This is the second part in my discussion about Henry George and Modern Monetary Theory (MMT). In general, there is nothing particularly incompatible between the introduction of a broader LVT at the Federal level to replace or reduce other taxes currently levied and the insights provided by MMT. However, once you understand MMT, you realise that the discussion of the design of the tax system is quite different than just raising income from the most ‘efficient’ means. The Georgists would do well to come to terms with that and demonstrate how a land value tax (LVT) would work to free up real resources to give the real space for governments to spend. There doesn’t appear to be any analysis provided by Georgists to calibrate the impacts on non-government spending of such a tax and how this would alter the tax mix required to maintain full employment spending levels and satisfy the socio-economic spending goals of government. There are other things that might be done as well (if not prior to imposing a LVT) which would reduce the likelihood of property price bubbles. Finally, the obsession with the single LVT as a saviour is in denial of the causes of recessions and the the role that financial capital plays in destabilising economic systems. A LVT alone will do little to resolve those problems.
Henry George and Modern Monetary Theory (MMT)
Henry George clearly operated in a paradigm that believed that the role of taxation was to raise revenue for the government to facilitate its spending options. He has subsequently been associated with ‘balanced budget’ adherents, although in Progress and Poverty he does not broach that issue.
Clearly, that paradigm is rejected by MMT proponents as is the idea that a sensible policy rule is the balance ‘budgets’ always or on average over a given economic cycle.
George was also preoccupied with a single source of rent – that accruing to land ownership and ignored other sources of economic and financial rents. He clearly did not anticipate the destabilising potential of the financial sector. He was also against regulation, the absence thereof, has been a major reason for the build up of financial risk which led to the GFC. So it is hard to see how his vision provides a general model for economic policy conduct.
His explanation of the economic cycle and depression is also deeply flawed. There have been some major recessions following speculative property crashes (for example, Japan in 1991) but these ‘balance sheet’ recessions are not very often encountered. Most recessions are driven by private investment falling due to a lack of confidence or from fiscal austerity due to misplaced fears of fiscal deficits. There have also been long periods of growth at times that land values have continuously accelerated.
Further, while the GFC was the result of a major collapse in private spending following a major property market crash, which ran first through the financial system, it still remains that the governments could have largely alleviated the real economy consequences of the financial turmoil with appropriate fiscal responses.
The real economies bore the brunt of the private spending contraction because fiscal deficits were not allowed to rise sufficiently to fill the spending gap that was created.
The central banks clearly stabilised the private banking system quickly but those responsible for fiscal policy were constrained by the dominant neo-liberal ideology that eschewed the use of discretionary fiscal stimulus packages.
It is clear now, some 7 years after the crisis began, that the nations that provided the largest fiscal stimulus packages and allowed the deficits to adjust more freely to growth, have fared better than nations that cut their fiscal interventions short and pursued austerity.
The doctrine of fiscal contraction expansion promoted by the neo-liberals has been a demonstrated failure across the globe. The turmoil in Europe continues because the policy makers refuse to acknowledge their errors and hang onto the structural explanation for the on-going economic stagnation.
The question then is to examine where the idea of the Single Tax sits within this MMT understanding, rather than in the flawed theoretical view promoted by George and his followers (to this day).
MMT demonstrates categorically that monetary transactions in the currency of issue between the government and non-government sectors are the only source of net financial assets in the non-government sector. That is often misunderstood but crucial to understanding the suite of options available to a currency-issuing government. In any monetary system there are financial assets and liabilities.
These are specified in monetary terms and can take a multitude of forms. A financial asset could be a bank deposit, some money in your pocket, a government bond, or a corporate bond. A financial asset is different from a real asset, such as property holdings or an art work because it has no tangible expression.
For example, a bank deposit is a virtual statement of wealth. A financial liability is usually a bank loan or some other debt that is owed. The difference between total financial assets and total financial liabilities is called net financial assets. It is different to total net wealth or net worth in that it excludes real assets.
Financial transactions within the non-government sector cannot create new net financial assets or destroy previous net financial positions. For example, when a bank agrees to a loan it creates a deposit that the borrower can draw upon to fund spending.
The loan is an asset to the bank but an equal and offsetting liability for the borrower. There is no net gain in financial assets for the non-government sector as a whole from this transaction.
Transactions within the non-government sector, may alter who owns the financial assets and the form those assets are held in, but they do not alter the net position of that sector overall.
For example, a household might use some cash it holds in a bank deposit to purchase a corporate bond. The person’s financial asset is now a bond rather than cash and the liability shifts from the bank to the corporation who has borrowed the funds. But there is still the same quantity of assets and liabilities in the non-government sector overall.
For the non-government sector to accumulate net financial assets (financial wealth) or lose net financial assets, there has to be a source of financial assets that is ‘outside’ the non-government sector. This can only be the government sector.
In this context, the government sector is considered to be the consolidation of the treasury function (fiscal policy) and the central bank (monetary policy), despite claims that central banks are largely independent of government. Consolidating the currency-issuing arm of government (central bank) and the spending and taxing arm (treasury) allows for a better understanding of how net financial assets can enter and exit the non-government sector.
It is the transactions that are conducted between the consolidated government sector and the non-government sector which determine the level of net financial assets (denominated in the money unit) that are held by the non-government sector.
Only these transactions can create or destroy net financial assets in the non-government sector. In our simple two-person economy, the fundamental principle is that the non-government sector can only accumulate net financial assets if the government runs a fiscal deficit.
We can now more fully appreciate that result. For example, when the treasury department purchases some equipment for a school, it will instruct the central bank to put funds into the bank account of the private supplier of the equipment. The bank entry is created because the government required it to be created.
In effect, the entry was created ‘out of thin air’. The private supplier now has a higher bank account balance (an increased asset) but there is no offsetting liability within the non-government sector.
Net financial assets have increased in that sector as a result of the government spending. Conversely, when the government extracts tax revenue from the non-government sector, the taxpayer will, depending on the arrangements within the tax system, see more income extracted on pay day or an existing bank deposit reduced by the amount of the tax liability.
Either way, financial assets decline in the non-government sector without any corresponding decline in liabilities. As a result net financial assets decrease.
But note that in the intrinsic logic of a fiat monetary system is that taxes do not finance government spending, even if the government has accounting structures that make it look like they do.
While taxes reduce balances in private sector bank accounts, the government doesn’t actually get anything it needs. The reductions are accounted in the ‘books’ but do not enhance the capacity of the government to spend.
Thus the concept of a fiat-issuing government saving in its own currency is of no relevance. Governments may use its net spending to purchase stored assets (for example, Norway’s sovereign fund) but that is not the same as saying that government surpluses allow the government to spend more in the future. That concept is erroneous.
These transactions occur every day and if the government spends more than it receives by way of tax revenue (a deficit) then net financial assets in the non-government sector will rise.
The main thing to keep in mind about taxes is that they reduce liquidity in the private sector. Fiscal deficits thus increase the financial wealth of the non-government sector. Fiscal surpluses, clearly, have the opposite effect. They destroy net financial assets and financial wealth in the non-government sector.
An understanding of these matters then allow us to understand how mass unemployment arises and why government is central to its solution.
There is no unemployment in traditional non-monetary economies or in non-monetary segments of a modern economy. For example, an unpaid child carer can never be unemployed.
In monetary economies, the output of goods and services responds to spending. Firms and other organisations do not produce if they are not confident of selling their output. The production process generates a flow of income (paid to the various inputs to production). One person’s spending is another person’s income.
A basic macroeconomic rule is that total spending must equal total income (whether actual income generated in production is fully spent or not in each period) for all the goods and services produced in any period to be sold. If total spending in a period is less than the total income generated, then firms will have unsold output in the form of unwanted inventory accumulation and will reduce future production and employment.
Why would total spending fall below total income in any period? A simple reason might be that households desire to save some of their income for future use or purchase imports, which means income generated in the domestic economy is spent abroad. The result of this spending deficiency is a rise in involuntary unemployment, which is idle labour offered for sale with no buyers at current wages.
In this situation, making labour cheaper (cutting wages) will not reduce the unemployment, unless those cuts somehow increase total spending. Clearly, wages are an important component of total income and spending is dependent on income. Cutting wages is likely to worsen a spending shortfall.
In a simplified two-sector economy, if the non-government sector desires to save overall, it will spend less than its income. That shortfall in each period has to be eliminated by the government spending more than it receives in revenue to prevent a rise in mass unemployment.
There is another complication. The non-government sector may desire to save overall but it also has to pay taxes from its income, which further reduces the amount that can be recycled back into the non-government spending stream each period. The imposition of taxation thus reduces the spending power of the non-government sector.
That gap also has to be filled by government spending, which means that the overall tax take has to be smaller than the injection from government spending.
Thus, in general, deficit spending is necessary to ensure high levels of employment. Where there are high levels of unemployment, we could say that government spending is too low relative to the current tax receipts, or that taxes are too high relative to the level of government spending, after taking into account the overall saving desires by the non-government sector that have to be matched by government deficits.
The conclusion that mass unemployment is the result of the government deficit being too low also defines the limits on responsible government spending. It is clear that government spending has to be sufficient to allow taxes to be paid.
In addition, net government spending is required to meet the non-government desire to save (accumulate net financial assets). The government should aim to maintain total spending such that firms are willing to produce and employ at levels sufficient to fully employ the available labour resources. Not a penny more need be spent by government.
This highlights the role of taxation, which is to create the real resource space (which could be termed unemployment) to allow governments to spend in a non-inflationary way. Note taxation does not create financial space (that is, provide the government with revenue it needs in order to spend).
Taxation reduces the income available to the non-government sector to spend and thus leaves real resources idle, which would have been absorbed by the higher non-government spending.
It is a political decision as to how large the public sector is relative to the total economy. While economics textbooks hint that smaller government is better, there is nothing in economic theory that substantiates that proposition. The size of government is determined in the political process. Small is not necessarily better or worse than large.
The point is that if the governments wants to expand its real resource footprint and maintain full employment (where all productive resources are being deployed) without triggering an acceleration of inflation, then it has to increase its taxation take to deprive the non-government sector of access to the extra real resources it wants to absorb.
The higher taxation is not providing the government with any larger financial capacity. It is, rather, reducing the financial capacity of the non-government sector in order to free up real resources that it would otherwise deploy in private consumption and/or investment.
Thus the role of taxation is not to fund government spending but to allow it to command real resources (labour, capital, land etc) in order to facilitate its socio-economic policy mandate.
Georgists should abandon the idea that taxes fund government spending and that land ownership is the single cause of economic cycles.
But that doesn’t mean the idea of a land value tax should be dismissed given that the government has to tax in order to bring the freed real resources into productive public use through government spending. Non-government saving overall also frees up real resources as does private domestic import expenditure.
The criteria that has to be deployed by governments when designing its tax system is to ensure they can command the required amounts of real resources without triggering inflation.
Once that level is determined, then the composition of the burden that is to be imposed on the non-government sector has to be determined. What sort of tax structure will the government introduce and maintain?
There are several different types of taxes that can be levied and here is not a place (time!) to review them in detail.
1. Taxes on earned income – labour taxes
2. Taxes on profits – corporate taxes
3. Taxes on resource use – resource rental taxes
4. Taxes designed to alter resource allocation – tobacco and alcohol taxes, environmental taxes.
5. Taxes on land.
There is a long literature that claims that taxes on income whether it be labour income or profits introduce disincentives to effort. People work less when taxes are imposed on them.
The evidence is not conclusive with respect to that assertion. Studies of labour supply suggest that tax rates within normal ranges have very little impact on the willingness of labour to supply hours of work. Rigidities in the working day help to explain the invariance among other things.
The George Single Tax proposal is justified partly on the grounds of these alleged disincentives.
Housing bubbles and home affordability
One of the challenges of the modern time, especially in many advanced nations is the problem of housing affordability. In Australia, the housing problem is acute.
The housing market problem is also interesting because MMT proponents suggest that monetary policy be taken out of the game by letting policy interest rates stay at around zero.
The argument is complex but can be summarised in this way. Monetary policy is not a reliable counter-stabilisation tool to deploy. The distribution consequences of interest rate changes with respect to their impact on creditors and debtors is uncertain and could be perverse relative to the policy makers aims (which are to reduce spending with higher rates).
There is no strong empirical research to tell us about the impact on debtors and creditors and their spending patterns. It is assumed implicitly that borrowers have higher consumption propensities than lenders but that hasn’t been definitively determined.
Interest rate changes cannot be spatially targetted or demographically targetted. Interest rate rises impose penalties on regions and cohorts that may not be contributing to the housing price pressures. The Eurozone has seen the consequences of one-size-fits-all interest rates before the crisis. In Australia, we have seen that when Sydney property prices boomed in the early 2000s, all of regional Australia which was not booming was forced to bear the higher interest rates
Further, the impact of interest rate changes on total spending are subject to unknown lags as consumers and firms adjust their plans. At times, more immediate policy intervention into the spending stream are required.
The aftermath of the GFC where interest rates have been close to zero in many advanced nations demonstrates that the sensitivity of total spending to interest rates is not high.
Conversely, fiscal policy is powerful because it is direct and can create or destroy net financial assets in the non-government sector with certainty. It also does not rely on any distributional assumptions being made although it can exploit known differences in spending propensities.
For example, a tax cut to lower income earners is likely to stimulate total spending more than a similar cut to high income earners.
Further, the desired economic state for a modern monetary theorist is full employment which means that unemployment should be frictional only (that is, very low – approaching 2 per cent or so in Australia, for example), zero hidden unemployment and zero underemployment.
Deviations from full employment reflect failed fiscal policy settings. As we saw above, unemployment is caused by the fiscal deficit being too small.
The size of deficit has to be judged in terms of the desire of the non-government sector to save overall in the currency of issue. So if the deficit is inadequate and unemployment arises we know the net spending has not fully covered the spending gap.
We also know that fiscal deficits add to bank reserves and create system-wide reserve surpluses. The excess reserves then stimulate competition in the interbank market between banks who are seeking better returns than the support rate offered by the central bank. Up until recently this support rate in countries such as Japan and the USA was zero. In Australia it has been 25 basis points below the cash rate although there is no theoretical reason for that setting.
It makes much better sense not to offer a support rate at all. In that situation, net public spending will drive the overnight interest rate to zero because the interbank competition cannot eliminate the system-wide surplus (all their transactions net to zero – no net financial assets are destroyed).
So in pursuit of the desired policy goal of full employment, fiscal policy will have the side effect of driving short-term interest rates to zero in the absence of any central bank intervention to the contrary.
If the central bank wants a positive short-term interest rate for whatever reason – then it has to either offer a return on excess reserves or drain them via bond sales.
The preferred MMT position is a steady state interest rate is zero and that the government engage in no bond sales to the non-government sector.
That policy stance would allow fiscal policy to make all the spending adjustments required to offset saving desires in the non-government sector and the introduction of a Job Guarantee could automate some of that adjustment.
Please read my blog – The natural rate of interest is zero! – for more discussion on this point.
The question then arises is whether the constant low (zero) interest rate regime would fuel asset price speculation.
We have to remember that housing bubbles are not uniform in their cause. Clearly, they result from the fact that demand rises faster than supply. But the cause of the rising demand is different in different housing markets.
In Spain, before the GFC, the massive growth in credit helped along by the low interest rates, which were suited to the German economy rather than to say Spain or Ireland, spawned the demand for housing.
The high prices in central London for example has nothing to do with credit. A vast majority of it is not subject to debt instruments. The price bubble reflects the cash flowing in to the market from the Middle East, Russia, and China, for example.
But, it is hard to disagree with the notion that credit availability at low interest rates can stimulate asset price bubbles in specific sectors such as property and housing.
It is here that a Land Value Tax (LVT) drawn from the foundations that motivated George to propose his Single Tax might have a role to play and would be consistent with MMT teaching.
The basic principle of taxing the economic rent (the payment excess over what is needed to keep the resource in its current use) would help stabilise land prices.
Such a tax, would clearly reduce the inequity that arises from the ability of landowners in high demand metropolitan areas to capture unearned income.
In this way, the multiple goals of government might be achieved – to free up real resource space by reducing the incomes of land owners and reducing socio-economic inequality.
The ability to retain the unearned surpluses also stimulates further speculative behaviour, which reinforces the inequality and introduces increased risk of financial instability arising from property market crashes.
Australia already has land taxes levied at the local government level on unimproved property values. They are riddled with inequities themselves and are offset against local government service provision.
In general, there is nothing particularly incompatible between the introduction of a broader LVT at the Federal level to replace or reduce other taxes currently levied and the insights provided by MMT.
However, once you understand MMT, you realise that the discussion of the design of the tax system is quite different than just raising income from the most ‘efficient’ means.
The Georgists would do well to come to terms with that and demonstrate how a LVT would work to free up real resources to give the real space for governments to spend.
There doesn’t appear to be any analysis provided by Georgists to calibrate the impacts on non-government spending of such a tax and how this would alter the tax mix required to maintain full employment spending levels and satisfy the socio-economic spending goals of government.
There are other things that might be done as well (if not prior to imposing a LVT) which would reduce the likelihood of property price bubbles.
In Australia, the government provides tax breaks (negative gearing) to property investors who can write of any recurrent ‘losses’ against other taxable income. A smart investor can arrange these losses and wait for the capital gains on the rising value.
Recent data released by the Australian Bureau of Statistics for – Housing Finance – shows that investment housing finance growth outstripped owner-occupied finance by a considerable margin.
The other policy failure in Australia has been the First Home Buyers grant, which doesn’t particularly help the first home buyer because house prices jump by the size of the grant. There are much better ways of easing the home affordability problem for young buyers. For example, there is a deficiency of state housing in Australia as the neo-liberals have undermined the willingness of government to building public housing infrastructure to keep pace with the population.
A major re-commitment to the provision of well-equipped public housing would reduce the demand for private housing considerably.
There is also no doubt that the conduct of banks needs to change because the financial sector is so powerful that the credit creation capacities of the private banks acts to transfer real income produced by the economy into non-productive uses, which undermines the overall material welfare of the nation.
It is also clear that the financial sector provides significant funding to lobby groups to ensure that the tax laws are skewed in their favour and to further transfer real income into their coffers.
Essential reform of the financial sector and banking is clearly required. Please read the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks for further discussion.
The aim of these reforms should be to eliminate the financial sectoral transactions which do not enhance the operations of the real economy. It will surprise some to know that the proportion of daily financial market transactions that are unproductive approach the high 90 per cent mark.
Industrial firms produce goods and service and enhance real income through productivity growth. Financial firms, which are now the dominant capitalist form, are less concerned with producing goods and services and more concerned with shuffling credit and interest in their favour.
Investment bankers use borrowed funds to engage in all sorts of transactions that look like they are building wealth but, which in fact, do nothing to build the productive capacity of the economy.
These reforms would go a long way to reducing the instability that housing and property markets introduce into modern economies.
Hudson (2010: 40) is critical of Georgists in their approach to financial capital. He wrote:
For real estate investors in today’s world, the motto is: “Rent is for paying interest.” What the tax collector relinquishes is “freed” to be pledged to banks—for loans to buy rent-yielding property. But Georgists have deemed the analysis of finance and Wall Street to be a socialist concern, and emulate George’s own conflation of physical and financial capital. There has been no attempt even to trace the incidence of land-price gains (“capital” gains), and many Georgists view such gains as legitimate returns to capital rather than as financial capitalizations of land rent bid up on credit. Not even the post-2002 real estate bubble has spurred research and publication along these lines. The failure to place land rent and other forms of economic rent in its macroeconomic setting has blocked a serious discussion of land-value taxation from academia and congressional law making, and hence from playing the popular role that it did in George’s own day.
One has to concur with that conclusion. The obsession with the single LVT as a saviour is in denial of the causes of recessions and the the role that financial capital plays in destabilising economic systems. A LVT alone will do little to resolve those problems.
There is no inherent incompatibility with the idea of levying a LVT to replace or supplement some other taxes and the insights provided by MMT.
But the idea of a Single Tax is not supportable and the alliance that Georgists have forged with libertarian movements that deny the central role of government in creating the essential conditions for full employment is also to be rejected.
Reliance on an unfettered private market will not create prosperity for all.
Modern-day followers of Henry George tend to align with these ‘free market’ movements, which Hudson (2010: 39) notes promote an “anti-tax ideology”.
Clyde Cameron Memorial Lecture – Tonight – February 18, 2015
I will be talking about these things when I present the Clyde Cameron Memorial Lecture tonight in downtown Newcastle.
The event is free for all and will be held at the University of Newcastle (City Campus), Room UNH421, Level 4 in University House, corner of King and Auckland Streets, Newcastle.
The lecture begins at 18:00 and will conclude at 20:00. A speaker from the Association for Good Government will also speak. Attendees are invited to the Surtaj Indian Cafe, Hunter Street, Newcastle (5 minutes walk from lecture) for dinner (at own expense).
Maybe I will see some locals there.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.