Everything You Know About Economics Is Wrong: If The Government Can Print Money, Why Do We Pay Taxes?

February 25, 2019 7 Comments

Why does the piece of paper in your wallet marked “One Dollar” have value?

Is it because the military tells us it has value? Is it because of our blind faith in the United States government?  Is it because it is backed by gold?  Or are we just all lemmings hypnotized by central bankers?

No.  All of those are wrong. The dollar doesn’t have value because of coercion, faith, gold backing, or hypnotism.

The US dollar has value because it is the only currency the US government accepts to pay your taxes. It is the government’s choice of the unit of account. If you go to the IRS to pay your taxes with bars of gold, bitcoins, or Yen, they will tell you to “try again.”  The only thing the government will accept is the US dollar.

As Hyman Minksey said, “Everyone can create money; the problem is to get it accepted.”

The only thing an issuer has to do to get its currency accepted is to take it back for something of value.  In the case of the US dollar, the issuer (the US Government) takes back its dollars as payment for your tax obligation.

However, this wasn’t always the case and that’s why countries sometimes fall back on the gold standard.  In 1836, after Andrew Jackson killed the Second National Bank of the United States, instead of the US government, many banks issued their own currency.  Some of those banks backed their currency with gold, making sure that it had value.  Those banks that backed their currency found it was more widely accepted than other banks which did not provide that guarantee.

As long as the issuer redeems its currency for something of value, the currency will be worth something. For example, any corporation can create a currency with gift cards. That Barnes & Noble gift card Aunt Betty gave you for Christmas has value because Barnes & Noble will redeem it for a book.  If you don’t want a book, you can exchange the gift card for dollars because Barnes & Noble has promised to honor that gift card, no matter who holds it. Gift cards are a form of currency.

In a similar way, the US dollar has value because the government spends it on goods and services and then demands it back through taxation.  The government designates the dollar as the only currency to meet your tax obligation.

The US Dollar is simply a tax credit.  You can argue this has no intrinsic value but it does.  The government has a claim on your property and income if you don’t meet your tax obligation.  If you don’t pay, the government takes your stuff. So a tax is an important tool for the government because it creates demand for its currency.

But taxation is NOT how the government raises money. The government does not have to increase taxes to raise revenues for its spending. Since it is the originator of the currency, it can just print the money when it wants to buy something.  And by paying for military defense, economic security, and infrastructure, the government provides value to its citizens.

Taxation can also be used to regulate demand in the economy.  If, for instance, unemployment is too high, the government can reduce taxes so that more money stays in the economy.  Congress is actually quite good at doing this. President George W Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 to stimulate the economy during a recession and President Barack Obama signed an income tax cut and a payroll tax cut in 2009 and 2010 to help the economy out of The Great Recession.  However, when governments increase taxes when citizens don’t have money, they get pissed.  In 1991, George H Bush learned this the hard way, when Congress raised taxes while the US was still in a recession.

Likewise, when the economy is strong and the government lowers taxes, it can create inflationary pressure.  In the 1980s, Margaret Thatcher’s government reduced top tax rates from 83% to 60% and the basic rate from 33% to 30%. After that large cut, the basic rate was cut in three successive budgets – to 29% in the 1986 budget, 27% in 1987, and to 25% in 1988. The top rate of income tax was cut from 60% to 40% in the 1988 budget (Wikipedia). While it’s a bit of a simplistic comparison since other factors affect the inflation rate, you can clearly see the resultant spike in inflation from each large tax cut.  In sum, when the government wants to stimulate demand and increase inflation, it can cut tax rates.  And when it wants to dampen demand and decrease inflation, it can raise tax rates.

UK Tax Rates vs Inflation

 

So despite the fact the government constantly prints money, you don’t have to fret about the value of the currency.  As long as the US government efficiently collects taxes in US dollars, you will need to get dollars. Otherwise, you will have your assets repossessed and you will potentially be thrown in jail. And that’s enough motivation for most sane folks to assign value the US dollar.

John McAfee, by the way, is insane.

Note: This post was updated to include the UK tax rate data on July 24th, 2019.

Everything You Know About Economics Is Wrong: Why Does The Government Issue Treasury Securities?

7 thoughts on “Everything You Know About Economics Is Wrong: If The Government Can Print Money, Why Do We Pay Taxes?”

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  4. I missed something. This article still didn’t answer the question. If they can print money any time they want and they do, why DO they demand taxes it from its citizens? Just proving that the ‘piece of paper’ has perceived value by the IRS still doesn’t answer that question.

    1. Taxes are necessary to 1) create demand for a currency so that a government can spend and provision itself and 2) drain the economy of “excess” currency that might cause inflation. If the tax system were removed, the government would eventually find that its fiat money would lose its ability to purchase goods and services. This would be seen as inflation in the real economy…i.e. the loss of purchasing power.

      You can see how this works in a real-life example. During the US Civil War, the South experienced inflation of over 2000%. While the North experienced some inflation, this passage from “Understanding Modern Money” explains why this hyper-inflation happened only in the South:

      Taxes equaled less than 5 percent of the South’s spending, which totaled about $2.7 billion, with bond sales equal to 30 percent, notes issued by ‘the printing press’ equal to 60 percent, and other revenue sources equal to 5 percent of spending (ibid.). Christopher Memminger, Secretary of the Confederate Treasury, advocated higher tax receipts; however, the Congress argued for lower taxes, the Confederacy did not ‘have the ‘machinery for collecting large amounts of taxes’ (ibid.), the southern states strongly resisted centralized state power, and, at least initially, the South expected a speedy victory. Secretary Memminger:

      “saw two immediate and indispensable benefits from levying taxes payable in government notes. First, taxes created a demand for the paper issued by the government and gave it value. Since all taxpayers needed the paper, they were willing to exchange goods for it, and the notes circulated as money. Second, to the extent that taxation raised revenue, it reduced the number of new notes at had to be issued. Memminger’s numerous public statements during the war show that he clearly realized that increasing a country’s stock of money much faster than its real income leads to runaway prices. They also show that he believed a strong tax program lessens the possibility of inflation. “(ibid.,-p. 508)

      Memminger proposed to levy money taxes primarily on property whose future yield would depend on Southern victory, in order to make best use of ‘patriotic’ sentiment, and provided incentives for states to collect the taxes. Unfortunately, the states did not cooperate Some merely confiscated the property owned by people in the North (counting the value as tax revenue), floated bonds and collected as taxes the money that would have gone towards interest, or borrowed the amount required from state banks. This is partly to be explained by the feeling of citizens that they were already paying tremendous human costs to prosecute the war; thus there were strong local feelings against the taxes. However, given our understanding of the taxes-drive-money principle, it is clear that confiscating the property of Northerners, or selling bonds to banks cannot create demand for the currency.

      Throughout the war, Memminger would propose measures to increase tax revenues, only to find that Congress chose to issue notes to ‘finance’ the war; even when tax rates were raised, it was easy to evade taxes and the States tended to side with their citizens against the Confederate tax. As a result, Memminger was forced to rely on bond sales and note issues. Indeed, Memminger often issued bonds used by the Treasury as currency, forcing Sellers to accept the bonds; however, he also allowed tax payments in the form of bonds — which means that bonds were essentially interest-paying currency. Memminger wrote to President Davis: “When it is remembered that the circulation of all the Confederate States before the present war was less than 100 millions, it becomes obvious that the large quantity of money in circulation today must produce depreciation and final disaster’ (Lemer, 1954, ‘p. 520). By February 1864, well over $1.5 billion notes had been issued by the Confederacy.

      I hope that helps. The tax system is vital to create demand for a currency. Without a system of taxation, governments will eventually find that a currency becomes worthless as the South found out during the US Civil War.

  5. “Taxes are necessary to create a demand for the currency.” Ridiculous!

    A currency is worthless unless it is printed and circulated in a country that PRODUCES goods and services (including security and defense of wealth). Your country produces cars, computers, paper, etc.? Well, other countries will need your currency to exchange for those things. They will WANT that currency.

    Does that same country protect property rights from rogue governments and political factions, and have a system of solid monetary stabilization? Well now you get foreign investment.

    None of those factors requires income taxation. None. It SHOULD be just like the Census Bureau. Government surveys the accounting books of businesses and prints money in proportion to profits.

    Double, triple, n-th degree taxation is virulently rampant in US at all governmental levels. Why would any educated citizen believe that to be just or responsible governance. Brainwashing that’s how.

    Free citizens are hard to manage without using coercion. Income tax is a form of monitoring and coercion. Sneaky government figured out a sneaky way to do it. Just like Stalin got citizens of USSR to spy on each other for political loyalty, the US uses greed and envy to motivate people to spy on each other for tax purposes.

    Industry accounting census would eliminate that sneaky income tax methodology.

    1. I agree. Personal income taxes are not necessary for a currency to have value. Saudi Arabia has no such taxes on individuals employed in the Kingdom, yet their riyal is still pegged to the dollar and has value because it is readily traded for high quality petroleum.

      Confederate money might have been worth something if it could have been easily traded for high quality cotton & tobacco, but naval warfare made that impossible…

      Other currencies which are not based in taxation: precious metals, cigarettes and other packaged vices (https://api.parliament.uk/historic-hansard/commons/1908/nov/11/gin-as-currency), cryptocurrency, etc.

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