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Tax And Spend Is Dead

12/07/2017 11:48 BST | Updated 12/07/2017 11:49 BST
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For years I believed the mantra "tax and spend" as though it were a law of physics: indisputable and unquestionable.

We have been told that this is how government pays for public services: it taxes people and then it spends the money.

This idea has been promoted in the press and by political parties for years and especially at election time, "We'll raise income tax by 1p to pay for new schools, hospitals and roads: the things we all use and need!"

This mantra is connected to a belief that the government and political parties must explain which tax will pay for which public service.

But why should we question this mantra? The government - or any party wanting power - should explain how it is going to fund public services. That's part and parcel of honest and transparent government.

That may be true, but that doesn't mean tax must be raised first to pay for anything.

It turns out, after all these years, "tax and spend" doesn't exist at all.

The government can create its own money without needing to first raise a penny in tax. It does this, not by planting a magic money tree, but by instructing the Bank of England to create it. Just as it did to help us out of the 2008/9 banking crisis.

It instructed the Bank to create £435 billion, which it then used to buy back government bonds and in the process inject money into the financial markets.

Did the government tax anyone before instructing the Bank of England to create that money?

No. It never raised a penny in tax to pay for it. There was no "tax and spend".

But the government did collect tax as a natural and necessary consequence of creating that money. Because when a bank lends money to someone to buy a house, or to a business to buy raw materials for example, the buyer then pays Stamp Duty and or VAT on the goods and services bought.

In other words, tax is collected by the government after the money has been created and spent.

It cannot be "tax and spend" because you can't collect tax from non-existent money or a non-existent sale or a non-existent salary: money must always be created first, otherwise there is nothing to tax!

Which means...

The correct order is in fact: create money, spend money, collect tax.

Which also means...

The government doesn't need to tax anyone or any business a single penny before it can build a school, hospital or road.

It can simply instruct the Bank of England to create whatever amount is needed and ask the builders to get on with the job. Tax is then collected when the builders use that money to employ workers and buy raw materials etc. And tax is collected again when the doctors and nurses who are employed by the hospital take home their salary and use it to pay for their mortgages, rent, food, petrol etc. etc.

So, the money created by the Bank of England to pay for public services comes back to the government when they collect tax from people and businesses.

Which means...

There is no such thing as "tax and spend" - as Mr. Spock would say, "It's illogical Captain."

Yet still we demand the government tell us where the money will come from to pay for public services!

This is not unreasonable.

What I mean by this is that yes, government must explain how it will pay for things like pay rises for nurses and nuclear submarines, but the answer to this question is not to state which tax will be raised.

Instead, the correct answer is to state how much money the government will ask the Bank of England to create. Because public services are paid for by creating money first, then spending it and then collecting tax.

So, it's not "tax and spend". It's create, spend and collect.

That's where the money comes from.

That's how public services are paid for.

So what is tax for then?

Tax is actually raised to control inflation i.e. to take money out of circulation when the economy starts to overheat.

Which means...

What the government can't do is suddenly create a gazillion bazillion pounds and blow it all in one day. The amount of money they can ask the Bank of England to create needs to be calculated and managed with respect to how it would influence growth and inflation.

But no tax of any kind needs to be raised first, because it's impossible to tax something that does not first exist.

And that is why tax and spend is dead.

Long live create, spend and collect!

(A kind thank you goes to Richard Murphy from Tax Research UK for his help making sure this article is factually correct.)