It seems logical to think that we pay our taxes and the government uses that money to fix our roads, run the health service, pay out benefits and so on. As Margaret Thatcher said (circa 1980s), running a country is just like running a household – so good balanced budgeting is essential. And she must have been right because our politicians are still saying the same thing today.
“It ain’t what you know that gets you into trouble. It’s what you know for sure that just ain’t so.”Samuel Langhorne Clemens (pen name, Mark Twain)
Let’s face reality, say those politicians, public spending must be paid for – either by putting up taxes or by borrowing more cash. Either that or you must run an austerity/cost-cutting policy to try to save money. Because the last thing a household, or a country, wants is unmanageably large debts or – worst of all – to go bankrupt.
And yes, to a large extent, this is how it works for Scotland; Scotland has a limited budget and limited borrowing and tax-raising powers. It has to balance its books; it can’t spend more than it has in its purse and it’s not allowed to run a deficit. It’s a truism that if Scotland wants to pay for a tax cut for the rich or a wage rise for refuse collectors, it has to find that money from some other sector of the economy. To use a jigsaw analogy: you can shift the pieces around a bit but there’s always the same number of pieces.
Scotland is a currency user and can go bankrupt
Technically speaking, Scotland is what is called a ‘currency user’; it uses the UK pound. From a monetary perspective, the pound is a foreign currency – Scotland doesn’t control or create the pound. And just for kicks, borrowing more UK pounds entails costs. For example, in 2021 Scotland borrowed £150mn at an interest rate of 1.14% and another £50mn at 1.25% – both over 25 years.
As a currency user, the Scottish Government has no control over monetary policy and limited control over its tax income: 67.6% of all taxation collected in Scotland goes directly to the UK Government, to be spent ‘on our behalf’. In theory, because Scotland is a currency user, it can go bankrupt, so best not to go into too much debt.
The UK is a currency issuer – it can supply or remove money from the economy
Hey, but it’s not all doom and gloom, there is another class of country called a currency issuer. These countries have ‘monetary sovereignty’ – defined as “Issuance and retirement – the exclusive authority to control the issuance and retirement of the legal tender”.
The key word here is ‘issuance’. Issuance means, “the action of supplying or distributing something, especially for official purposes”.
So, a monetary sovereign country is one that can supply or remove money from the economy. Monetary sovereign countries include, among others, the UK, the US, Japan, New Zealand, and Australia. These countries have control over monetary policy and are currency issuers.
In the UK, the sole currency issuer is the UK Government. Only the UK Government can spend pounds into the economy. Every pound in your wallet or your bank account initially came from the UK Government. And every year, you pay some of that money back to the government when you pay your taxes.
The UK Government issues pound notes; you send some back when you pay taxes
I’m sure you know that you are not allowed to pay taxes in chocolate buttons, monopoly money or bitcoin – you can only pay in pound sterling. It’s the fact that you must pay your taxes in UK pounds that makes the currency valuable; pound notes themselves have no inherent value. You work to get those pounds because you know those are the only things you can use to pay your taxes with. That’s what makes pounds valuable as the UK currency and chocolate buttons, well, they’re just chocolate buttons.
As I mentioned in a previous article, it is not your taxes that pay for services – it is always new money that the UK Government generates when it spends it into the economy. The government deletes your tax payment from the monetary system. I’m not saying it doesn’t take note that you have paid your taxes, but it doesn’t store them for a rainy day. When it needs to spend money, it spends brand new money into the economy.
Running a monetary sovereign country is not like running a household
Because the UK is a currency issuer, it doesn’t have the restrictions Scotland has; it spends according to its priorities. If it wants to spend money on a new royal yacht or more London infrastructure, or a tax cut for the rich (i.e. it gets less tax income from those rich people), it can do that. If it wants to put up MPs’ pay, spend on PPP or spend to ensure businesses do not collapse during Covid, it can do that.
So if Thatcher was talking about Scotland when she said, “running a country is just like running a household”, then fair enough, there is some truth in that. But if she was referring to the UK, i.e. a currency-issuing government, the analogy fails; households cannot create pounds by spending them and, if they borrow, they have to pay interest on that borrowed money. Just like Scotland, households are not currency issuers, they are currency users.
On the other hand, monetary sovereign countries spend money based on their priorities. How much they can spend is limited by real resources, e.g., full employment would be one such limit; spending beyond full employment leads to inflation, as employers use higher wages to attract workers away from their existing jobs. What monetary sovereign countries do not have, is a limit on their finances.
Monetary sovereign countries can, if they want to, spend money to train more doctors and nurses, spend money to develop new medical drugs, spend money to develop new treatments, spend money to implement green policies, spend money to reduce inequality, spend money to reduce poverty, spend money to train tomorrow’s scientists or tomorrow’s artists, and so on.
“Free of the constraints that bounds us to the gold-standard world, the US now enjoys the flexibility to operate its budget not like a household, but in the true service of its people.”Stephanie A Kelton, professor at Stony Brook University New York and a Senior Fellow at the Schwartz Center for Economic Policy Analysis at the New School for Social Research
Whatever their priorities are, the UK Government can spend the money to meet those priorities. And they can do that up to the point that resources are fully used because at that point inflation will kick in.
The limits on spending are to do with real resources in the economy, i.e. the population size, the education and talents of that population, the machinery, factories, energy and so on. Finance is not the limiting factor when it comes to currency-issuing governments.
When to explain why “that politician is talking nonsense”
And neither is government debt. The UK has paid off very little of its ‘debt’ in the last 300 years and has paid only “1.7% since about 1945”. Government ‘debt’ is not like your debt. Unless the UK Government is borrowing from a country that has a different currency, debt is not a burden, it is not debt as you or I would define it.
So the next time you hear a UK Government politician nattering on about why we need a new round of austerity because ‘we’ are running out of money, turn to your friend or partner and explain to them why that politician is talking nonsense. UK Government ‘spending money’ comes from the UK Government, not from your taxes. The money, i.e. UK pounds sterling you paid your taxes with, came from the government in the first place, not the other way around. How the hell can it be you funding government spending if it was the government who gave you the cash to pay those taxes? Think on that.
A more in-depth explanation can be found in ‘The self-financing state: An institutional analysis of government expenditure, revenue collection and debt issuance operations in the United Kingdom.’ Published by UCL – the Institute for Innovation and Public Purpose.