Tax Revenue Comes From Funds Previously Spent By Government

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The following assertion by Bill Mitchell has triggered a question that I (writing under the pseudonym "lector") put to the commentators and a longish and very fruitful thread of answers. I reproduce some of these contributions in the present post:

Bill Mitchell's assertion:

Taxation revenue comes from funds that the government has already spent into existence.

My question:

You write: “Taxation revenue comes from funds that the government has already spent into existence.” 

I understand, however, that the largest amount of money is created by commercial banks in the process of extending credit/loans. I assume further that it is from this money that most taxes are paid/most tax revenue stems. 

Why, then, do you not write: 

“Taxation revenue comes from funds that the government has already spent into existence as well as funds that commercial banks have lent into existence?” 

Why do MMT-texts tend to suggest that only money created by government provides the money that flows back to government as tax revenues? 

Am I overlooking something?

The various attempts to answer my question:

Writes Jerry Brown:

Lector, here is my understanding of your question. The currency issuing government probably could decide what it will accept for payments of taxes. It might decide that gold or cows or labor would fulfill a tax obligation. It might decide that a promise to pay the government’s currency in the future, or upon demand, which is what bank created money is, would be acceptable. But usually in the present time, taxes get paid through the banking payments system and obligations between parties (various commercial banks and the government) are settled by transferring reserve balances at the central bank. Since the central bank is really an arm of the government, and is the only source of these reserves, central bank reserves really are ‘government created money’.

Mel:

“[Why not] “Taxation revenue comes from funds that the government has already spent into existence as well as funds that commercial banks have lent into existence?””
Another angle, or maybe the same angle but spelled differently:
That’s not how lending works. 

When I bought my last car, the bank arranged a 5-year loan. They did NOT go to the dealer and say “It’s being payed with a 5-year loan; you’ll get the money over the next 5 years.” They paid the dealer right away, with their money. I’m paying the bank over 5 years. 

Similarly, if you borrow money to pay your taxes, the bank will cover your check to the Tax Authority right away, with money from their reserves. The loan deal between you and the bank stays between you and the bank.

lector:

Jerry Brown, larry, paulmeli, Mel and Derek Henry – I want to thank you for taking up my question. 

I can’t pursue your much appreciated contributions in this thread today or tomorrow, as I’m off on a business trip. But I shall certainly mull over your attempts at helping me. 

In the past, I’ve had a number of issues when I thought MMT has got it wrong, while it actually was right. In every case, it turned out that I had not fully grasped or inadvertently distorted the MMT position. Frequently, the problem is that I tend to smuggle in assumptions that I’m not aware of myself and that are not part of the MMT take.

Adam:

It really comes down to operation impossibility. Banks create bank money by creating bank liabilities (bank deposits). When a government initially sells a government security (bond) it only is for sale in the government’s currency (or equivalent central bank deposit). Whoever wishes to buy the government security must first therefore acquire the necessary government currency which can only come from the government via prior government spending (or from the central bank). 

As Warren (and I’m sure Bill) has said… reserve drains (tax collection & government security sales) can only happen after reserve adds (government spending or central bank lending/purchasing/direct adds).

Some Guy:

Lector: This may be the problem. You or I can pay taxes with bank money, by writing a check on our bank account. As far as you or I see, there is no difference between bank money and government money here. (Say that this tax check exhausts, closes our bank account, for simplicity) But that is not the end of the matter, which I think may be your assumption. After the federal government has accepted our tax check, the bank now owes the government. 

It is as if the government now has our account at the bank. The government wants to be paid now, wants to close this account. The only thing it will accept from the bank as payment when it closes this account is federal money, reserves that it has earlier issued. If the bank does not have the reserves to pay up immediately, it will be in debt to the government, and the discount rate – determined by the government – is the rate that the bank will be paying the federal government on its “account”. If the bank can never pay this debt, it is eventually declared insolvent by the government. 

Always, the government want’s its own money back. Rendered unto Caesar, as an ancient economist said.

Simon Cohen

In relation to Lector’s useful question and Some Guy’s excellent response can we say: 

All money is ultimately Government money because when we pay for things, reserves move around so we are, in fact, using reserves all the time. 

When a bank creates a loan, it later looks for reserves which are Government money (usually backed by repos-also a Government issued financial asset). 

So maybe this distinction between loans and Government money is otiose? The main difference being, as Derek pointed out, that one is a net asset and the other a simultaneous asset and liability but all the payments are the movement of reserves, hence Government money. 

I only appreciated this more recently when my friend Nigel Hargreaves pointed out to me that we are using reserves all the time and the ‘financial asset’ in ‘my’ account is not something parallel or separate from the reserves but ‘permission’ to use reserves. 

Keyne’s seems to say this in his Treatise on Money: 

‘The State-Money held by the central bank constitutes its “reserve” against its deposits. These deposits we may term Central Bank-Money. It is convenient to assume that all the Central Bank-Money is held by the Member Banks – in so far as it may be held by the public, it may be on the same footing as State-Money or as Member Bank-Money, according to circumstances. This Central Bank-Money plus the state money held by the Member Banks makes up the Reserves of the Member Banks, which they, in turn, hold against their Deposits. These Deposits constitute the Member Bank-Money in the hands of the Public, and make up, together with the State-Money (and Central Bank-Money, if any) held by the Public, the aggregate of Current Money. (Keynes, 1930 pp. 9–10) ‘ 

Not sure I quite get Keyne’s terminology here but he seems to support the point.

So maybe the artificial separation of this putative 97% from 3% cash is all unfounded?

Nicholas

Hi Lector 

Government spending adds to the non-government sector’s net financial assets.

Taxation reduces the non-government sector’s net financial assets. 

The non-government sector comprises the domestic non-government sector and the external sector (the rest of the world). 

The non-government sector’s net financial assets (denominated in the government’s currency) comprise three things: reserve balances, government securities, and physical cash on issue (i.e. physical cash that is held by banks, households, firms, sub-national governments, foreign governments – any entity that is not the issuer of the currency that we are talking about). 

Note that we are only talking about financial wealth, not real wealth (land, buildings, factories, equipment, tools, cars, art works – anything tangible). 

Retail bank deposits are NOT part of the net financial assets of the non-government sector. 

Why? 

Because retail bank IOUs are offset dollar for dollar by other IOUs within the non-government sector. 

When a retail bank issues its IOU (a bank deposit), a household or a firm is issuing its own IOU to the bank. The IOUs net to zero. They cancel each other out. 

Therefore ultimately households and firms pay their taxes with reserves, not with retail bank deposits. 

The government always taxes by writing down reserve balances. 

The government always spends by writing up reserve balances.

Nicholas

Hi Steve_American 

Sure, monetary units are fungible. We don’t know which particular dollar originated as government spending or as credit creation by a retail bank. And we don’t need to know. 

What matters is that only government spending can increase the net financial wealth of the non-government sector and only taxation can reduce the net financial wealth of the non-government sector. 

The government ALWAYS spends by crediting reserve accounts. 

The government ALWAYS taxes by debiting reserve accounts.

Nicholas:

So basically, you are asserting that if I borrow by getting a 2nd mortgage and therefore get bank created dollars; and then pay my taxes with them, that those dollars are magically converted into reserve dollars during the process of clearing the check. 

It isn’t magic, it’s just how the monetary system works. The government only accepts payments in its own IOUs. 

The government does not directly accept your retail bank deposit as payment of your tax liability. Your bank writes down your transaction account, and your bank instructs the central bank to write down its reserve account and to write up the Treasury’s reserve account. That’s how your taxes get paid.

Nicholas Haines:

all bank created money are liabilities to convert on demand into notes and coins

…and into reserves as well. 

The retail bank’s IOU is a promise to convert your bank deposit on demand into any of the two forms of high-powered money (reserves and physical currency). 

If you want to use your demand deposit to make a payment, your bank must honour its promise to convert your demand deposit into reserves. Your bank will write down your demand deposit, instruct the central bank to write down its reserve account and write up the reserve account of the recipient’s bank, and the recipient’s bank will write up the transaction account of the recipient. 

You can invoke this process to pay your taxes to the Treasury, make payments to individuals and businesses and organizations, move your demand deposit to a transaction account that you hold with a different bank.

And so on ...