Are social policy activists channelling their energy in the right places? Would understanding the basics on how Government finances actually work strengthen demands on funding public services and other social policy? It could be argued that it would be beneficial for anyone who is interested in protecting our public services to know what is set out below.
Social policy activists daily campaign for our public services; e.g. the NHS, welfare, housing etc, which are often our only fallback against social and economic inequalities so prevalent in modern societies and that are caused significantly by capitalist systems and beliefs. Such ideologically based policy profoundly affects our abilities to live healthy, dignified and meaningful lives, not to mention limiting many of us from satisfactory economic participation in society.
These days, many are familiar with the phrase “Government finances are not the same as household finances” but do we really understand what this means and specifically for demands on public spending?
Demands tend to revolve around seeking higher taxes from the rich to “pay for“ public services. The assumption being that greater tax revenues accumulate a bigger “pot” from which public expenditure must come. Activists focus on persuading politicians to apportion more of that “pot” to public services and social policy. What they are describing are the circumstances relating to a currency user ie an individual, household or business required to earn income in order to spend or a country which uses/earns the currency of another country ie the “household finances” analogy.
What if social policy activists, in the U.K. for instance, understood that there was no “pot” from which public expenditure comes and that currency used to pay taxes is effectively deleted from the economy on receipt. Where does that leave their demands for redistribution?
The main functions of taxation in a currency issuing state; e.g. the U.K.
A) to E) are basic, immutable facts. F) to H) are political choices.
A) to enforce the legitimacy and use of the state currency. As taxes are required in the state currency only, everyone is compelled to collect it to pay them;
B) in order to collect the currency (tax credits) to pay taxes, people need to seek paid labour and/or sell some other resource they produce;
C) this means the state can motivate people to work for the currency (tax credits) and sell resources to the state to build and provision what is required to create society, an economy and markets which result in the ability to enact policy.
D) to reduce the risks of inflation by removing some of the currency previously spent into the economy to facilitate B) and C). This controls consumer spending which ensures the demand of currency circulating doesn’t exceed the supply of goods and services.
E) to create a record of entitlement. For instance, National Insurance Contributions (NICs) are labelled as hypothecated taxes which basically means ring-fenced to “pay for” specific policy areas. In the case of NICs we are told they “pay for” our state pensions and towards the NHS. However, there is no pot accumulating the currency to pay for these items. NICs are accounted for in a convoluted way, but, like all taxes, end up reducing the deficit overdraft from previous spending ie are effectively deleted from the economy. In actuality, pensions could still be paid and the NHS funded without collecting these as hypothecated taxes or indeed as any kind of tax. NICs only create an individual record of entitlement eg to the state pension or benefits.
F) to act as incentives/disincentives for certain behaviours eg a tax on alcohol, carbon tax or reduced business taxes for environmentally responsible activities.
G) to reduce the influence the wealthy can have in politics and civic life, their ability to buy and hoard resources and their disproportionate tendency to buy and use harmful resources such as fossil fuels.
H) In economic systems where we see the accumulation of wealth and income in fewer hands ie capitalist-based economies, it is possible to enact some redistribution. Wealthier taxpayers can be required to pay more as a proportion of their incomes so that lower-income individuals pay less. This reduces inequality. It would also be possible to levy a land or property tax.
We can see that none of the above is about creating a pot from which spending comes. In fact, taxation and spending are not operationally connected at all. To collect the currency to pay taxes does depend on previous Government spending putting currency into the economy to be earned but spending does not depend on tax revenues. In fact, spending can happen even if no taxes are raised but no one is suggesting this is a good idea for the ongoing management of a healthy economy.
So what does government public spending depend on?
Countries like the U.K., US, Australia, Japan etc are not currency users they are currency issuers.They create their own currency which only their Central Bank can issue or authorise. Spending is by instruction from the Government Treasury Dept and notionally guided by the democratic and political process. Most modern currencies are fiat meaning there is no technical limit to how much might be created. Fiat currencies are not tied to any commodity such as the value of gold as was the case prior to the end of the global gold standard in 1971. They are not limited by the requirement to match spending with commodity reserves and therefore to tax in equal amounts to spending; i.e. “balance the books”.
They are known as sovereign currency-issuing states. In simple terms, they issue their currency to spend, always and every time creating new currency.
The real constraints on government spending
How much a currency issuer can spend will depend on the productive capacity of the economy ie its ability to absorb currency spent into it without creating undue inflation – we can see that taxation has a role in controlling inflation as already explained. In many economies, there is a degree of headroom for spending before capacity is reached.
As long as the state has access to resources to buy in its own currency, the state can use these to maintain or boost the productive capacity of the economy to ensure supply meets demand. Assets for the state can be created in the process eg infrastructure, public services which support citizens, sustainable green energy production. All help maintain future productivity. Resources are finite which ultimately constrains spending. Exports earn foreign currency with which necessary imports and resources can be acquired. Government investment can also help to boost export industries.
Public spending is not limited to the “tax base” of a sovereign fiat currency issuing state
A Government deficit, the difference between how much is spent and how much is taxed, is a non-government (you, me and business) surplus. Without this surplus, the non-government sector (us) has little ability to invest, save and spend and must rely more on bank loans and credit (private debt). Every time the Government pays for public expenditure eg housing to be built or NHS resources or staff wages, currency goes into and circulates around the economy, eventually ending up in our wages or as our savings. So we can see why Government spending deficits are important to our finances.
The National Debt (ND) is an accumulation of our savings, investments and money supply as a result of previous deficit spending (Government “debt”). It is currency spent into the economy and not yet removed as taxation, it will all return to the state this way in time. It’s not real debt in that it’s held in the currency of the state, that only it issues and will issue in future. The state does not require to earn currency to pay back holders of Government debt.
Government finances for a fiat currency issuer are nothing like household finances . In fact, the role of Government is more like the accounts keeper for what it issues out in its own monopoly currency and what comes back in taxes so it can balance the economy towards its aims which arguably should prioritise the wellbeing of citizens. All of this is without reference to having to “earn” the currency to do so.
The deficit and ND act as policy tools and levels depend on ideological and political choices. The purpose of deficits is to affect policy objectives and their deployment is related to the above real constraints not being able to “find the money”. For a deficit to be beneficial to the most people it matters a great deal what they are spent on eg targeted to increase productive capacity and create assets for the future or on advantages to the vested interests of the few, also political choices.
The neoliberal narrative on spending and taxation lies about the facts
The capitalist narrative, in particular neoliberal capitalism which became popular with Thatcher in the U.K. over 40 years ago, is filled with rhetoric about reducing deficits and the National Debt. They favour private sector provision in every sector and wish to reduce the size of the state ie public spending. Scaremongering on deficits is used to justify policies like austerity, claiming “the state has no source of money of its own…only your taxes to spend”. We can see this isn’t true.
Neoliberal capitalists and economists, over the last 40+ years, have promoted their ideological beliefs and interests by talking about state spending as if Government finances are exactly the same as household finances. Thus the economy can easily be explained in terms that people relate to in their everyday lives. The problem being that for a currency issuer this is not true, not even slightly.
We used to know this about government public spending
So let’s stop talking about the NHS being “tax based” ie paid for and limited to taxes raised and that we “can’t afford” welfare support or to build social housing unless we tax millionaires and billionaires or that austerity is necessary because we “can’t find ” the currency to spend or it will surely lead to inflation. None of this is true when you understand how currency sovereign states fund policy and manage the economy through political choices.
If we look at post war U.K. at a time when the national debt was over 250%/GDP under the New Deal we built one million council houses, put in place the NHS and the welfare state, built new towns, public facilities and so much more – we did know how public spending worked back then and how to manage our economy to achieve social policy goals.
Activists can completely disarm the lies and failure to invest in social policy to reveal they are mere justifications for pushing ideological beliefs, not based on purely financial considerations. They can turn the spotlight on how much is being spent in areas which are favoured by ideological thinking eg wars, funnelling state money to private healthcare providers and dodgy contracts to mates and donors.
There is a global ecosystem of media, politicians, commentators and economists trained and motivated to maintain the narrative that Government spending is the same as household spending. Even if they know the truth, they do this for personal advantage and that of the vested interests which donate to their political parties and careers not because of the real constraints on Government spending.
There is an extra dimension for Scotland
As a currency user Scotland cannot issue currency, within the Devolution Settlement, the Barnett Formula has been used to calculate Scotland’s block grant, which represents a fixed pot from which spending must come. Public Spending on England’s public services sets the level of Scotland’s block grant. Underfunding as well as increases are therefore reflected in the amount. The currency issuer, Westminster, determines what Scotland has to spend. The best Scotland can do is allocate more of a fixed budget to social policy but that inevitably means less to spend elsewhere. There have been a couple of reforms to Scotland’s funding formula in the last ten years which are even more detrimental. The post-Brexit Tory Internal Markets Bill, also gives Westminster the ability to override Holyrood legislation towards homogenising our economy in line with standards set in Westminster. It is also an avenue through which Westminster can interfere with our Scottish Health Service and other social policy.
A sea change in public spending in England could happen but there appears to be no political will for it among Westminster based political, parties, In fact, the situation is worsening over time. Unless Scotland becomes an independent nation and has its own currency, it is relatively powerless to increase public spending, invest in our productive capacity and attend to all other Government expenditure. I have written above about the importance of resources to Government spending, Scotland has many and diverse resources.
Because of the democratic deficit ie England’s size of voter base compared to Scotland’s, Scottish voters have little to no effect on Westminster policy. We can see that under the Devolution Settlement, the Scottish Government is simply not able to enact policy which fully reflects differing Scottish values and priorities. The above points add an extra dimension for Scots to be aware of.
Social policy activists need to arm themselves to be effective
Social policy activists understand that public spending is an investment in our people and our future economic sustainability and as such could and should be a priority. I hope they can now see there are no purely financial constraints to this spending for currency issuers.
Activists can arm themselves by understanding the above factors. They can now see that while there are plenty of good reasons to tax the rich as outlined, none of them is about creating a “pot” from which spending comes so this should not be the focus of demands to fund public services. Taxation reform is largely a separate or parallel campaign. Instead pressure should be applied to sitting and potential Governments on social policy which benefits the majority and managing the economy to absorb that spending now and in the future. Government public spending can, should and has to be about investment in the well being of people and creating state assets to support present and future sustainable productivity within planetary boundaries.