L: One critical indicator of whether government spending is good is its impact on the rate of unemployment and inflation. If there is unemployment in the society, then that means that the non-government sector is not generating enough demand to employ everyone who wants to work. In this situation the government should spend to employ the unemployed without any concern about the effect of that spending on the national debt.
I: When is it good to tax?
L: Any tax introduced will change and/or reduce demand in an economy. For instance a tax on a particular fuel type will reduce demand for that fuel type. This will create unemployment in the industrial sector that produces that fuel type. Demand for other fuel types may increase and that may lead to increased employment in other sectors. If a government decides to increase the tax rate on those earning over £100,000 that will also reduce demand and therefore increase unemployment – perhaps in the yacht building sector. The main point of taxation is to redirect resources towards socially desirable objectives. A fuel tax may be levied for environmental reasons. An income tax may be introduced for equality reasons. But the initial effect of both taxes is to reduce the spending capacity of the non-government sector which may result in increased unemployment. If the increased unemployment is not absorbed by the non-government sector then a progressive government must increase its spending to bring those made unemployed into useful employment. The important point, however, is to realise that the objective of taxes is not to raise money but to redirect resources. Currency creating governments never need to ‘raise’ money. They have an infinite amount of money. They don’t have infinite resources.
I: So governments never need to tax?
L: A government will almost certainly need to tax. It will have policies around education, health, housing, defence etc that it wants to implement when in power. It then has to acquire the resources to implement its policies. Taxation is the way a government acquires resources from people to implement its policies. Since it has been elected by the people on the basis of the policies that it proposes to implement, it is implicit that people are prepared to give up resources to allow the government to implement its policies. People experience a tax as a reduction in their personal income. It is natural to think that they are transferring their money to the state and that the state will then use that money to buy the resources it needs to implement its policies. However that’s not really an accurate description of what is going on. It is more accurate to say that a tax is freeing up resources (people and materials) because a tax has reduced people’s purchasing power. The state will then buy those resources with money that it creates. This distinction may seem subtle but it becomes crucially important if there are unemployed resources in the society.
If there are unemployed resources (workers and materials) in the society, the state can acquire them without taxation. So in the 2008 Global Financial Crisis (GFC) there was a huge increase in unemployed resources – particularly workers as unemployment increased. In this situation the government should have created and spent money without increasing taxes. And so the national debt (the difference between government spending and taxes levied) would have gone up. Raising taxes in 2008 would have been the wrong thing to do because it would have taken demand out of the economy. Since the economy was already suffering from a lack of demand, government spending should have taken place without an increase in taxation. A currency creating government can always spend without increasing taxation. This would have been a moment to do that.
I: When is it good for a government to borrow by issuing bonds?
L: A currency creating government never needs to borrow. A government bond is a riskless asset that earns interest. It allows those with cash savings to change their portfolios to holding an interest earning asset rather than just cash. A government may choose to issue bonds for welfare reasons. For instance George Osborne issued a bond which could only be bought by the retired and there was a maximum amount that each individual could buy of £20,000. Its purpose was to increase pensioner welfare and not to raise money.
I: Will government spending not create inflation?
L: It could do. But only if the government is competing with the non-government sector for resources. It will not be the case if the government is employing resources that the non-government sector does not wish to employ. I cannot see how an extra £20 per week for Universal Credit would result in the government competing with the non-government sector for resources. Particularly when more than 1.5 million people are unemployed.
George Osborne should have engaged in extra government spending in 2010 since the economy was suffering from insufficient demand. But instead, Osborne chose to use the Global Financial Crisis (GFC) to realise his objective of a small state. Osborne pretended the size of the national debt was the most important problem that society had to deal with. He cut state spending to slow the rate of increase of the national debt and was prepared to let unemployment grow. With disastrous consequences.