Congress does not need to get money from rich people in order to fulfill its responsibility to do what is in the public’s interest. This does not mean we shouldn’t raise taxes on the wealthiest Americans, but rather that we should do so for the right reasons, and there are many good reasons. Fundraising for the Treasury just isn’t one of them. Congress is never constrained by the amount of taxes received. So when we raise federal taxes on those with high incomes it should be either to help maintain a strong currency or because doing so serves some benefit to the economy or society – i.e. public purpose and general welfare. More on this in a moment.
Our collective failure to understand this distinction is undermining our ability to utilize fiscal policy appropriately for the general well-being of our nation and the long term health of our economy. It is essential that we regain a proper understanding of our currency in order to avoid the kind of disastrous bi-partisan policy-making that stems from a misguided linkage of federal taxation and federal spending.
Bear with me a moment as I do some important table setting before returning to why we should tax high income earners more.
Lessons from World War II
We learned a lot about money during World War II. We used our government’s currency-creating power to hire millions of civilians and pay for a large portion of our nation’s productive capacity to manufacture and farm for the war effort. Government purchases credited billions of instantly created US Dollars into the bank accounts of businesses and households, causing profits and wages to rise, unemployment to fall, and necessitating measures to guard against inflation. Taxation was one such measure, along with price controls, rationing of consumer goods, and the promotion of war bonds to increase saving.
As a sovereign nation we make our own currency and this is enormously important. This allows us to do remarkable things that would be impossible without it. Mobilizing for war is one thing, but developing our nation is greater still. We are limited only by our imaginations or our fears – and by what resources we can buy and what talent we can hire with our currency.
The federal government creates US Dollars when it spends and removes US Dollars when it taxes. Note the crucial sequence: WWII government spending added currency in the form of wages, sales and profits to the economy that were not otherwise there (remember we’d been in a long depression); higher taxation subsequently removed a lot of that extra currency so as to reduce the rise in spending power of the population. Our government is not revenue-constrained and Congress knows it. The rich did not fund the WWII war effort; they did not fund our more recent war efforts. Rather, they became richer as a result of it and were therefore (in the 1940s) taxed at higher rates to reduce their spending power.
Public purpose, not taxes, sets the size of government budgets
Now it was public purpose (in this case, “providing for the common defense”) that established the size of the government’s economic activity during WWII. This consisted of a very large government budget although much of it was channeled into private businesses not just government institutions, as is often the case in the US. Public purpose also necessitated higher taxes on incomes and corporate profits to offset this dramatic increase in spending. Both spending and taxation fulfilled public purpose, but independently and for different reasons.
I use this example as it illustrates the right way to run a sovereign currency:
- first establish what is in the public interest via the democratic process and authorize the spending;
- second, establish the appropriate level of taxation to maintain currency stability and full employment.
We cannot reverse the order and we should never limit public purpose by how much money the government collects in taxes, as if it were not the issuer of the currency.
Public purpose means to provide for the general welfare at least as much as it means to provide for the common defense. There is so much more we can and should do together. Why are we holding back?
A sovereign currency means everything
Now before I go too far, it is important to draw a clear distinction between a currency-issuer and all other economic entities, whether governments or businesses or households. This distinction is what helps us redefine the purpose of federal taxation.
A truly sovereign nation is one that:
- issues its own currency,
- allows the value of their currency to float in exchange with other currencies,
- makes no promise of rigid convertibility (such as to gold or another currency at a fixed price), and
- does not have debt denominated in a foreign currency.
By definition, the currency issuer must spend or lend its money into the economy before we can obtain it to pay our taxes. US Dollars can only come from the issuer of US Dollars – other sources are counterfeit. And by definition, such a nation cannot become insolvent or default, unless by choice, since it “owes” only that money which it creates on demand.
Countries that lose any one of these criteria have imposed restrictions on their ability to use fiscal policy in the national interest and for the good of their people. For example, countries in the Eurozone (including Portugal, Ireland and Greece) gave up full monetary sovereignty. They have become like currency-using states. Their governments must tax or borrow Euros in order to spend them. Now you can begin to understand why Japan has no sovereign debt crisis while Greece does.
You should now also be able to see a very clear distinction between our federal government and all of our other currency-using governments – states, cities and counties – all of which must collect taxes or issue bonds in order to have money to spend. The federal government is unique. It is entirely unlike a household or business or local government.
As we saw clearly during wartime, the spending of US Dollars into the economy by the government must precede the returning of US Dollars to the government in payment of taxes or saving US Dollars in the form of US Dollar Treasury bonds.
I apologize if this is your first time to hear all this. Your head may be spinning as was mine when I first began to study modern money. Unfortunately, like those in Galileo’s time who thought the sun went around the earth, we’ve been looking at the process of national currencies the wrong way. This is in part a vestige of a bygone era of fixed exchange rates and gold convertibility (refer to the limiting criteria mentioned above).
You may need to re-read this a few times and let it sink in, but we do need to move on. Let’s return to our topic at hand.
Why tax the rich if we don’t need their money?
If taxation at the federal level simply removes some of the government’s currency back out of the economy after it first spent or credited it into existence, why do we need to tax at all?
I find it helpful to separate the purpose of currency taxation into two broad categories: i) maintaining a useful currency, and ii) achieving public purpose (which of course includes a healthy economy and stable currency).
- Taxes drive the currency
To briefly address the first point, we need some form of taxation simply to have a currency. That’s what makes it all work. Behind our acceptance of US Dollars is the fact that most of us owe US Dollars to our government to redeem tax liabilities. By imposing a tax that can only be paid in US Dollars, the government can then issue US Dollars and find ready workers and businesses willing to accept them as payment for goods and services. We have lost sight of this fundamental connection because our economy and financial system have grown large and complex, but it remains nonetheless. Remove taxation and the basis for stable government currency is undermined.
Now since the government sets the amount of currency it adds into the economy by spending (or paying interest & making transfer payments), and also controls the amount of its currency subsequently removed from the economy via taxation, the government is in a unique role to maintain the right balance between these two actions. That balance has nothing to do with the size of deficits or the so-called “national debt”.
Economist Abba Lerner, who coined the term “Functional Finance”, wrote the following during WWII about how our currency should be managed:
The first financial responsibility of the government (since nobody else can undertake that responsibility) is to keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce. If total spending is allowed to go above this there will be inflation, and if it is allowed to go below this there will be unemployment.
Recognizing the challenge that this creates politically (relying on Congress to constantly adjust taxes up and down to balance the economy), we have automated the heavy lifting of this kind of countercyclical tax policy via a combination of progressive income and profit taxes. As the economy grows, more currency is removed via taxation, and as it contracts, less is removed.
This approach makes a lot of sense and we should work to further improve such policies. A federally funded job guarantee to support full employment at all times would be a complimentary spending approach to further help stabilize the currency and the economy.
This topic deserves more treatment than space here allows, but the essential point is that some amount of taxes are required to create acceptance of the government’s currency and to help regulate the economy. A combination of tax policies would do this job effectively, and taxing high income earnings at higher rates should be part of that mix.
- Taxes express public policy
This is where we really need to focus our attention if we are to make any headway in addressing the growing inequity in our society. Misguided arguments that the wealthy should “pay for” federal programs only serve to give more power to the wealthy over our government policymakers, artificially restricting spending for public good until tax concessions can be obtained from them. The government doesn’t need their money in order to spend. However, high income earners should absolutely be taxed and disproportionately so.
There are vital social, economic, and democratic reasons to prevent excessive accumulation of wealth, shape the distribution of incomes, and encourage the kind of economic behavior that promotes sustainable prosperity for all.
Taxation reduces spendable income and influences economic behavior. As such, it is a tool to express public policy and should be designed to achieve a given public purpose, not as a source of funds for the Treasury. Once the mistaken “pay for” rationale has been removed we can focus on what taxes really do for us. For example, we can:
- tax wages if there is a good reason to lower the spendable income of wage earners;
- tax income at different tiers if there is a good reason to shape the distribution of incomes;
- tax profits if there is a good reason to reduce profits;
- tax some products more than others if there is a good reason to make some products more expensive or discourage their production or consumption.
With this in mind, we can begin to rationalize the public purpose for increased taxation on the upper end of society. Note that we have moved the debate away from what the rich should pay for and toward a conversation about the kind of country and economy we want. For example:
- Are growing wealth dynasties unhealthy for democracy?
- Does our economy need less debt-fueled speculative investing and more consumption-driven growth?
- Are executive compensation packages and corporate finance practices supporting long term sustainable growth and value for all stakeholders?
- Do billionaires and corporations have an unhealthy influence over the legislative, judicial and executive branches of our government?
- Are wealthy interests controlling, exploiting or otherwise harming our ecological systems that are essential for our long term health and prosperity?
- Do low- and average-income workers have enough take-home pay to live well or are their incomes too small and taxes too high?
- Is finance being used primarily to serve the productive economy and public needs or is it undermining long term economic growth and societal well being?
These are just a few questions to start our public discourse and many of you will have important contributions to make in your respective fields. Tax policy clearly can’t do everything. We have significant investment opportunities throughout our nation that could serve to greatly improve the quality of life for many people and set a path for our nation’s future prosperity. We can and should be working in parallel to increase funding for such initiatives while also addressing tax reforms that will serve to strengthen our democracy and economy, including ending tax favoritism for investors. Congress needs to sever the link between taxation and spending, and start redesigning fiscal policy – both spending and taxing – in ways that serves to increase the general welfare of all Americans.
Geoff Coventry is a founding member and owner of Tradewind Energy, Inc. Prior to this position, Geoff was a co-founder and vice president of NetSales, Inc. Additional postings by Geoff can be found on his blog “It’s The People’s Money.”