By Lambert Strether of Corrente.

Since April 15, tax day, has just past, and tax reform is part of the national conversation, I thought it would be helpful to bring forward this parable on how taxes work from Warren Mosler, who runs Mosler Economics and is a central figure in the Modern Monetary Theory community[1]. (The material that follows comes from the Fiscal Sustainability Conference, organized in 2010 as a counter-conference to a Peterson Foundation-supported Fiscal Summit, as described by Joe Firestone.)

First, here’s the video. You only have to listen to the first 2:58:

And here is the transcript:

[WARREN MOSLER:] The question is, “How do you turn litter into money?” So, I take my business cards out here, and these are twenty dollars a piece, if anybody wants to buy any. No? Any takers? No? Okay. [00:00:19] All right, well if anybody wants to stay after and help clean up the carpet and tidy up the room, I’m going to pay one per hour. Or five per hour, or whatever, one per hour. Anybody want to stay and help? Okay, not a lot of takers. [00:00:30] Then I add one more thing: Look, there’s only one way out of here and there’s a man at the door with a nine millimeter machine gun. Okay? And you can’t get out of here without five of my cards. Now things have changed. I’ve now turned litter into money. Now, you will buy these, you will work for these things if you want to get out. The man at the door is the tax man and that’s the function of taxes. Stephanie [Kelton] talked about how taxes do it. But you can recreate that… [00:01:08]

So, is there an example of a currency that works like that in the real world? I mean, aside from the real world? Why yes:

[WARREN MOSLER:] There’s a currency that’s circulating at the University of Missouri Kansas City that we started way back called the buckaroo because we wanted to replicate a currency for the students to understand National Income accounting and how a currency works and that it doesn’t matter if you are a small open economy and what they did is that you need something like twenty buckaroos a semester to be able to get your grades in the economics classes. [00:01:37] The way you earn buckaroos is that you can do public service, community service, at some of the local institutions whether it’s the hospital, the police department or helping out locally. And they pay one per hour. Back ten or fifteen years ago, whenever these were started, they were worth… And they were freely exchangeable. So you would have to go earn your buckaroos. You’d have to have twenty of them to pay your taxes, your buckaroo tax. [00:02:09] But you didn’t have to earn them. You could buy them from other students, you could do work for them. Nobody really cared what you did for them, you just had to somehow get buckaroos to turn in. Just like you have to pay your taxes here and whatever you do to get your money. [00:02:23] So, the students would go to work and they would earn these things and at the end of the year, the first year, I did the accounting at the Post Keynesian Conference for the buckaroos and it went something like this: The total tax was a thousand buckaroos across the classes. Students came and earned eleven hundred buckaroos. And they paid a thousand for taxes. The School ran a deficit. They spent eleven hundred but they only collected a thousand. Did that affect their credit rating with the rating agencies or anything? Of course not.

I used the word “parable” quite deliberately, because my goal, readers, is to open your minds to a paradigm shift (and not to do a full-fledged, economist-style explication of the history and current operations of the U.S. financial system, which, like juggling flaming power tools, would require more practice time from me than I have right now)[2]. However, if you find Mosler’s parable illuminating, we can glean some additional insights:

(1) Money (“litter”) does not emerge from barter (that is, historically, the “double coincidence of wants” is a crock). (2) Money need not be “backed by” anything (gold, for example). (3) The sovereign (whoever controls the “man at the door”) creates demand for the money it issues through taxes. (4) Taxes do not “pay for” the services the sovereign provides. That is not their function. [3]

(In the news coverage of tax reform, you’ll hear that taxes “pay for” government spending constantly, expressed as a truism.)

Of course, Mosler’s parable is really a thought experiment, and greatly simplified; there are no banks, and there is no financial sector. L. Randall Wray expands on Mosler’s parable and draws out some implications:

In previous instalments we have established that “taxes drive money”. What we mean by that is that sovereign government chooses a money of account (Dollar in the USA), imposes obligations in that unit (taxes, fees, fines, tithes, tolls, or tribute), and issues the currency that can be used to “redeem” oneself in payments to the government. Currency is like the “Get Out of Jail Free” card in the game of Monopoly. Taxes create a demand for “that which is necessary to pay taxes” (and other obligations to the state), which allows the government to purchase resources to pursue the public purpose by spending the currency. Warren Mosler puts it this way: the purpose of the tax is to create unemployment. That might sound a bit strange, but if we define unemployment as a situation in which job seekers want to work for money wages, then government can hire them by offering its currency. The tax frees resources from private use so that government can employ them in public use. To greatly simplify, money is a measuring unit, originally created by rulers to value the fees, fines, and taxes owed. By putting the subjects or citizens into debt, real resources could be moved to serve the public purpose. Taxes drive money. So, money was created to give government command over socially created resources. This is why money is linked to sovereign power—the power to command resources. That power is rarely absolute. It is contested, with other sovereigns but often more important is the contest with domestic creditors.

* * *

I was inspired or reminded to write this post by this recent summary article from Deutsche Bundesbank, “How Money is Created.” The Bundesbank adopts the MMT view that loans create deposits, writing:

In terms of volume, the majority of the money supply is made up of book money, which is created through transactions between banks and domestic customers… [B]anks can create book money just by making an accounting entry: according to the Bundesbank’s economists, “this refutes a popular misconception that banks act simply as intermediaries at the time of lending – ie that banks can only grant credit using funds placed with them previously as deposits by other customers”.

And in an extended response to that article by MMTer Bill Mitchell (“Deutsche Bundesbank exposes the lies of mainstream monetary theory”) introduces the role of the sovereign:

Banks lend if they can make a margin given risk considerations. That is the real world. If they are not lending it doesn’t mean they do not have ‘enough money’ (deposits). It means that there are not enough credit-worthy customers lining up for loans. Banks lend by creating deposits and then adjust their reserve positions later to deal with their responsibilities within the payments system, knowing always that the central bank will supply reserves to them collectively in the event of a system-wide shortage.

So, at the end of the day, somebody always has to turn litter into money[4].

NOTES

[1] As MMTers joke, MMT is neither modern, nor monetary, nor a theory. Branding is hard!

[2] For a very pragmatic, policy-driven discussion, see “MMT on a Postcard.”

[3] The several states are not currency issuers; they don’t print dollars.

[4] “[N]o sovereign issuer of the currency needs to borrow its own currency from its population in order to spend.”