Economic Issues

The Operational Reason Why Federal Taxes are Not Revenue for the Federal Government

Operationally, it is impossible for the federal government to spend the proceeds of tax collections. Since this is a major topic of interest for laypersons, I’m going to explain operationally why your dollars paid in federal taxes are not spent by the federal government on anything.

There are measures of the so-called ‘stock of money’ in the economy.

M1 is cash and coin and checking accounts.

M2 is M1 plus savings accounts, and things like mutual funds and other time deposits.

Good so far? Great. Now we will go a bit deeper.

The US Treasury has an account from which it spends. This account is just a spreadsheet containing numbers. It is held at the Federal reserve but sits outside of the banking system. Nothing in this account is part of the stock of money. The reason for this is because in order for the numbers on the spreadsheet to become actual spendable dollars that make up the stock of money, they first must be injected by the government into the economy. The federal government injects the numbers into the economy by crediting individual bank accounts. Once the federal government credits individual bank accounts, what it credited to those accounts then becomes part of M1 or M2. What it spent is called High Powered Money (HPM), which is ‘government money’ and it is injected into reserve accounts held at the Federal Reserve. Only the federal government can create HPM.

Good so far? Fine. Now let’s dig even deeper.

Reserves held in reserve accounts at the Federal Reserve and all Federal Reserve Notes are central bank liabilities. So, when the government spends, its creating liabilities and those liabilities enter the economy winding up in the hands of people who spend them on goods and services. To cancel those liabilities, the currency must return to the federal government. How does the federal government ensure that the currency returns to the government so that it can cancel its liabilities?

Federal taxation.

When the government spent the central bank liabilities into the economy, some of them wound up in your hands either directly from the government or by income, gift, or some other means. When the federal government taxes you, it is placing a tax liability upon you. You settle your tax liability to the federal government by giving the federal government its liability (currency) back. Both your tax liability and the government’s liability are then cancelled. More simply, the US dollar is a tax credit. Once you use the credit to settle your federal tax liability, the liability and the credit are annihilated. They are cancelled. In other words, reserves and Federal Reserve Notes are nothing more than a promise on the part of the federal government to take back its own liability (currency) in exchange for settling any federal tax liabilities the federal government imposes on you. Since the federal government promises only to accept its liability (currency) to settle federal tax liabilities placed upon you and nothing else (gold, goats, chickens, weeds, small rocks, clay pottery), this is why you demand US dollars (the federal government’s liability) and why everyone uses US dollars to buy goods and services, and why goods and services are not for sale priced in gold, goats, chickens, weeds, small rocks, and clay pottery.

Doing alright? Great. If not, don’t panic. Just re-read the previous section until you understand it.

And now finally, why the dollars paid to the federal government are not revenue for the government to spend, or in other words, why you do not fund the federal government, but the federal government funds you.

Recall what we discussed in the beginning about the US Treasury’s account:

The US Treasury has an account from which it spends. This account is just a spreadsheet containing numbers. It is held at the Federal reserve but sits outside of the banking system. Nothing in this account is part of the stock of money. The reason for this is because in order for the numbers on the spreadsheet to become actual spendable dollars that make up the stock of money, they first must be injected by the government into the economy. The federal government injects the numbers into the economy by crediting individual bank accounts. Once the federal government credits individual bank accounts, what it credited to those accounts then becomes part of M1 or M2. What it spent is called High Powered Money (HPM), which is ‘government money’ and it is injected into reserve accounts held at the Federal Reserve.. Only the federal government can create HPM.

Let’s say that you use your checking account to pay your federal taxes. When you do this, the numbers in your checking account drop by the amount paid in federal taxes and are not transferred to any other entity within the banking system.

Thus, since federal taxation is not a transfer of money within the banking system, but rather, it is a removal of money from the banking system altogether, the money in your checking account is deleted from the banking system, and M1 is destroyed because of that.

Again - The ‘money’ in your checking account comprising M1 that was used to pay taxes was destroyed and now no longer exists as part of the stock of money.

HPM in a reserve account at the Federal Reserve is now deleted from the reserve account to settle the tax liability, because HPM is the only thing that will settle it. The US Treasury’s spending account, the contents of which are not part of the stock of money in the economy, is credited and so, the tax liability is settled and the HPM used to settle the tax liability is also destroyed.

The federal government simply cannot finance its spending operations with ‘money’ it has destroyed. In other words, the only possible way for the federal government to fund anything, whether it be universal healthcare, a job guarantee, the military or anything else, is by literally spending into existence the dollars required to fund these things.

And so, the notion that the federal government has no money of its own and must rely on taxpayers to give it some dollars, or that it must go out hat in hand borrowing dollars from private entities and other nations in order to afford to spend, is, operationally, an impossible condition.

All federal spending is dollar creation. All federal taxation is dollar destruction.

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