Friday, 20 August 2010

The reason for taxation, and what a deficit really is.

Any interesting revelation from Modern Monetary Theory is the real reason for taxation. It provides friction on government spending so that it doesn't get out of control and cause inflation.

If a government spends without taxation then that spending will bounce around the economy a very large number of times in separate transactions. There may not be enough real stuff to absorb such spending and you would likely get an inflation.

The rate of tax limits the number of times the unit of spending bounces around - just as the water creates friction on a stone as it skips along the surface. The higher the rate of tax the greater the friction,  and the fewer number of transactions are stimulated before the spend vanishes.

This leads to another insight that is quite important. The government gets to have its cake and eat it. When it spends money, it gets the real stuff in exchange for the money, but also the money is recovered by taxation. All of it, always. It's just a logarithmic progression to zero. As the money bounces along a series of transactions a part is taxed away until it disappears.

So how come we have a deficit? That is simply the amount of money spent by the government in the period that didn't reach the end of its transaction series in that period. In other words some of it was 'saved' by somebody somewhere. And the 'national debt' is just the total amount we have 'saved' throughout the history of our currency.

Just remember that a government doesn't spend like you do. It can tax and get its money back.