Cactus offers a reader's new tax system:
In a nutshell, here is my idea:1. All taxes are removed - income tax, sales tax, company tax... everything.
2. The government creates the money it needs via seigniorage (printing money).
3. The Central bank then controls inflation by increasing the Reserve requirement of bank deposits (on M2 and maybe M3).
Cactus muses:
1. Government spending in 2006 was over 20% of GDP. Can that be funded simply by printing money? And if not, can government spending could be shrunk enough for it to be funded entirely this way?
2. Fiddling with the money multiplier does affect the money supply (and hence, inflation), but its small potatoes relative to open market operations (the Fed buying and selling bonds). Will it be enough?
3. Banks make their money by loaning out money. One Salient Oversight's plan wouldn't necessarily create funds out of thin air - some of those funds would come from reduced profits that the current system creates (out of thin air) for the banks. Will the banks agree to it? And if not, can they be forced into it? After all, banks are powerful enough, politically, to get bail outs when they do incredibly stupid things?
4. As much as they say they're for tax simplification, I just don't see the big accounting and tax law firms agreeing to something like this, and they're pretty powerful entities too.
Let's say money supply needs to grow an average of 3% a year, and we can tolerate inflation of 3% a year. That implies, I think, a limit to economically tolerable seignorage of 6% a year. Above that, the Fed will have to start raising reserve requirements to tamp down credit creation. The problem is, reserve requirements have a hard upper limit of 100%, since you will probably find few banks willing to get into the business of holding more money than people will deposit with them. The practical limit on reserve requirement increases is, of course, well below this; long before you hit 100%, the credit system would basically shut down. Need I point out that capital accumulation and distribution to investments in future productivity is one of the main reasons that we have this awesome modern economy?
If you cut taxes to zero, government revenue will increase to infinity.
It's even worse than that. The velocity of the money base is pretty high, something like fifteen. Based on the postwar experience with >3% inflation, seigniorage has come out to be about 0.3 or 0.4% of GDP. (approx. 0.06/15) Anything much higher than that and people will start to complain about inflation big time. In a properly functioning modern economy, seigniorage is pretty immaterial.
A seigniorage-funded government would look a lot like an oil-funded government: unaccountable to its people.
I agree that the idea is totally bonkers.
I disagree with your claim that the credit system would break down with higher reserve requirements. Sure the current system would cease to exist, but I think it is entirely possible that a functional (and perhaps better?) credit system could exist divorced from deposit banking.
Basically, I'm suggesting that path-dependency has encouraged the current system, and that financial markets could quite possibly do just as well under different rules.
Trying to control inflation while funding the government through seigniorage is pretty pointless. The government is diverting real resources, so the cost will have to show up somewhere. Also, the dollar would be hit with another devaluation due to the fact that part of its value comes from its ability to cover tax obligations. If the government never actually bills anyone for taxes, dollars are less valuable.
I still think it's a pretty good idea, since the cost of adjusting to high interest rates is lower than the deadweight losses and collection/avoidance costs of taxes.
Whoever suggested this clearly doesn't understand monetary economics. As "Person" above me said, the government's spending uses real resources that have to come from somewhere: printing money causes inflation, and is basically equivalent to a flat tax on money holdings.
I disagree with Person, however, that this is a good idea. Here's the problem: insofar as money is actually useful, taxing money holdings creates a severe inefficiency. Alternatively, insofar as money isn't all that important, and we could avoid holding it most of the time without too much of a problem, this policy will cause real money holdings to decrease dramatically. If the latter's true, the government's seignorage will be very large compared with the money supply, and we'll get even larger inflation. (Which will lower the desire to hold money yet further, making the government having to print even more to fund itself, etc. etc. until we're in Zimbabwe.)
I think that the second alternative is closest to reality, and it illustrates a point that should be obvious to anyone with much economics training: don't tax something with elastic demand.
This idea isn't new; it's also proposed in this conspiracy video.
Revisiting what I wrote earlier, I should probably change this:
"Don't tax something with elastic demand."
After all, there's an important qualification to add...
"Don't tax something with elastic demand when your primary aim is to raise revenue."
(Taxing, say, a readily eliminated kind of pollution might be a good idea precisely because it wouldn't give you much revenue -- instead, everyone would stop doing it.)
Matt Rognlie is correct on why this is a crackpot idea. High inflation, especially as a clear policy (as opposed to a stealthy one), cannot but lead to hyperinflation as everyone who has at least half a brain flees from money into hard assets.
However, let me take issue with this bit of economic ignorance:
Not true.
First off, there is no necessary contradiction in reserve requirements of greater than 100%, although it would be economically silly as well as creating a huge incentive for black-market banking. But say I have a million dollars of demand deposits in my bank. With a reserve requirement of 200%, what that means is that I need $2m on hand: I can do that by using $1m of my own money (capital paid into the corp by owners), and keeping all the deposits on hand. No problem. This is not profitable, of course; I'd have to charge fees for deposits to make any money doing it, and rather stiff ones to earn a market rate of return. But it is possible. (If the average market rate on return on capital is 10%, then you'd have to charge just a bit over that in negative interest to earn a market rate of return on your paid-in capital that is being use to backstop demand deposits. A regime like this would severely penalize demand deposits; essentially all saving would thus be pushed into alternate forms.)
But second, the entire point of reserve requirements is something that you, Megan, apparently don't understand. Any reserve level lower than 100% is an unsafe banking practice, wherein a bank claims to be holding money owned by you, available on demand (that's why it is called a demand deposit), and also to have loaned it out. Money, like any other property, cannot have two exclusive owners. This fundamental mistake sits at the center of banking law, having been made centuries ago and never corrected.
In a free market, the practice of fractional reserve leads to banking runs, bank failures, panics, etc. The capitalists running the specific banks that use the practice lose, as do the depositors (who are essentially defrauded), as well as more distant people who merely accepted a banknote. To fix the problems created by bad law at the heart of the system, in our money regime, the Fed and the FDIC socialize risk by making taxpayers pay for failed banks. This works better, at the cost of centralizing power and also creating a system so huge that when it does fail, it will create a depression of historical dimension.
The correct solution is to ban fractional reserve, seeing it as a species of fraud, which is what it is.
But how can depositor money be lent, then, in a proper free market system w/o fraudulent fractional reserve? Easy enough: via CDs. When you buy a CD from a bank, the money is not a demand deposit. Rather, you have bought an IOU from the bank. Thus, the money you spent becomes legally the bank's money, and can be lent without fraud so long as the repayment period is shorter than the repayment period on the CD. More importantly, the money can be lent with no risk of a bank run developing: you own an IOU from the bank; the bank owns an IOU from the creditor, and the creditor owns the money. Everything is owned once, and only once, just as things ought to be.
Leonard-
Abolishing fractional reserve banking will destroy the modern economy and return the world to a dark ages as inevitably, albeit less quickly, then Cactus's plan in the original post. If you abolish this liquidity from the modern fiat system, you have effectively abolished money. And yes, the gold standard would probably correct this. Except to go back to the gold standard, you would likely cause the economy to contract the economy back to 1973 levels. (about 1/4 the size of today). And there is about 100 million more people now than in 1973. So, 75% total decline in economy + 33% rise in population = approx 86% reduction per capita -> mass hysteria, all the worst parts of the bible, dogs and cats living together -> dark ages.
Feel free to economize on the word 'economy' as I failed to do above.
Kenny, "liquidity" (whatever that is) does not cause money. Money is the means of final payment. Period. It is a fallacy to think that the amount of money must be a function of the size of the economy. No. Any amount of money will work fine. (To the extent that a particular good either cannot be subdivided, or can be circulated only with substantial friction, it does not make good money. These are attributes which people want in money, and which will determine which goods will end up being money in a free market.)
It is of course true that Western prosperity is in part due to our having somewhat sound money, which facilitates capital formation, allows easy financial reckoning, etc.. But the idea that the size of the economy is a consequence of our fiat currency is silly. The size of the economy is a result of people producing valuable things within vast structures of capital, within a context of the rule of law. Change the amount of money and the existing capital structure, the existing law, and existing people, do not change. Rather, the value of the money will.
Controlling inflation via reserve requirements is ridiculous. The reason we have mostly static reserve requirements is because planned reserves dictate a slew of activity in banks, and if the amount of reserves held varies wildly to combat inflation from macro shocks, it will severely adversely affect time horizons for banks.
Hello,
Just letting readers know that I was the original writer of this proposal and the direct link to the article is:
http://one-salient-oversight.blogspot.com/2007/12/zero-tax-economic-system.html
To quickly explain - raising the reserve requirement is a deflationary move since it reduces the amount of money multiplied in fractional banking. Thus the inflationary effect of money created via seigniorage is cancelled out by less money being created by the banking system.
This is no free lunch - tax is removed but is replaced by higher market interest rates. Nevertheless the removal of the tax system will result in higher efficiency gains since no more tax departments, tax accountants or tax lawyers will be required in an economy.
Also note that I have put the reserve requirement on M2 and probably M3. Standard practice in the past is for the reserve requirement to apply only to M1. Thus the effect of increasing (or decreasing) the reserve requirement will be much greater than it currently is (since it only applies to M1 at present).