Rich people have a gazillion dollars hidden away in offshore bank accounts. "Alas!" the progressives wail, "Think of all the good we could do if we could get just the taxes on that money!"
Hold up. We don't have to get the taxes. If there a 10% of a gazillion dollars worth of things that we think are worth doing, we can just "print" that money. If something is worth doing, it's worth printing the money to get it done: people will, you know, do stuff if you give them money to do so.
"But if we print the money, we will cause inflation! Inflation is Really Bad, right?"
Inflation is not the worst thing in the world, but just printing and spending money by itself will not cause inflation. The proximate cause of inflation is not too much money, it's too much money in circulation (and too much money in circulation in the wrong places). As long as the gazillion dollars just sit quietly hidden in these offshore accounts, we can print exactly as much as we would have collected as taxes, and we will have exactly as much or as little inflation as we would if we didn't print it but instead took it from taxes levied on this money. The rich cannot hold the government hostage by hoarding money; money is useful only when it's spent.
"Ah, but if we print the money, and then rich people spend their money, we will have inflation!"
Excellent, grasshopper! Now you're thinking with portals!
The key, then, is to not to find and levy taxes on the hidden money before, but make it so that it won't cause inflation unless the rich reveal the money. It's the difference between trying to break into the bank or just posting a guard outside the door catch withdrawals. The second is a hell of a lot easier than the first.
I mean, if they want to (snicker) act in the public interest (chortle) and voluntarily (snort) repatriate their money... sorry, I can't stop laughing long enough to complete the sentence.
I'm not an expert in tax law, but it seems like it's a lot easier to force the rich to keep hiding their money than it is to find it and tax it.
Showing posts with label inflation and deflation. Show all posts
Showing posts with label inflation and deflation. Show all posts
Saturday, October 12, 2019
Wednesday, April 17, 2019
Taxes and government production
There is a paradox in how we talk about "paying for" what the government produces. Yes, taxes do pay for government production. And no, taxes do not pay for government production. Wait, what?
As best I can tell, Modern Monetary Theory scholars* stress the idea that taxes do not pay for government produces in a "financial" sense: unlike a household or a firm, government does not collect taxes to obtain money to spend on government production. A household or a firm must obtain money, via revenue, borrowing, or theft, before it can spend it. A government need not do so; to the extent that the government says it does need to collect money before it spends it, the government is at best disingenuous and at worst deceptive. Financially — and this qualifier is crucial — the government spends whatever it chooses to spend, regardless of ex ante taxation or borrowing. A household or firm cannot choose to spend money it has not already obtained; a government might choose to spend only the money it has previously obtained, but it can choose not to.
*I will repeat my usual disclaimer: I am not a scholar of MMT; any mistakes in my present description of MMT ideas are my own.
I suspect that MMT scholars stress this financial freedom precisely because not only governments but orthodox economists, while they formally acknowledge government's financial freedom, either don't understand this freedom — a lot of economic theory depends on a financial budget constraint to make any kind of sense — or they don't want people to intuitively grasp the government's financial power. What is to become of the captains of industry, the titans of finance, if their years of hard work accumulating money can be duplicated or undone in seconds by some faceless downclass bureaucrat in a cheap suit? Worse yet, what if the unwashed masses catch on and start, gasp! voting on that basis? No, such nonsense simply will not do.
But of course even that the government has financial freedom, i.e. it can spend as much or as little money as it pleases, the government does not have "real" freedom: it cannot choose to escape opportunity costs. Especially when the economy is at full employment, anything the government creates money to produce means using that money to reallocate real labor and capital away from other production. At full employment, government spending on one thing, regardless of the source of the spending, means giving up something else.
Governments usually produce public goods, and the opportunity costs of public goods are harder to distribute than are the opportunity costs of private goods. Suppose a firm produces a private good, a new and improved widget with extra frobulousness. The firm improves society if and only if individual consumers individually choose to buy its widgets instead of now unfashionable and obsolete doodads and gewgaws. Ideally, the private firm merely poses the option: the individual consumer decides whether the new option is worth the opportunity cost, and what the opportunity cost actually is in real terms. And we know when the firm produces the optimal quantity of new and improved widgets precisely when the marginal consumer is indifferent between the new widget and the next best choice. With apologies to Landseer and à Kempis, the firm proposes, the consumer disposes.
Public goods simply do not work that way, as economists orthodox and heterodox all know: the math is clear and unequivocal. Individual consumers cannot individually choose how much of a public good they receive: all consumers receive benefit from all production of a public good, regardless of their individual preferences. If the government produces clean air, I cannot help but breathe it.
Thus, the government must distribute the opportunity costs. They can do so in two ways: increase or keep constant the supply of money and let everyone's money purchase less stuff per dollar, i.e. no taxation and some inflation, or decrease the supply and let everyone's money retain its purchasing power, i.e. some taxation and no inflation, i.e. price stability.* So in the sense of the distribution of opportunity costs, taxes do in a sense "pay for" government production.
*Strictly speaking, there is a continuum between zero taxation and zero inflation.
On the one hand, government has financial freedom; on the other hand, the government has real constraints. On the gripping hand, there are some circumstances where government spending neither requires taxation nor generates inflation (or at least not nearly as much as it might otherwise do). When government spending promotes short run or long run real economic growth, the economic growth itself "pays for" government spending in both the financial and real sense. In the short run, when real economic output is below potential — i.e. under recessionary conditions of less than full employment, especially when the recession has been caused or exacerbated by collapse of the money supply as during the Great Depression — government spending causes an increase in both financial and real economic activity. The injected money just keeps flowing; it does not (all) need to be leaked back out by taxation, and the increase in real economic activity absorbs the extra spending without causing (too much) inflation.
Similarly too with long run economic growth. Government spending in research and development, especially for the military, initiates much (if not almost all) of the growth of inventive technology. (See e.g. Doing Capitalism in the Innovation Economy by William H. Janeway.) Again, the spending is "paid for" by the increase in real economic activity.
Many critics of MMT argue that the above exposition is just warmed-over bog-standard Keynesian macro. Perhaps. If so, the profession of economics has been trying to at best downplay and at worst obfuscate its importance and relevance not just to the general public but to undergraduate students of economics. I know: I just finished an undergraduate and graduate economics education, and I found the claims of MMT were both shocking and obvious in retrospect.
Even the Holy Bearded One says in his own Macroeconomics textbook that the government should run a balanced budget on average (my copy is in my office; citation to follow). But this cannot be so. In an ideal world where we always have zero inflation and no short-term fluctuations, to preserve perfect price stability, the amount of money flowing through the economy* must increase as long-run potential output increases. Since money cannot flow arbitrarily quickly, the overall supply must increase, so either the banks create it or the government has to create new money.
*Technically the money supply times the velocity of money.
We could, I suppose, allow the private banking system complete control over the flow of money. When unconstrained by government regulation, complete private control of money generally has not worked worked all that well. Seriously. It's a Bad Idea. If we want to make the foundation of economy the government's power to collect taxes, then the government must run a deficit on average.
As best I can tell, Modern Monetary Theory scholars* stress the idea that taxes do not pay for government produces in a "financial" sense: unlike a household or a firm, government does not collect taxes to obtain money to spend on government production. A household or a firm must obtain money, via revenue, borrowing, or theft, before it can spend it. A government need not do so; to the extent that the government says it does need to collect money before it spends it, the government is at best disingenuous and at worst deceptive. Financially — and this qualifier is crucial — the government spends whatever it chooses to spend, regardless of ex ante taxation or borrowing. A household or firm cannot choose to spend money it has not already obtained; a government might choose to spend only the money it has previously obtained, but it can choose not to.
*I will repeat my usual disclaimer: I am not a scholar of MMT; any mistakes in my present description of MMT ideas are my own.
I suspect that MMT scholars stress this financial freedom precisely because not only governments but orthodox economists, while they formally acknowledge government's financial freedom, either don't understand this freedom — a lot of economic theory depends on a financial budget constraint to make any kind of sense — or they don't want people to intuitively grasp the government's financial power. What is to become of the captains of industry, the titans of finance, if their years of hard work accumulating money can be duplicated or undone in seconds by some faceless downclass bureaucrat in a cheap suit? Worse yet, what if the unwashed masses catch on and start, gasp! voting on that basis? No, such nonsense simply will not do.
But of course even that the government has financial freedom, i.e. it can spend as much or as little money as it pleases, the government does not have "real" freedom: it cannot choose to escape opportunity costs. Especially when the economy is at full employment, anything the government creates money to produce means using that money to reallocate real labor and capital away from other production. At full employment, government spending on one thing, regardless of the source of the spending, means giving up something else.
Governments usually produce public goods, and the opportunity costs of public goods are harder to distribute than are the opportunity costs of private goods. Suppose a firm produces a private good, a new and improved widget with extra frobulousness. The firm improves society if and only if individual consumers individually choose to buy its widgets instead of now unfashionable and obsolete doodads and gewgaws. Ideally, the private firm merely poses the option: the individual consumer decides whether the new option is worth the opportunity cost, and what the opportunity cost actually is in real terms. And we know when the firm produces the optimal quantity of new and improved widgets precisely when the marginal consumer is indifferent between the new widget and the next best choice. With apologies to Landseer and à Kempis, the firm proposes, the consumer disposes.
Public goods simply do not work that way, as economists orthodox and heterodox all know: the math is clear and unequivocal. Individual consumers cannot individually choose how much of a public good they receive: all consumers receive benefit from all production of a public good, regardless of their individual preferences. If the government produces clean air, I cannot help but breathe it.
Thus, the government must distribute the opportunity costs. They can do so in two ways: increase or keep constant the supply of money and let everyone's money purchase less stuff per dollar, i.e. no taxation and some inflation, or decrease the supply and let everyone's money retain its purchasing power, i.e. some taxation and no inflation, i.e. price stability.* So in the sense of the distribution of opportunity costs, taxes do in a sense "pay for" government production.
*Strictly speaking, there is a continuum between zero taxation and zero inflation.
On the one hand, government has financial freedom; on the other hand, the government has real constraints. On the gripping hand, there are some circumstances where government spending neither requires taxation nor generates inflation (or at least not nearly as much as it might otherwise do). When government spending promotes short run or long run real economic growth, the economic growth itself "pays for" government spending in both the financial and real sense. In the short run, when real economic output is below potential — i.e. under recessionary conditions of less than full employment, especially when the recession has been caused or exacerbated by collapse of the money supply as during the Great Depression — government spending causes an increase in both financial and real economic activity. The injected money just keeps flowing; it does not (all) need to be leaked back out by taxation, and the increase in real economic activity absorbs the extra spending without causing (too much) inflation.
Similarly too with long run economic growth. Government spending in research and development, especially for the military, initiates much (if not almost all) of the growth of inventive technology. (See e.g. Doing Capitalism in the Innovation Economy by William H. Janeway.) Again, the spending is "paid for" by the increase in real economic activity.
Many critics of MMT argue that the above exposition is just warmed-over bog-standard Keynesian macro. Perhaps. If so, the profession of economics has been trying to at best downplay and at worst obfuscate its importance and relevance not just to the general public but to undergraduate students of economics. I know: I just finished an undergraduate and graduate economics education, and I found the claims of MMT were both shocking and obvious in retrospect.
Even the Holy Bearded One says in his own Macroeconomics textbook that the government should run a balanced budget on average (my copy is in my office; citation to follow). But this cannot be so. In an ideal world where we always have zero inflation and no short-term fluctuations, to preserve perfect price stability, the amount of money flowing through the economy* must increase as long-run potential output increases. Since money cannot flow arbitrarily quickly, the overall supply must increase, so either the banks create it or the government has to create new money.
*Technically the money supply times the velocity of money.
We could, I suppose, allow the private banking system complete control over the flow of money. When unconstrained by government regulation, complete private control of money generally has not worked worked all that well. Seriously. It's a Bad Idea. If we want to make the foundation of economy the government's power to collect taxes, then the government must run a deficit on average.
Thursday, November 25, 2010
Real and Nominal Prices
Before I continue to talk about inflation and deflation, I want to take a detour and discuss real and nominal prices. Nominal prices are prices denominated directly in units of money; real prices are more subtle. If, as I note in my previous essay, the nominal prices of everything change all at once, by a little or by many orders of magnitude, nothing real has changed. The real height of a building remains the same whether we measure it in feet, inches meters, micrometers, or even fractions of a light-year. Economists go to great trouble to try to abstract away purely nominal prices and measure real quantities, such as Real Gross Domestic Product.
If it's so important to measure and talk about real prices, if nominal prices are as irrelevant as they seem, why not cut to the chase and do our economic transactions directly in some "real" quantity? Scientists do so all the time: They measure length in real meters, weight in real kilograms, etc.; the notion of a purely nominal measure with a varying relationship to anything real would be inconvenient and pointless*. The problem in economics, however, is that it's impossible to immediately determine real prices; whereas nominal prices are by definition immediate; they measure the immediate relations of particular commodities and factors to each other. It is only in retrospect, when we can identify how all these ever-changing relations have sorted themselves out, that we can actually identify real prices. (And economists cannot really identify real prices; they can only estimate real prices.) We can know nominal prices exactly, although we cannot know what they "really" mean; real prices by definition mean something real, but we cannot know them at all immediately, and only imperfectly in retrospect.
Physical objects — a house, a table, a cabinet full of canned goods — always have a specific real value that can be related to the nominal price at any given time: it is simply the replacement cost in present nominal price less the present nominal maintenance price. Regardless of what I nominally paid for my house ten years ago, its real value today is the nominal price of a new house minus the nominal price of fixing the house to make it of a similar quality to a new house. (If standards of quality have fallen, the maintenance price may be negative, increasing the real value of the house.) Since the real value is a function of present nominal value, we can hold the real value constant and use simple algebra to make nominal price a function of time in relation to the constant real value.
Another way of looking at real value is to look at the specifically physical components of a house.
A house requires a certain amount of lumber, wires, pipes, shingles, etc., all of which require raw materials; everything, from the extraction of the raw materials, to the manufacture and transport of the intermediate components to the final assembly of the house require a certain amount of human labor, fixed by the natural world and current levels of technology. So long as none of these components change substantially — the cost in labor of extracting materials, or manufacturing wires or pipes, etc. — change, the real value of the house will not change, even if prices overall rise or fall, changing the nominal value of the house. Of course, if the fundamental natural or technological conditions change — wood becomes more scarce, requiring more labor to satisfy marginal demand, or efficiency of production lowers the total labor cost of producing wires and switches — then the real value of the house — irrespective of the nominal value — will change.
If all wealth were held in purely real terms — in things such as houses, factories, cans of food, or even ingots of gold — then there would be no nominal prices, and inflation and deflation would be meaningless. The problem comes in when we start to socially construct assets with purely nominal value. I'll talk about the effect of these assets in another post.
If it's so important to measure and talk about real prices, if nominal prices are as irrelevant as they seem, why not cut to the chase and do our economic transactions directly in some "real" quantity? Scientists do so all the time: They measure length in real meters, weight in real kilograms, etc.; the notion of a purely nominal measure with a varying relationship to anything real would be inconvenient and pointless*. The problem in economics, however, is that it's impossible to immediately determine real prices; whereas nominal prices are by definition immediate; they measure the immediate relations of particular commodities and factors to each other. It is only in retrospect, when we can identify how all these ever-changing relations have sorted themselves out, that we can actually identify real prices. (And economists cannot really identify real prices; they can only estimate real prices.) We can know nominal prices exactly, although we cannot know what they "really" mean; real prices by definition mean something real, but we cannot know them at all immediately, and only imperfectly in retrospect.
*I am not a scientist; it might be the case that scientists do use purely nominal measures. If so, I would very much like to know about these measures, and how scientists go about relating them to real quantities.
A house requires a certain amount of lumber, wires, pipes, shingles, etc., all of which require raw materials; everything, from the extraction of the raw materials, to the manufacture and transport of the intermediate components to the final assembly of the house require a certain amount of human labor, fixed by the natural world and current levels of technology. So long as none of these components change substantially — the cost in labor of extracting materials, or manufacturing wires or pipes, etc. — change, the real value of the house will not change, even if prices overall rise or fall, changing the nominal value of the house. Of course, if the fundamental natural or technological conditions change — wood becomes more scarce, requiring more labor to satisfy marginal demand, or efficiency of production lowers the total labor cost of producing wires and switches — then the real value of the house — irrespective of the nominal value — will change.
If all wealth were held in purely real terms — in things such as houses, factories, cans of food, or even ingots of gold — then there would be no nominal prices, and inflation and deflation would be meaningless. The problem comes in when we start to socially construct assets with purely nominal value. I'll talk about the effect of these assets in another post.
Thursday, November 18, 2010
Why deflation is a Very Bad Thing part 1
In the long run, inflation and deflation (negative inflation) don't matter. At all. In the short run, though, they do matter. A lot.
Macroeconomic inflation, remember, is a change in aggregate price levels; by "aggregate", economists mean all prices, including wages, rent, interest and profits. If the price of beef goes up, but all other prices stay about the same, that's not inflation. There are a lot of reasons why the price of some individual good can change without any change in overall price levels. For example, market forces or government regulations might require beef producers to spend more money on healthier feed or veterinary examinations, causing the absolute cost of producing beef to rise. There might also be a temporary shortage of beef, causing supply to be allocated to those who prefer beef the most, i.e. those are willing to forego more of other goods and pay more for beef. Similarly, improvements in efficiency can lower the absolute cost, or a temporary surplus would cost the cost to fall until the supply was adjusted. None of these phenomena have much to do with macroeconomic inflation. Inflation is a change in all prices and wages, not just one price or another.
This is an extremely critical point. A person can go into the grocery store and observe that the price of beef has just gone up, and say, "Wow! inflation is killing me!" He would often be wrong. When economists measure inflation — and I must repeat: inflation means changes in all price levels, the aggregate price level — they tend to exclude (at least in the short run) products with a lot of price volatility, such as, well, food. The price of food is dependent on an enormous number of factors: weather and climate conditions, consumer tastes, government policy; inflation — changes in the aggregate price level — is only one factor out of many. It is possible to have the price of food, oil* and other volatile prices go dramatically in directions other than the overall aggregate trend in prices. There are a lot of ways to measure inflation (core inflation, trimmed mean levels, rolling multi-year averages) but all of these measures try to factor out extremely volatile prices.
In the long run, inflation doesn't matter. The long run is by definition as long as it takes for all prices to adjust. We can see that inflation doesn't matter in the long run by imagining that the "long run" is instantaneous. Imagine that the government decides to add a zero to everything: to all prices, all wages, all bank accounts, all loans... everything. Yesterday, Alice makes $20/hour, has a $100,000 mortgage at 6% interest for which she pays $800/month, a $1,000 credit card bill at 10% for which she pays $80/month, and buys bread in the store for $2.50 a loaf. Today, Alice makes $200/hour, has a $1,000,000 mortgage at 6% and a $8,000 payment, a $10,000 credit card bill for which she pays $800, and bread costs $25/loaf. Nothing at all about Alice's standard of living, nothing about her real economic situation, will have changed. The same is true if we have instantaneous deflation, if we knock a zero off of everything. So if we define the "long run" as "the time it takes for all prices to adjust", inflation doesn't change anything about the real economy.
But as Keynes notes, in the long run we're all dead. Inflation and deflation matter a lot in the short run. Inflation matters in the short run because all prices and wages do not change all at the same time. Not only do they not all change at the same time, there's a pattern to the changes, and this pattern itself has an effect on the real economy.
Inflation essentially "measures" the relationship between the present and the future, or more precisely our expectations about the future. Very high inflation "says" that the present is much more important than the future; very low inflation (or deflation, i.e. negative inflation) "says" that the future is much more important than the present. Moderate levels of inflation, unsurprisingly, represent a balance between the present and the future. When inflation is very high, consumers want to spend their money as quickly as possible; they will be induced to save only with very high interest rates or rates of return on profit. Because interest rates are high, businesses, which shoulder the bulk of planning for the future by investing in physical capital, will borrow or invest less. (Note that even though prices will be higher in the future, increasing the nominal return on any investment in the present, other factors, especially wages, will also have increased, also increasing the costs.)
When inflation is very high, everyone spends. When inflation is very low or negative, everyone saves. But economics is built on trade. We want the people who want to save to trade with people who want to spend. If everyone wants to spend or save, there's no trade happening, which is (usually) bad.
I'll go more into the dynamics of inflation and deflation in another post.
Macroeconomic inflation, remember, is a change in aggregate price levels; by "aggregate", economists mean all prices, including wages, rent, interest and profits. If the price of beef goes up, but all other prices stay about the same, that's not inflation. There are a lot of reasons why the price of some individual good can change without any change in overall price levels. For example, market forces or government regulations might require beef producers to spend more money on healthier feed or veterinary examinations, causing the absolute cost of producing beef to rise. There might also be a temporary shortage of beef, causing supply to be allocated to those who prefer beef the most, i.e. those are willing to forego more of other goods and pay more for beef. Similarly, improvements in efficiency can lower the absolute cost, or a temporary surplus would cost the cost to fall until the supply was adjusted. None of these phenomena have much to do with macroeconomic inflation. Inflation is a change in all prices and wages, not just one price or another.
This is an extremely critical point. A person can go into the grocery store and observe that the price of beef has just gone up, and say, "Wow! inflation is killing me!" He would often be wrong. When economists measure inflation — and I must repeat: inflation means changes in all price levels, the aggregate price level — they tend to exclude (at least in the short run) products with a lot of price volatility, such as, well, food. The price of food is dependent on an enormous number of factors: weather and climate conditions, consumer tastes, government policy; inflation — changes in the aggregate price level — is only one factor out of many. It is possible to have the price of food, oil* and other volatile prices go dramatically in directions other than the overall aggregate trend in prices. There are a lot of ways to measure inflation (core inflation, trimmed mean levels, rolling multi-year averages) but all of these measures try to factor out extremely volatile prices.
*And derivative products such as gasoline.
In the long run, inflation doesn't matter. The long run is by definition as long as it takes for all prices to adjust. We can see that inflation doesn't matter in the long run by imagining that the "long run" is instantaneous. Imagine that the government decides to add a zero to everything: to all prices, all wages, all bank accounts, all loans... everything. Yesterday, Alice makes $20/hour, has a $100,000 mortgage at 6% interest for which she pays $800/month, a $1,000 credit card bill at 10% for which she pays $80/month, and buys bread in the store for $2.50 a loaf. Today, Alice makes $200/hour, has a $1,000,000 mortgage at 6% and a $8,000 payment, a $10,000 credit card bill for which she pays $800, and bread costs $25/loaf. Nothing at all about Alice's standard of living, nothing about her real economic situation, will have changed. The same is true if we have instantaneous deflation, if we knock a zero off of everything. So if we define the "long run" as "the time it takes for all prices to adjust", inflation doesn't change anything about the real economy.
But as Keynes notes, in the long run we're all dead. Inflation and deflation matter a lot in the short run. Inflation matters in the short run because all prices and wages do not change all at the same time. Not only do they not all change at the same time, there's a pattern to the changes, and this pattern itself has an effect on the real economy.
Inflation essentially "measures" the relationship between the present and the future, or more precisely our expectations about the future. Very high inflation "says" that the present is much more important than the future; very low inflation (or deflation, i.e. negative inflation) "says" that the future is much more important than the present. Moderate levels of inflation, unsurprisingly, represent a balance between the present and the future. When inflation is very high, consumers want to spend their money as quickly as possible; they will be induced to save only with very high interest rates or rates of return on profit. Because interest rates are high, businesses, which shoulder the bulk of planning for the future by investing in physical capital, will borrow or invest less. (Note that even though prices will be higher in the future, increasing the nominal return on any investment in the present, other factors, especially wages, will also have increased, also increasing the costs.)
When inflation is very high, everyone spends. When inflation is very low or negative, everyone saves. But economics is built on trade. We want the people who want to save to trade with people who want to spend. If everyone wants to spend or save, there's no trade happening, which is (usually) bad.
I'll go more into the dynamics of inflation and deflation in another post.
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