Economic Issues

Semantics Regarding Taxes Do Not Fund Spending

"How Congress, the Fed, and the Treasury Actually Operate. How Taxes Are Destroyed in Monetarily Sovereign Nations. Dispelling all Conspiracies and Other Unfortunate Misguided Stories." -- Steve Grumbine

QUES: "So where did the money originate from if Congress holds the purse strings? Is Congress just another Capitalist entity. I do not know of any other system where tax is not used via the government."

ANS: Congress delegated its constitutional power to "coin money" to the Fed and the Treasury. The Treasury retains the power to "coin money" in the narrow sense of actually creating coins. The US Mint performs this function for the Treasury. The Fed must order coins from the Treasury for use in the banking system and distribution to the economy. The Fed was delegated the authority to create high-powered additions to checking account balances (i.e. reserves) and to order paper money from the Treasury, which only it can issue* as Treasury Notes. The Treasury, however, retains the power to print those notes in the Bureau of Engraving and printing.

Currently, in the modern system, the Treasury only spends money into the economy that Congress has previously appropriated, mostly in the form of reserves. It adds to private balances by using keystrokes on computers that spend the reserves in its spending account.

Its spending is mandated by Congress’s appropriations. That’s what’s meant by saying that "Congress has the purse strings." 

The way Treasury actually gets the money to spend when the balances in its spending account are getting low is that it either waits for the Fed to credit its account in the normal course of its business or it follows certain rules and procedures to make requests from the Fed. If the Treasury follows its legal procedures and rules, and the Fed also follows its own rules and procedures based on legislation and the US code then the Fed is a passive actor in this process in the sense that it has no choice about whether to fill Treasury’s account or not as long as both follow long-standing rules and procedures.

So to answer your direct question, the reserves that are spent to fulfill appropriations are created by the Federal Reserve through its marking up Treasury accounts with high-powered reserves using its authority derived from the Congress. Tax revenues do not directly impact this process. All that is directly involved is: 

(1) Congress’s appropriation;

(2) Treasury’s collaborating with the Fed to mark up its spending  account;

(3) the Fed marking up the Treasury spending account, and

(4) Treasury spending what Congress has directed it to spend into the economy.

The taxes you and I pay to Treasury are important because they drain money from the economy, thus constraining the development of demand-pull inflation, and also aiding the Fed in its goal of maintaining its target overnight Federal Funds, which most other interest rates are pegged to. However, this draining of money from the economy is not directly involved in the funding process, so it doesn’t “fund” or “finance” federal spending. It cannot do that because our tax money is actually destroyed during the Fed’s banking processes and the money involved never reaches the Treasury spending account, which is filled only with reserves newly-created by the Fed.

The facts of this matter are documented by Professor Stephanie Kelton, in this article and are depicted in my graphic below.

On: “I do not know of any other system where tax is not used via the government.” I can only say that the process I’ve outlined for you is not restricted to the US, but that the general process goes on in a number of monetarily sovereign nations including the UK, Australia, NZ, Japan, Canada, and a number of others around the world. These nations can never have issues of government solvency because each can issue its own money in whatever it desires. Spending too much of what it creates can present serious problems, such as inflation or a variety of other bad effects if they spend on the wrong things. However, again, these nations cannot be forced into insolvency by external economic or financial constraints giving them deficit spending policy space other nations do not have.

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