The Magic Money Tree: From Modern Monetary Theory to Modern Tax Theory

John Christensen from the Tax Justice Network addresses the Modern Monetary Theory idea that governments don't need tax revenues if they want to spend money. Doing so, he sums up the main points made by MMT proponents and their critics, and shows how MMT can be reconciled with another progressive economic narrative: "Modern Tax Theory". While MMT made valuable contributions to the policy debate on fiscal policy, it misrepresents the importance of taxation as a political matter and as a way to generate public revenues. This is where MMT steps in.

Comment from our editors:

Modern Monetary Theory (MMT) provides a compelling critique of the damaging austerity policies that were implemented since the global financial crisis, and an important principle of new progressive thought. Whilst an increasing number of critiques on MMT has arisen, the Tax Justice Network argues the MMT offering an important debate on the role of tax.

What is MMT?

Whilst many believe that a government budget is like personal or household finances: money need to be earned before they can be spent.

The first central tenant of the MMT is the existence of a “magic money tree [which can be found] in each country’s central bank” (Fazi and Mitchell, 2018). Indeed, central banks can engage in multiple productions of money e.g. printing, Quantitative Easing…

However, this raises an important question - ‘if governments can just create money, what’s the point of tax?’ 

To understand the point of tax we need to consider what money (those ‘bluish-green piece of paper) is worth - the answer is nothing. Money hold value because enough people believe they are worth something - However, why do people believe is in such thing? MMTers explain that ultimately people believe in the value of a currency because of its attachment to the government. Following this argument, money is created first and tax is paid later. 

Thus, the second tenant of the MMT is that the purpose of tax here isn’t to fund spending: it’s to provide that essential role tying money to something solid.

However, injecting large amount of money in our circular economy might lead to e.g. hyperinflation. Therefore, a third principle of the MMT is that government should supply sufficient money for a health economy and use a variety of tools to withdraw money from circulation e.g. increasing taxes. Therefore, tax and money creation are tools for fine-tuning the economy, where tax becomes purely a means to ‘destroy’ money.

Can MMT be compatible with the tax justice movement?

To sum up, the insights from MMT show that (i) spending comes before taxes, (ii) spending can happily outstrip revenue, and (iii) that while fiscal deficits (that is, more spending than revenue) do matter in some circumstances, there’s plenty more flexibility in the system than most people realise. 

The Tax Justice Network argue that MMT is helpful as a political tool to push back against austerity. However, what are the criticisms and why might the MMT not be compatible with tax justice?

Firstly, MMTers admit that there are situations where it simply doesn’t apply. The article offer different examples where this might apply such as countries where people lack confidence in the state or European countries which are institutionally constrained in terms of spendings.

Secondly, if the MMT is to serve as a useful policy tool, it needs debt markets to be efficient and investors to be wise. MMT may struggle do deal with bubbles, manias and panics.

So where does MMT meet tax justice? 

From an economic point of view the MMT argument is that governments need not collect a dollar in tax for every dollar they spend. Most economists agree that government (or central banks) can create money and fiscal deficits are acceptable in principle. MMTers agree that if there’s too much money in circulation, higher taxes can help re-balance things.

However, taxes and spending are not just economic matters: they are intensely political: the political climate dictate how far government spending is constrained by the levels of taxes. 

Whilst, MMTers attack the linkage of “taxes pay for schools, hospitals and firefighters” because they want to emphasise taxes not being the sole tool for such spendings. The tax  justice movement add “taxes help pay for school, hospital and firefighters”. The article argue that a continuous attack on this linkage might send a politically wrong message - that tax serves one purpose. The Tax Justice Network stresses the need for MMTers to take more on board the many purposes of taxes:

1. Raising Revenue - more tax revenues at the very least create the political space, and even the economic space, for more spending on schools, hospitals etc.
2. Redistribution  - the tax system in itself is a fine tool for tackling economic (and political, gender, racial, and other) inequalities.
3. Repricing - tax policy can also create incentives and disincentives to encourage or discourage desirable and undesirable things, like curbing smoking or alcoholism, tackling climate change, stimulating certain kinds of investment, discouraging excessive borrowing, curbing rent-seeking, and so on. 
4. Representation - citizens pay taxes as part of a grand social and democratic bargain, that government will be accountable to them in return.
5. Ratifying the value of money - money has value because people have faith in it, and they have faith because they know government will accept it for tax payments.
6. Reclaiming money that has been created - to help regulate the economy and stop it overheating or stagnating.

The structure of a tax system

The Tax Justice Network argue that the MMTers’ main fight is about the overall levels of taxes relative to overall levels of spending - not a theory about a tax system, which which in turn hinges on the all-important question of who pays - which is the core work of the Tax Justice Network.

Therefore, MMT does not necessarily clash with the tax justice movement - they are fighting different battles. The  Tax Justice Network explain that the MMT creates interesting insights about tax. If a core purpose of tax is to take money out of circulation (or ”destroy money“) to prevent excessive inflation, then the wealthy should love paying tax, because inflation erodes the value of their assets. The problem is, the wealthy want poorer people, and not them, to have their money taken out through tax.

This lead onto further arguments. For instance, some MMTers argue against e.g. Corporate Income Tax because of a preoccupation of corporations being incentivised to seek tax havens abroad with tax havens being too difficult to crack down or not the real problem. Whilst MMT does not take a clear stance in this matter, the Tax Justice Network explains that it is, to an extent, easy to fall back on such ideas - “don’t tax the rich because they’ll dodge the tax” arguing for ‘pre-distribution’ tools to tackle inequality. Nonetheless, the Tax Justice Network argues that pre- and after- distribution methods are essential for tax justice, or Modern Tax Theory.

At last, traditional tax theorists - including MMTers - will look at the measurable benefits of the corporate tax cuts – especially higher profits for corporations – and highlight them, but then airbrush out that much broader range of equally important costs e.g. rising inequality, damage to labour an jobs, because so many of them are hard or impossible to measure. Nonetheless, the Tax Justice Network argues that an increasing body of research on these matters is allowing to shape a Modern Tax Theory which does not need to be incompatible with Modern Monetary Theory.

Go to: The Magic Money Tree: From Modern Monetary Theory to Modern Tax Theory