Somewhat straight forward. If the federal reserve can print money to buy treasuries to fund deficit spending, what is the purpose of taxes? Sure, taxes reduce the amount of deficit that needs to be picked up by the Fed, but if, as ive seen argued, money “printing” doesn’t necessarily lead to inflation whats the point of levying taxes? Why doesn’t the fed just procure all of the money itself if it could theoretically do so without adverse affects?


2 Answers 2


Because Fed or any central bank cannot fund 100% of a budget without any adverse effect. I do not know where you heard such argument but it is blatantly false.

First, it is virtually unanimously agreed by top policy economists that government cannot fund arbitrary amount of real spending (i.e. spending on real goods and services). This question was actually put forward in a poll among the top Ivy league US economists by IGM and there was almost unanimous agreement that government cannot do that (in fact there was no one who even agreed that it could just few responses with no opinion, with low confidence, since the poll scores that as well).

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Second, money supply increase does not necessarily cause inflation because other variables might push inflation into different direction. For example, increase in money supply can be offset by velocity of money or change in real output etc. However, money supply increase, ceteris paribus, does cause inflation.

Numerous studies including Frain (2004) or DeGrauve & Polan (2005) show that there is causal relationship between inflation and money supply.

You can also see that just by plotting money supply growth against inflation. In the figure below on a left you can see the relationship between money supply growth and inflation in the US over several years, on a right you can see cross-sectional plot of money supply growth and inflation across various countries. The images of course only show correlation, but causality is further corroborated by empirical studies as those cited above (the charts are taken from Mankiw Macroeconomics 8ed pp 107-108).

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There is very little doubt in empirical research that there is relationship between money growth and inflation. There are still questions on how strong the relationship is, and how stable the relationship is over time, which is discussed in the studies cited above, but either evidence points toward causal relationship.

However, this does not mean government cannot monetarily finance some of its real spending, as despite of the above government can still earn seignorage on issuing money, and it can take some time before inflation kicks in as the relationship described above is not necessarily immediate but can work with lags. As a consequences taxes are necessarily to fund all other real spending that cannot be funded monetarily.

  • $\begingroup$ Is there any insight onto what percentage it becomes “not ok” to fund? Also you make a point related to money velocity… would a slower money velocity not just lead to delayed inflation? Not counteract the inflationary result of money printing, just delay its effect? $\endgroup$
    – Runeaway3
    Commented Jun 18, 2021 at 21:00
  • $\begingroup$ @Runeaway3 1. What amount can be founded depends on time and place. I seen some work showing that developed nations typically are able to get about 2% of real GDP but that is not necessarily maximum. However, maximum won’t be far from that. Also note that does not mean government should not create more money than that as sometimes having inflation is important economic goal in itself. 2. No it actually counteracts inflation it does not just postpone it. Decrease in money velocity will lead to actual decrease in inflation ceteris paribus $\endgroup$
    – 1muflon1
    Commented Jun 18, 2021 at 21:18
  • $\begingroup$ A note on that 2% figure, as I think it obfuscates the point a little bit. Gov't spending only accounts for say 17.5% of GDP (the amount in Q2 2021) that is growing at say 3% a year. So in reality, the debt burden in the U.S. is substantial relative to the federal spending. For instance, in 2020, the U.S. borrowed almost as much as they collected in taxes (\$3.4T) and in 2019, they borrowed about \$1T compared to \$3.5T in tax revenue. Over the last few years, they have consistently financed 20-35% of the budget through debt. $\endgroup$
    – user37832
    Commented Aug 26, 2021 at 2:16

The purpose of some taxes is not only to finance government expenditure. Taxes are often partly to raise revenue and partly for other purposes, which include:

  1. To change the distribution of post-tax income (relative to what it would be if everyone were taxed at the same rate, regardless of their income). The US, like many countries, has what is known as a progressive income tax with, broadly, those with higher pre-tax incomes paying tax at higher rates, as summarised here.
  2. To change behaviour in ways the government considers desirable. For example, the US taxes cigarettes (see here), partly to raise revenue but also to discourage smoking and so reduce its adverse effects on health. Also in this category, if it were ever to be implemented, would be a carbon tax to address climate change by discouraging the use of fossil fuels.
  3. To protect domestic industries by taxing imported goods. The US has taxes (or tariffs as they are often known) on many kinds of imported goods at various rates as set out in its Harmonized Tariff Schedule.
  • $\begingroup$ +1 the points 2 and 3 are valid points but regarding 1, if we would as a thought experiment imagine that government can fund infinite amount of real spending by monetary financing (as you do in the first paragraph) you could always arrive at equal distribution of income just via spending by providing subsidies to low income/wealth people until their income/wealth would equalize with the richer ones, so I do not think the point one is actually necessary if we would run with the premise of the Q $\endgroup$
    – 1muflon1
    Commented Jun 16, 2021 at 21:34
  • 1
    $\begingroup$ @1muflon1 Agreed, although to change income distribution entirely via expenditure and without taxing income would make total government expenditure even larger. Anyway, I have amended my first paragraph to take out the thought experiment. $\endgroup$ Commented Jun 18, 2021 at 10:42

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