Labour Needs To Tell The Truth About Tax

If the UK has another general election this year (or next) Jeremy Corbyn’s Labour Party will lose. Again.

In their euphoria at outperforming everyone’s expectations in the election just past Mr Corbyn and his merry crew appear to have overlooked the fact that they polled the best part of a million votes fewer than the Tories and fell 66 seats short of a majority in parliament.

Closing that gap will not be easy. Much of Labour’s success on June 8th can be ascribed to complacency on the part of the Conservative Party and a terrible performance by its woefully inept leader. Labour will not have such an easy ride next time around.

Voters are sick of austerity, are warming to Mr Corbyn, and they like a lot of what was in the Labour manifesto. They see the consequences of cuts to public services and they want it to stop but the persistent whine of the Tory spin machine  – “we have to live within our means” – tells them that it can’t be done.

Labour’s promises are “unrealistic” because the economy can’t cope with any more taxation, and government debt is “unsustainable”, is how the story goes.

This is the argument that underpins the logic of austerity. It’s the argument that will lose the next election for Labour and condemn us all to another five years (at least) of economic stagnation and crumbling public services unless politicians, academics and journalists step up and tell the truth about money, tax, and government borrowing.

We grow up being told that government spending is funded by “our taxes”, which means that by the time we’re aware of paying tax we’re already disposed to the idea that the government should spend as little as possible.

We’re also led to believe that government shouldn’t spend more than it collects as tax because otherwise the government must borrow money which is a very bad thing, morally and economically.

We all want good public services but our popular understanding of how government is funded is constantly telling us that, for one reason or another, “we can’t afford it”. Thankfully this popular understanding is a heap of mince.

In reality the government can spend as much money as it likes whenever it likes. We’re told that this ability to make unlimited payments takes the form of an overdraft facility at the Bank of England but this is just another helping of mince. The money that the government spends is created out of thin air by the Bank of England. It can do this because sterling is a sovereign currency which is under government control.

Tax and spend is an obfuscation, and an inversion. When the government spends it creates new money and distributes it into the economy. When we pay our taxes the government removes money from the economy and destroys it. The spend comes before the tax: creation before destruction.

Government borrowing is another way for government to remove money from the economy. Again there is a pretence that this borrowed money gets spent on public services and then, when the loan expires, money is collected as taxes and repaid to the lenders. A more accurate interpretation is that when an investor buys a government bond the money is destroyed, and when the bond matures the government creates money to repay the lender along with the interest due.

So the purpose of taxation and government borrowing is not to fund public services but to help maintain the value of the currency by removing money from circulation.

The reality of government spending being funded by money creation rather than taxation means that Labour’s public spending proposals are, self-evidently, affordable. There never was, never is, and never will be any shortage of money.

Our question, as a responsible electorate, should be about the amount of money a Labour government would destroy via taxation and borrowing to maintain the value of the currency.

In this respect Labour appears to be trying to play the game. It proposes increasing taxation on the incomes of the highest earners and corporations, and by collecting tax that is currently evaded and avoided. It’s also proposing to continue to borrow money every year.

Because the actual revenue raised from taxation is difficult to predict it’s hard to say if the amount of extra money that Labour proposes to create (spend) matches the amount that it proposes to destroy with extra tax and borrowing but, regardless of how the sums work out, there is a strong argument to say that the economy can withstand the addition of a lot more money without causing devaluation of the currency.

The Bank of England’s interest rate is close to zero. The purpose of setting the rate so low is to encourage people who have spare money to invest it in some sort of productive enterprise – to take money that’s currently lying idle and spend it into the economy. But investment remains sluggish (or non-existent), wages are stagnant, and the forecasts for the UK economy are universally gloomy. The interest rate tool is obviously not up to the job.

If the private sector refuses to be stimulated by interest rates close to zero then the government can provide an economic boost by increasing money creation (spending) without increasing money destruction (tax and borrowing).

In fact, it would make economic sense, in the short term at least, to restore funding for public services to pre-2010 levels and cut some of the taxes that inhibit private enterprise. National Insurance (a tax on jobs) and VAT (a tax on commerce) are obvious targets. All three of these things would increase the availability and mobility of money, which is what an economy needs in order to thrive.

The proposition of spending increases and tax cuts would provoke howls of protest from the right-wing press but Labour – if it chose to break ranks with the establishment and tell the truth about tax and borrowing – would have a logical and compelling response to anything that the economically illiterate tabloids could throw.

The middle ground of UK politics is looking a bit lost right now, stuck between what it sees as idealistic clowns on the left and nationalistic jokers on the right. In the absence of something more compelling it will resign itself to the grim (fallacious) responsibility of “living within our means” and vote, reluctantly, Tory.

If Labour wants to win the next election it has to look right as well as left and grab the attention of those stuck in the middle. It has to explain how public finances actually work and present a logical set of proposals for rescuing the economy – especially private enterprise – from the hole that has been dug for it by the slack-brained austerity-pedallers.

Compassion and integrity are not enough. Anti-austerity rhetoric is not enough. Labour needs to show that it understands how the productive economy works and what can be done to help it to thrive. If Labour activists want to turn austerity into prosperity the first thing they have to do is tell the truth about tax. When the electorate gets that message everything else will be easy.



4 thoughts on “Labour Needs To Tell The Truth About Tax

  1. “[…]there is a strong argument to say that the economy can withstand the addition of a lot more money without causing devaluation of the currency”.

    Malcolm, could you humour my sluggish and uneducated economic brain, and briefly spell out a bit more explicitly what that argument is? I feel intuitively that your way of looking at the money system is true and could help to unlock a lot of society’s dilemmas. But I confess I am still not clear why adding money in current conditions would not devalue it. And it is the objection which opponents immediately raise.

  2. Matthew, fear of the inflation (devaluation) bogeyman is a hard thing to shake off, especially for those of us who lived through the 1970s, but all of the conventional indicators suggest that there is a shortage of money flowing round the economy. Interest rates have been close to zero for years. Wages are stagnant or shrinking in real terms. Financial wealth is being concentrated in fewer hands (which means less of it gets spent into the productive economy).

    We also have two massive black holes in our economic system that are capable of absorbing huge volume of money, sucking it out of circulation.

    1. Private debt is gargantuan in quantity. When the principal of a loan is repaid the money is destroyed. Up until 2007/08 this money was (more than) replaced by the issuing of more debt but since the credit crunch the reduction in lending has reduced the amount of new money being spent into the economy.

    2. Our appetite for storing wealth in the form of money is insatiable. Corporations and individuals are sitting on mountainous piles of cash reserves and will happily add to these whenever they get the opportunity. Much of this cash is used to gamble on financial markets which inflates the prices of financial assets but not real stuff in the real productive economy.

    So any money created by government to do useful stuff will quickly be destroyed/absorbed by debt repayment, hoarding, and taxation.

    I will try to find time to write an article about the inflation bogeyman. It is, as you say, the biggest obstacle in the argument against austerity.

  3. Pingback: The Armchair Inflation Fallacy | Views From The Boatshed

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