1. I feel a contradiction between Prof. Howard Chernick's answer and Redditor "galivet"'s comment? Who's correct? Chernick has

B.A., Johns Hopkins University, Economics, 1969
Ph.D., University of Pennsylvania, Economics, 1976

Here's What Would Happen if No One Paid Taxes

ICE: What would happen if no one filed a tax return?**

Howard Chernick: Well, the income tax is probably fifty or sixty-five percent of the federal government's money. Most people pay their income tax in the form of withholdings throughout the year. So the federal government has our money already, and what's happening on the end is just accounting reconciliations. But if no one filed his or her income tax, that would mean a huge increase in tax evasion, and much less money for the federal government, which already runs substantial deficits. So the government would have to borrow a lot more money, and the spending would have to go way down. After that, the US economy would begin to go into the tank. So as painful as it is, if you wind up owing taxes, as Oliver Wendell Holmes said, that's the price of civilization.

ELI5: When the US government uses emergency funding in the billions or even trillions, where is it getting the money from? : explainlikeimfive

The government does not need to fund its operation through revenue (e.g. tax revenue) because it create money at will. Taxes don't pay for government services; that's an illusion. Taxes accomplish two things: maintaining a mechanism whereby the government can uphold the value of the dollar by reducing the supply of dollars, and redistributing wealth. When the government taxes some people more than others while offering services to everyone (and more services to some), it's engaging in a kind of social engineering. The government could pay for all of its services and never tax anyone because it can create all the money it needs; the downside is that the dollar would decline in value over time and $\color{red}{\text{the government would have no way of stopping it (i.e. runaway inflation)}}$. When the government decides to destroy certain types of people's money to a greater extent than others, it's putting the burden of maintaining the value of the dollar on those who pay the greater share of the tax. And it turns out that those who pay more in taxes usually benefit more from the dollar maintaining its value anyway, so it's a reasonably fair deal.)

  1. Is the red text true? Can't the government Quantitative Tightening?
  • $\begingroup$ Distinction between taxation and money-printing is false. Printing money can be thought as a form of taxation, namely it's taxation of people who keep money, especially savers. The government gains ability to pay for things that it wants at cost of savers and other money-holders. $\endgroup$ Commented Aug 3, 2020 at 11:14
  • $\begingroup$ Some people do think of money. They think of government spending as printing money, and taxation as a way to delete money to prevent inflation, not as a way to pay for the spending itself. $\endgroup$ Commented Aug 4, 2020 at 16:58

1 Answer 1

  1. It is true that government can print as much money as it wants but value of money is not constant. For example, under 101 econ quantity theory of money the price level is given by: $$P = \frac{MV}{Y}$$ Where $P$ is the price level (with change in price level giving you inflation), $M$ money supply, $V$ velocity of money and $Y$ real output. Assuming $V$ constant government can increase money supply only by the growth rate of economy without incurring inflation. In more complex IS-LM AS-AD model the story is a bit more complex but the main message that government cant expand money supply freely without risking inflation holds (the equation above is actually an simplified equilibrium condition at money market in IS-LM).

    Most modern governments run spending at a level of somewhere between $25\%-60\%$ GDP (see the OECD data) while real output grows at around $2\%$. There is no way that even the modest $25\%$ spending could be covered without government running two digits inflation in the best case scenario ignoring other issues this would create.

  2. In fiat money system collecting taxes is what actually gives money value in the first place. See this thread that discuses this issue in greater detail (especially Holger's and Brian's +1 answers). If government will stop collecting taxes there is no guarantee that in the long term its currency will still be acceptable, especially since given the point 1 the currency would be rapidly loosing its value.

  3. "Can't the government Quantitative Tightening?":

    It can use it reduce the problem but it would not be any solution. Raising interest rates helps contract money supply itself but at the cost of depressing economy and increasing unemployment. For example, prior to Volker disinflation the US inflation during late 70's and early 80's was even in the worst times below $12\%$ and to bring it down to low inflation it took interest rates that were almost as high as double the inflation rate with the funds rate reaching more than $19\%$ (see Goodfriend & King 2005).

    Moreover, some point rising interest rates higher and higher would not help fighting inflation just due to the fact that $Y$, which varies negatively with interest rate $i$ (that is $\partial Y/ \partial i<0$ see for example Blanchard et al Macroeconomics an European perspective) would fall more than $M$. Furthermore, in the end raising interest rate can only reduce the broad money supply not actually the base money i.e. the actually printed coins and notes in circulation so if government will insist on continuing to print money to cover all its expenses raising interest rates would just slow the inevitable.

  4. The view of those economists are not necessarily contradictory. One way how government could avoid some disastrous inflation is to slash its spending dramatically, borrow at rate that keeps debt to GDP stable due to growth and try to live of the seigniorage from some reasonable slow paced money supply expansion (assuming they would be still in demand due to issue covered in 2). According to Fed Dallas the US seigniorage revenue accounts for less than $2\%$ of real output so with some balanced borrowing my guesstimate is that US government could run spending on level $4-5\%$ of GDP in this scenario. That would be barely enough to cover US defense spending itself and not much else. The second economist just assumes that government spending would not change and hence stresses the effect this would have on the value of money itself. There is no contradiction there both are valid options that government could pursue.


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