Twenty-Six / Modern Monetary Theory, Deficit Myth, and the Role of Taxation

This week's article covers the Modern Monetary Theory, a post-Keynesian heterodox school of thought. Then, read book notes on Stephanie Kelton's Deficit Myth and the PAYGo model. Why taxation matter, even for Modern Monetary Theory?

Weekly Article

Modern Monetary Theory: A Paradigm Shift or Drift?

Modern Monetary Theory is a post-Keynesian heterodox theory postulating that an economy holding a sovereign currency can never run out of money.

To read a detailed description of the Modern Monetary Theory, read the full article using the link below.

Read Article

Book Notes

Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy by Stephanie Kelton (2020)

“Deficit spending is the norm, and everyone in Washington, DC, knows it. And so do voters. That’s why so many politicians complain that Congress needs to get its fiscal house in order before it’s too late. To demonstrate their commitment to good, old-fashioned household budgeting, the Democrats, led by Speaker Nancy Pelosi (D-CA) reinstated a budget rule known as pay as you go (PAYGO) in 2018. With PAYGO in place, borrowing to finance new expenditures is technically off limits. That reduces (TAB)S to just tax and spend (T)S, so lawmakers face intense pressure to cover any proposed new spending with revenue from new taxes.”

For the reader's context, (TAB)S stands for Taxation And Borrowing Before Spending. By this definition, (T)S stands for Taxation before Spending.

While the book stresses how state budgeting differs from household budgeting due to the Central Bank's power to print currency when required - one of the powers the households lack, we can draw some similarities in their functioning too. 

Pay as you go (PAYGo) is not only a tool that Congress or governments, in general, can use to balance the national budgets. Over the past decade, the PAYGo model has found its use in expanding energy access and financial inclusion to low and middle-income populations, who otherwise would have remained off-grid, in developing countries like Africa. The technical idea behind this innovative business model remains the same - end-users pay weekly installments depending on their financial liquidity in exchange for using solar lighting systems. The PAYGo model relies on equity financing than debt financing, depending upon funders and investors in place of taxation - a tool in Congress's arsenal.

What are we Thinking?

If financially sovereign governments, along with the Central Banks by their side, can finance fiscal deficits and debts, what role does it leave for taxation to play?

The answer to this lies in a four-point framework adapted from Stephanie Kelton's Deficit Myth. 

First, taxation is not a way to raise money for the state but to provide for it. When the state is the sovereign currency issuer, creating more money is not a problem. But, ensuring that we use this money is one of the concerns. So, the government taxes the currency we hold to encourage our demand for money. 

Second, taxes control inflationary pressures in an economy where the state can print money. Though inflation is not all bad, high consumer price inflation and signs of hyperinflation are worrying. Taxation keeps a check on rising inflation levels.

Third, taxation has the power to redistribute wealth and reduce inequalities. Though the effect of wealth taxes on inequality remains equivocal, it can be an effective policy measure if political will allows it to be. 

Finally and most importantly, taxes can encourage or discourage our actions. Imposing heavy taxation on cigarettes and carbon emissions can reduce smoking and environmental pollution. Tax rebates, on the other hand, can also be effective in encouraging behaviors. These are shifting to electric vehicles, traveling by public transportation, or replacing old bulbs with energy-efficient appliances.

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