In this article, I explore the topic of UK Government expenditure. First, I will outline the commonly held beliefs, i.e, what we hear every day from politicians, the media and economists.
And then I will poke holes in that story. In the process, I will demonstrate the logical impossibility of such an explanation, before setting out how UK Government services are actually funded. Much of what I have written in this article is both inspired by, and is a summary of, the book Diagrams & Dollars by J.D. Alt. I recommend you obtain it and read it.
Here’s how you think it works:
- UK Government services are paid for by the private sector, via tax returns. Expanding public services requires higher taxes.
- If taxes don’t bring in enough money, the Government sells government bonds, in return for cash. A bond is simply a ‘promise to pay’. It is a piece of paper – just like a pound note. The only difference is that the bond pays interest to the person purchasing that bond. I say it is a piece of paper, but of course these days it is just an entry in a computer spreadsheet.
- Taking the above two points together, the idea is that this is how the UK Government gets the money it spends.
- If the Government drains money from the private sector with high taxes, then the private sector won’t have enough left to invest and grow the economy. So it is best to have taxes low and a small state that doesn’t spend a lot of cash.
- However, paying for services and the interest on government bonds means that Government’s coffers, inevitably, get drained. At some point, it will need to ask for more money from the private sector.
- If there comes a point when the Government can no longer borrow from the private sector – because it is damaging its ability to invest and grow – and it can’t sell more bonds, it will have to borrow from another country. The UK Government will have to pay interest on that borrowing in the currency of the country it is borrowing from. That is a very expensive thing to do – and will increase the country’s debt ever further.
- As you can imagine, things can spiral out of control. You need more and more money to pay for more and more outgoings. There are no limits to the services people want – yet there is a limit to the amount you can take from the private sector. Additionally, the amount of interest paid on borrowing goes up continually. The country finds itself with spiralling levels of debt from borrowing to fund services and to fund the interest on previous borrowing.
- So, Government spending needs to be constrained. There will be a point where the country can’t afford higher wages or better health care, or new houses or high welfare costs or… there is a need to stop the spiralling of outgoings. The solution is to stop or cut spending, therefore the Government needs to introduce austerity measures.
- On top of that, the borrowing means the national debt is becoming so big we are putting a huge burden on our future generations – on our children and their children, who will have to pay it back. Again, the Government says austerity is the answer. Austerity is also the answer to getting some of that debt paid back now, rather than later.
Pretty damn upsetting, don’t you think? It looks like there’s no way out of this awful situation other than having successive cycles of spending and austerity.
Here’s how it actually works:
- The picture above leaves out quite a few important details. Not least of which is that the money the Government spends goes directly into the private sector. The above picture suggests that when the Government borrows from the private sector, it is draining the private sector of cash. It fails to mention that the money that it is spending is being spent into the private sector.
- Clearly, the only way that the private sector is drained of money is if the Government takes more out in taxes than it puts in, in spending. However, if we look at the records of Government spending, we see that, over the last 300 years, it has consistently put more in than it has taken out i.e. the UK has consistently run a deficit. It has run a deficit apart from a few decades in the 19th century when it was receiving additional income from UK colonies, and the odd year here and there since. The UK rarely pays off what it calls the national ‘debt’. For example, since 1945, it has only paid 1.7% of this ‘debt’.
- The other important detail left out is that all this doesn’t explain where the private sector gets the money in the first place? You might be thinking, well, business can borrow from the banks. That’s not it. Bank loans are debts that must be paid back. No extra money is put into the economy via bank borrowing – it balances out – when loans are paid off. But clearly there is money floating around the private sector – so where did it come from? Who made those pound notes? Are there private citizens hiding in back rooms with printing presses? Obviously not, because that would be a criminal offence. So where do you think the money came from?
- You guessed right. It came from the Government. You have a vague memory of seeing printing presses making notes and coins – ‘The Royal Mint’ you think it was called. You are on the right track. The UK Government is a currency issuer. And, of course, only the UK Government is allowed to collect taxes and only the Government can spend new money into the economy. The UK Government made every single bit of cash denominated in UK pounds that you have in your pocket, under your mattress and in your digital accounts. ‘It is the Government what did it.’
- But wait a minute – how does that fit with the story above? If the UK Government makes the cash – why the hell does it need to borrow from the private sector? It doesn’t. This is your ‘ah-ha! moment’. Remember I said earlier that the Government has put more money into the private sector than it takes out? How would that be possible if the private sector was the source of all spending? And while I’m here, if spending was limited to the amount of taxes the Government could collect, where did it get the money to bail out the banks, support businesses during the Covid lockdown and to spend all that money on PPE during the pandemic? Hmm, I’m sure that’s crossed your mind at some point – you’ve always had a vague feeling that something didn’t quite add up.
- The truth is the tax revenue from the private sector is a just portion of the money the UK Government spends into the private sector. So when citizens are taxed, all that is happening is that the Government is taking back some of the money it spent.
- And here’s something you didn’t know. The private sector does not pay for Government services using your taxes. Every pound the Government spends is new money. In fact, it doesn’t even use your taxes. There’s no big pile of tax money that it draws from. It takes a note that you’ve paid your taxes and metaphorically brushes your tax payment down the drain in the middle of the tax agency floor. Gone! Taxing and spending are two entirely different systems – based on different pieces of legislation. They are not linked.
- I mentioned earlier that the Government sells bonds to raise money. Well, in practice, government bonds are used to remove money from the economy more than they are used as a way to raise money. Government bonds are, as I mentioned, interest-bearing and the only way you can get interest on borrowing is if the money is put away in an account for a period of time without spending it. So, when the private sector buys a bond, the money the Government hands over is essentially removed from the economy. It is put away in a long-term account so that it can’t be spent immediately. You’ve heard of 100-year bonds, 50-year bonds, 10-year bonds, 1-year bonds and so on. That’s how long you have to wait before you can get your money back. I’m ignoring the complexity of trading existing bonds. When money is sitting in savings, it is not circulating in the economy and it is not being spent; the money supply has gone down. Selling bonds, therefore, is a way to control inflation.
- So the way the Government pays for services is the exact opposite of what you thought. Taxes don’t pay for services. And Government spending is not a debt as you understand it. Currency sovereign governments, like the UK Government, can never run out of money. It makes the stuff for goodness sake! And by the way, how can you call it debt – when what happened was that the money moved from the Government sector to the private sector. You are in the private sector. You are not in debt. The country is not in debt. To say that the country is in debt due to Government spending, which, as you now know, is money spent into the private sector, is a bit like me transferring a fiver from my left pocket to my right pocket and saying my jacket is in debt. The country consists of the private sector and the Government sector – payments that go from one to the other are still in the country. The country is not in debt.
- The only time there is a real debt is when the UK Government borrows from a different country and pays for the debt in that country’s currency. The amount of foreign debt that the UK Government has is only a tiny proportion of what it calls the national debt.
Everything I have said above is, of course, a gross oversimplification. However, even a basic understanding of how Government spending works in practice is useful, as it helps to discredit the stories we hear every day in the media. Those stories are based on theoretical models that do not reflect, and have never reflected, reality.
The Government can never run out of UK pound notes – that’s a cast iron fact. But that does not mean it can just keep spending endlessly. Because real resources are finite – people, skills, hospitals, factories, energy and so on.
Limited finances are never the issue, limited resources are
The critical factor is that you can only spend money to buy things, including people’s time, until there are no things left to buy. And, as you get close to the point of running out of things to buy, you will get inflation. So, let’s be clear, finance is never the issue. The issue is the amount of resources and the capacity left in the economy. For example, if you have millions of people unemployed, that tells you that your country is not running at capacity and you can safely spend money to train and employ those people.
And we should not forget that a country’s resources can be increased, for example, more nurses can be trained, more hospitals built, more jobs created, more innovative research projects born in universities, more widgets made and more wind turbines built to harness more energy. More capacity enables more spending, more spending creates more resources and more resources can be used to create more capacity – i.e. economic growth.
The pie gets bigger when all of a country’s resources are being used. And yes, I’m aware that the planet has finite resources and unlimited growth hastens climate change. However, I am working within the parameters of the story set out in my earlier points, and sticking to addressing the points made in those earlier scenarios.
As the pie gets bigger that also means more workers are spending more money into the economy. So we have to recognise that this too can be a problem – as when the amount of money spent exceeds the amount of goods that can be bought, once again we can get inflation.
We can build a better, fairer future for all Scots – financial constraints are not an issue for currency sovereign governments
If you grasp the story of how UK Government spending really works, you will start to realise the orthodox story you hear on your news is often used to support a particular ideological stance. Orthodox neoliberal economics provides justification for a small state, low taxes, austerity and curtailing public spending.
A real understanding of how the economy works is not a justification for any particular political stance – either left or right. Understanding how the economy works provides the tools to achieve economic and social goals, whatever they are.
In Scotland’s case, that can mean providing a better life for all of its citizens. In an independent Scotland with its own currency, this understanding makes clear that we are not limited by financial constraints. The only constraints are the limits of the country’s resources, including the talents of all citizens.
Note: The points made above apply to the UK Government – not the Scottish Government in the devolved parliament. Only the UK Government is a currency issuer. Within the UK, Scotland is a currency user i.e. it uses the UK pound but it has no control over it and cannot create new pounds.