Friday, 6 October 2017

Economic Myths: deficit spending reduces deficits

In this article in Counterpunch, the author states that tax revenues are 26% of US GDP and the velocity of money is seven. Therefore, if the government pays out $1 extra as unfunded Citizen's Income/helicopter money, it will be spent seven times in a year (the velocity of money, a separate Economic Myth); so total spending will be $7 more, generating $1.82 in additional tax.

This is of course mathematical nonsense, but you hear it a lot from left wingers.

Best case,the recipient gets a fresh new unfunded $1 at the start of the year, let's assume that genuinely does increase demand so total spending goes up by $1. The supplier receives $1, pays 26c tax and spends 74c; the next person in the chain receives 74c, pays 19c tax and spends 55c, and so on.

It is a circular calculation, after a year and seven times round, the total tax paid will be 88c, so this deficit has, unsurprisingly, increased the deficit (although not by as much as the original spending). No matter how many times it is spent, it is mathematically impossible to get the full $1 back in tax.

Funny that lefties go along with this sort of thing while denying there is a Laffer Curve - despite they are the same thing (up to a point).

Think about it, in economic or cash flow terms from the government's point of view, it is the same whether you give people an unfunded UBI or an unfunded tax cut. Politically they are different but no matter. So using the left wing logic, reducing tax rates would always increase tax revenues.

Funnily enough, the right wing nutters believe this, even though it is clearly not true. All the Laffer Curve says is that while very high rates of tax on earnings* bring in less revenue than sensible rates; sensible rates bring in more than very low rates. (* The Laffer Curve doesn't apply to taxes on rents, of course).

As per usual, the left and right wing extremists accidentally agree with each other without realising it. And they're both wrong anyway.


Tim Worstall said...

Her own example disproves her contention. She says:

" A new economic study found that a UBI of $1000/month to all adults would add $2.5 trillion to the US economy in eight years."

$12,000 a year to 240 million people is some $3 trillion a year. Do that for 8 years and you've increased GDP by $2.5 trillion. She says, not me.

Thus the issuance of new money doesn't multiply the economy as she assumes later, does it? And thus that 26% as tax revenue ain't flowing in.

Lola said...

And what's more it is 'money for nothing'. Which whatever way you look at it is massively distorting and as it is de facto inflation it is an assault on the property rights of the a priori holders of the currency.

Ralph Musgrave said...

Lola, What exactly is "de facto inflation"? If the amount of new money printed and spent into the economy each year is enough to maintain full employment, while not exceeding the 2% target, I can't see what's wrong with money printing or deficits.

Ralph Musgrave said...

Ann Pettifor (e.g. in her book “The Economic Consequences of Mr Osborne”) also claimed that deficits as it were “pay for themselves” in the form of increased taxes resulting from said deficits. I fully agree with her that deficits are needed in a recession, but (like Mark) I’m suspicious about the “pay for themselves” bit.

Mark Wadsworth said...

TW, nice one. Going by her logic, annual GDP increase would be £21 trillion.

L, yup, inflation is a stealth tax on savers.

RM, it's a question of getting the balance right, isn't it?

Lola said...

RM. The arbitrary expansion of the money supply without any justification. From memory you are an MMT'er (if not -apologies) and we are therefore not going to agree.

Dinero said...

Deficits don't increase the money supply , they transfer money from bond buyers to the recipients of government spending.

paulc156 said...

Money creation is for practical purposes identical to increases in gold supply under a gold standard. The former may appeal more to those on the left (though monetarists who are most definitely on the right argue for the same in deflations) whilst the latter (gold standard) is favoured by righties who prefer to make a fetish of the quantity of shiny metals. You pays your 'money' you makes your choice.

Lola said...

P156. I broadly agree. (!). But it seems that the advantage of a metallic standard is that it constrains arbitrary government money creation.

Mark Wadsworth said...

L, don't knock MMT. It merely describes how government finances work, quite accurately IMHO. It doesn't really provide any policy recommendations though.

Din, there is that argument as well.

PC, I don't really understand that comment.

L, just because a currency is denominated in gold, does not mean it is actually backed by gold. Government money is back by future tax receipts. I'm against pegging currencies, to other currencies or anything else, ergo I don't see the point of the gold standard as such.

paulc156 said...

MW. New gold discovery would (under a full gold standard) allow increase in money supply just as government monetisation of debt under fiat system. Same thing, One is deliberate the former accidental.

Lola said...

MW. I wasn't knocking MMT as a method of explaining how government finances work. What I am not happy about is when it gets touted as the solution to everything that is wrong with money currently.

P156. Precisely. The difference is crucial. The expansion of supply of gold money by the 'accidental' discovery of more gold supply is materially different from the 'deliberate' expansion by governments to escape their own failures. The Ponzi scheme of the warfare welfare state for example.

Ralph Musgrave said...

MMT advocates what Keynes advocated, namely that (as I intimated above) enough money should be created to keep the economy at capacity, but not so much as to create excessive inflation. Can't see much wrong with that.