While state taxes fund state spending and local taxes fund local spending, federal taxes do not fund federal spending. Even if all federal tax collections fell to $0, the federal government still continue to spend, forever.
The reason: The federal government uniquely is Monetarily Sovereign. It has the unlimited ability to create its own sovereign currency, the U.S. dollar. Unlike state and local governments, the federal government never unintentionally can run short of dollars.
Economics is one of those sciences everyone has mastered — or at least, everyone thinks they have mastered — simply by reading an occasional newspaper or by watching the TV news.
In that vein, allow me to introduce you to Jeff Spross:
How Democrats can raise taxes without technically raising taxes
By Jeff Spross, September 16, 2019
Income tax brackets have been indexed to inflation since the 1980s (meaning that as incomes gradually rise due to inflation, taxpayers aren’t pushed into paying higher and higher tax rates), and the White House was considering extending that same benefit to people who pay capital gains taxes. It ultimately demurred.
But Democrats — or anyone, really — should take a hint from Trump’s decision. It’s not just that capital gains shouldn’t be indexed to inflation; income taxes shouldn’t be either.
Doing away with that indexing would raise plenty of new revenue for the government. But more fundamentally, it would fix a basic misunderstanding about good macroeconomic policy.
Mr. Spross is one of the many writers who strangely seems to think your Monetarily Sovereign federal government is running short of dollars, but you aren’t.
So he advocates you sending more of your hard-earned money to a government that never has, and never can, run short of dollars.
If you think that sounds nuts, you’re right.
The U.S. income tax has several brackets, each with its own tax rate. When you pay taxes in 2021, the rates will be the same, but the income thresholds — where each bracket ends and the next one begins — will have risen. That’s inflation indexing at work.
The Economic Recovery Tax Act of 1981, passed under President Reagan, was primarily a massive tax cut. But it also introduced inflation indexing into the tax code. Before that, the cutoff for each tax bracket would remain the same year after year until Congress explicitly changed it. Thanks to the Economic Recovery Tax Act, those brackets have automatically adjusted with inflation every year since 1985.
Had Congress not introduced income tax indexing, everyone in America now would pay at the highest tax rate.
Mr. Spross seems to think that would be just fine:
Congress should go back to the old, pre-1985 way of doing business. Doing so would have two advantages.
First off, it would bring in a lot of new tax revenue without having to do the politically unpopular thing of actually hiking rates.
President Trump and the Republicans didn’t end inflation indexing, but they did change the measure of inflation in the tax code to a new version that tends to rise more slowly — thus, the tax bracket thresholds will rise more slowly in the future as well.
According to one estimate, that change will net the government an extra $134 billion in tax revenue over the next 10 years.
Thus, while an exact figure is beyond my abilities to calculate, the revenue brought in over a decade by simply getting rid of inflation indexing entirely should be several times that $134 billion haul.
Mr. Spross opts for taking not just $134 billion from the economy, but “several times that $134 billion haul.”
But, taking “several times $134 billion” from the economy would cause a recession if we are lucky and a depression if we aren’t.
Federal surpluses take money from the economy. Here is what they do to the economy:
I. U.S. depressions are caused by federal surpluses.
1804-1812: U. S. Federal Debt reduced 48%. Depression began 1807.
1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1997-2001: U. S. Federal Debt reduced 15%. Recession began 2001.
II. U.S. recessions come on the heels of reductions in federal debt/money growth (See graph, below), while debt/money growth has cured recessions. Taxes reduce debt/money growth. That is why tax cuts stimulate economic growth.
No government can tax itself into prosperity, but many governments have taxed themselves into recessions. Tax increases (aka “austerity”), cause recessions and depressions.
Plenty of economists and experts argue bracket creep damages the economy: By shoving people into higher tax rates, even though their pay hasn’t increased, bracket creep discourages economic activity and slows down growth.
Here’s the problem with that logic: If your economy is experiencing high inflation, like what we went through in 1980, then it needs to slow down.
No, the economy does not need to “slow down.” Economic growth and inflation are completely different, having no relationship. It is most common to have one without the other.
Mainstream macroeconomics assumes that high inflation is evidence of an overheating economy: too much demand chasing too little supply. In which case, to cool inflation off, money needs to be taken out of the economy. And taxes are one tool for doing just that.
The above may be popular wisdom but is completely false. As shown in number I. above, every depression in U.S. history has been caused by taking money out of the economy.
Depression is not a cure for inflation. In fact, nearly all hyper-inflations have occurred simultaneously with a depressed economy.
The notion of cutting demand by impoverishing the populace is incredibly wrongheaded.
Inflations never are caused by federal deficit spending. Inflations are caused by shortages: Most often shortages of food, and sometimes shortages of energy (oil).
The illusion that inflations are caused by money “printing” comes when a government prints money in response to inflation. That is, the inflation causes the money-“printing,” and not the other way around.
In other words, a system of income tax brackets that isn’t indexed to inflation would act as a kind of natural thermostat for an overheating economy.
As inflation rates rise, bracket creep would shove more people into higher rates more quickly.
As a result, the same set of tax brackets and rates would take more money out of the economy than it did before, and help to cool the economy off and bring inflation back down. Bracket creep is a feature, not a bug.
I do not have the words to describe how incredibly wrong is the notion of impoverishing the economy to cure inflation.
The belief that an economy should be “cooled” (i.e. kept from growing) is utter nonsense. Inflation is not caused by a so-called “overheated” economy. Overall price increases (inflation) are caused by shortages of food and energy.
The problem is not that you are demanding too much food and energy; the problem is that these commodities have become in too-short supply, because of some exterior circumstance.
The notorious Zimbabwe hyperinflation came when its President Robert Mugabe stole farmland from white farmers and gave it to blacks, who did not know how to farm.
The inevitable food shortage caused hyperinflation.
While federal deficit spending has increased massively, inflation has remained modest.
Do you see how the dramatic increase in deficit spending that began in 2008 did not change inflation, as Mr. Spross’s hypotheses demands?
Ironically, the shortages of food and energy, which cause inflation, can be cured by increased federal deficit spending to increase food and energy production.
Russel Long, a Democratic senator from Louisiana at the time, made this exact point, arguing indexing would “make inflation worse by pumping more money into circulation at a time inflation is at its worst.”
Clearly, Russel Long does not understand economics.
There are, of course, other ways to remove money from the economy when it overheats.
Over the last few decades, we’ve primarily relied on the Federal Reserve to do that, through interest rate hikes.
Wrong again: Interest rate hikes do not remove money from the economy. In fact, higher interest rates require the federal government to spend more on interest, which adds dollars to the economy.
Interest rate hikes combat inflation by increasing the demand for dollars.
But the social and human costs of interest rate hikes fall disproportionately on the poor, the uneducated, and minorities, through lower employment rates and lower wage growth.
Bracket creep hits people at all income levels, and thus its pain can be spread a lot more evenly across the whole population. This would be even more true if Congress went back to having 30 or so tax brackets, as opposed to the current seven.
Bracket creep does not “hit people at all income levels.” Bracket creep hits the lower-income groups hardest.
The very rich pay at the highest levels, whether or not there is bracket creep. The current highest level is 37%, which begins at an income of about $500,000 (depending on marital status).
For someone earning $1 million a year, bracket creep is pocket change. However, for someone earning $100 thousand a year, bracket creep can constitute a significant tax hit.
We’ll end with the article’s final bit of foolishness:
For the sake of the government’s coffers, for the sake of better macroeconomic management, and for the sake of economic justice, inflation indexing for the income tax should go.
- The federal government has no “coffers.” In fact, it destroys those tax dollars you send it, and it creates new dollars, ad hoc, every time it pays a bill.
- Reducing the economy’s money supply does not constitute “better macroeconomic management.” It is a formula for recessions and depressions.
- “Economic justice” is not achieved by raising the tax rates for the non-rich to the tax rate the rich pay. Quite the opposite.
Aside from being wrong on every point, Mr. Spross’s article serves as a valuable lesson — in how economic ignorance could drive us to economic disaster.
Rodger Malcolm Mitchell
Search #monetarysovereignty Facebook: Rodger Malcolm Mitchell
The most important problems in economics involve the excessive income/wealth/power Gaps between the richer and the poorer.
Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics.
Implementation of The Ten Steps To Prosperity can narrow the Gaps:
Ten Steps To Prosperity:
3. Provide a monthly economic bonus to every man, woman and child in America (similar to social security for all)
The Ten Steps will grow the economy, and narrow the income/wealth/power Gap between the rich and you.