Will we really pay higher taxes?

While the specifics of this discussion are confined to Australian institutional arrangements, the general principles apply to any sovereign nation. This will take several blogs because it is quite detailed.

In this blog we will focus on the question: Will we really pay higher taxes?. Short answer: yes and no!

In reference to the Australian Government stimulus Malcolm Turnbull, former Opposition Leader and former Shadow Treasurer has previously told national news media that “Australians may be laughing now, but will pay later” because all this spending “means higher taxes and higher interest rates in the future.”

It is a line he had consistently running when he was a prominent figure in the Opposition.

He has correctly noted that any fiscal stimulus that is completely saved will not expand spending. Of Course!! He claims that “now beyond any doubt that over 80 per cent of that money was saved and not spent. We’ve seen a very big increase in household income but a very modest increase in household expenditure and household consumption …” I would actually like to see the data he is basing this claim on. Surely some was saved but there is no data to render the 80 per cent claim “beyond any doubt”.

He then said that:

… but the one thing we know, even though it produced a very small economic stimulus, it will produce a very big economic drag in years to come when it has to be paid back because every cent of that $10 billion will have to be paid back, as will every cent of the $42 billion the Government is undertaking right at the moment. And that will mean higher interest rates for Australians in the future and, of course, higher taxes.

This is representative of the nonsense that parades as informed economic comment out there which swamps the news and print media day after day.

He is of-course just pushing the hollow rhetoric that neo-liberals use to exploit our confidence and comfort in a sovereign government that is actually using its fiscal capacity, in this case, to increase the budget deficit, to shore up aggregate demand and, hopefully, prevent damaging employment losses. While I have a disagreement over the composition of the fiscal expansion (I would prefer much more to be spent on direct job creation), the conservatives are attacking the notion of a deficit per se and want it limited (at some level that is undefinable) or else “all hell will break loose”.

I have been urging journalists to ask the politicians to define the “ideal” budget deficit. In fact, trying to target a specific deficit size is pointless. The national government has to target a level of activity – preferably full employment – and then let the deficit be whatever it has to be to support the level of aggregate spending that will deliver that target. A budget deficit is what economists call an endogenous artificat of economic activity. In this specific context, it is the budget is determined as an ex post accounting outcome of the current level of economic activity.

So when private spending is low, the deficit increases without the government doing anything because tax revenue falls (less sales, less employment etc) and welfare payments rise (more people on income support). Economists call these “non discretionary” movements in the budget balance automatic stabilisers because they work without any government discretion and help to put a floor in the plunging aggregate demand.

Clearly, the reverse holds when the level of activity is higher. More people are working and incomes rise as does the tax revenue and less people receive income support payments. As a consequence, the budget deficit would decline without any discretionary government policy change. It means that the economy is getting stronger again.

When I am speaking to business forums I make the point that if they do not like the current size of the budget deficit then they can easily do something about it. Start investing, start creating employment and before too long the deficit will be lower. So you can think of the deficit as being something that the private sector chooses by their spending (and saving) decisions. The more the private sector wants to save the income that is generated each period, the higher the deficit has to be to maintain that level of income (and related production). This is all a matter of national income accounting.

Now think about these swings in economic fortune. A strong economy generates more tax revenue because employment and income are higher. A weak economy generates less tax revenue because employment and income are lower. We will come back to that in a moment.

However, the budget deficit is also increasing at present (in all countries) because governments are acting responsibly and making discretionary decisions to increase their net spending (perhaps by tax cuts but more typically by increasing outlays). The aim is to stop the hemaoerraging in aggregate spending and to restore employment growth. The latter is driven by spending despite what the conservatives (and most of the employer associations) will tell you. Their claims that lower wages are the solution to higher employment growth fails to take into account that at the aggregate level lower wages reduce spending which causes unemployment.

So in that case, if the strategy works, and it will eventually … it is just a matter of increasing the deficit until it does … then economic growth will resume and … without there being any further changes in tax structure (rates, exemptions, thresholds etc) … taxes will be higher!.

Did I just say that? So am I actually agreeing with the scaremongers? Not at all.

What they want you to believe is that the government will be so heavily indebted that they will have to increase tax rates to pay the debt back. As you will understand from my previous blogs, any sovereign government such as we have in Australia or, say, the US Government, or British Government, or Japanese Government, or the hundreds of other governments around the World, do not face a financial constraint. This means that: (a) the spending does not need to be financed; (b) that any debt instruments (bonds) that mature can be easily paid out by the government crediting relevant bank accounts for the coupon value (face value of the bond) plus interest owed; and (c) that neither of these actions have any necessary implications for future tax rates or interest rates.

In fact, the tax revenue can rise at the same time as tax rates are falling – namely the previous Government’s booming tax revenue from the commodity boom accompanying their handouts to high income earners.

In the next blog in this series I will talk specifically about interest rates because understanding how bonds are issued and priced is more complicated. But for now, it is clear that the Government may increase or decrease tax rates in the future as a policy decision.

But an understanding of the sovereign government’s place in the modern monetary system will tell you that they do not have to increase tax rates to raise revenue to pay back spending they have made on our behalf sometime in the past. They may decide the economy is growing too quickly or that some segments of the workforce have too much disposable income (perhaps they want to reduce imports of luxury cars and so they would hike tax rates for high income earners).

In these situations, they will make a decision at some particular time about the appropriate level of net government spending that is required to maintain high levels of employment. But these tax rises are not funding anything! They are draining purchasing power to stabilise aggregate spending at the desired level.

So we should applaud the use of fiscal deficits at this time. They are helping us restore our private balance sheets (by “financing” saving) which were undermined by the previous obsessive pursuit of budget surpluses and also providing spending support for local production. Higher deficits look like they will be required but the Government is heading … sort of chaotically … in the right direction. Yes, tax revenue will rise with the increased economic activity but that is a different matter to saying the tax burden on anyone currently employed will rise. That is a separate matter altogether and the conservatives try to conflate the two to perpetuate their filthy side of the debate.

The statement “Higher deficits today mean higher taxes tomorrow” in fact is saying:

Higher deficits today when unemployment is high will cause unemployment to go down to the point we need to raise taxes to cool down a booming economy

Next time  I will ask: Will we be paying higher interest rates because of the debt? Which will move us into a narrative about why is the Government issuing debt if it is not financially constrained!

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2 responses to “Will we really pay higher taxes?

  1. Pingback: Will we really pay higher taxes? | Modern Money Mechanics - - govtpays.com

  2. Thank you for explaining a truly perplexing issue to we non economists.

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