An open let­ter to Brus­sels

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The Euro­pean Sta­bil­ity and Growth Pact is based on the prin­ci­ple that sta­bil­ity and growth are enhanced when gov­ern­ment deficits are either min­imised or elim­i­nated. I want you to dis­pas­sion­ately con­sider an argu­ment that reaches a dif­fer­ent con­clu­sion. It may sound like some­thing you have heard before from oth­ers and already dis­missed. But bear with me.

When con­sid­ered from a strictly mon­e­tary point of view, an econ­omy can be regarded as hav­ing five major sec­tors: house­holds, firms, the gov­ern­ment, the banks, and the exter­nal sec­tor. To focus on money flows, I will diverge from main­stream eco­nomic the­ory by treat­ing house­holds as con­sist­ing exclu­sively of work­ers, while I will com­bine firms and their own­ers into the firm sec­tor, and do like­wise with banks and their own­ers. I also treat the cen­tral bank as part of the gov­ern­ment sec­tor, and I ignore cap­i­tal and income flows between nations in this sim­ple expo­si­tion.

Nei­ther house­holds nor firms can pro­duce money, while the other three sec­tors are poten­tial sources of money. As is now well known (though this fact is still con­tested by aca­d­e­mic econ­o­mists), banks cre­ate money by mak­ing loans:

When­ever a bank makes a loan, it simul­ta­ne­ously cre­ates a match­ing deposit in the borrower’s bank account, thereby cre­at­ing new money. (Bank of Eng­land Quar­terly Report 2014 Q1Money cre­ation in the mod­ern econ­omy.)

Gov­ern­ments can also cre­ate money by run­ning a deficit (if it is financed by the cen­tral bank, or by bonds sold to banks in return for excess reserves). Money can also be cre­ated by run­ning a bal­ance of pay­ments sur­plus (which in this sim­ple expo­si­tion is exclu­sively a bal­ance of trade sur­plus).

In order to sim­plify my argu­ment, I will assume that

  • Gov­ern­ment spend­ing goes exclu­sively to firms;
  • Taxes are paid exclu­sively by firms;
  • Only firms bor­row money from banks;
  • Banks charge inter­est on loans but do not pay inter­est on deposits;
  • Only firms trade with the exter­nal sec­tor, sell­ing goods as exports and buy­ing goods as imports;
  • Ini­tially, the exter­nal sec­tor is in bal­ance so that exports equal imports; and
  • Ini­tially, the gov­ern­ment sec­tor is in bal­ance so that gov­ern­ment spend­ing equals tax­a­tion

These assump­tions lead to the pat­tern of mon­e­tary flows shown in Table 1.

Table 1: Basic mon­e­tary flows

Graph for Europe takes a battering for Brussels' stability and growth delusions

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • Derek R

    This is straight­for­ward com­mon­sense. Why does it seem so hard for peo­ple to under­stand?

  • Steve Hum­mel

    The fly in the oint­ment is house­hold sec­tor will not run a macro-eco­nomic sur­plus, ever, with­out a con­tin­ual, direct and tax free sup­ple­ment to indi­vid­ual incomes. I’ll get to that shortly. You are com­pletely right that table 8 is a long way off from real­ity for every nation on the planet. The key is to make the sup­ple­ment to indi­vid­ual incomes cre­ate a con­comi­tant reduc­tion in total money cre­ation by Banks. They will still be able to be prof­itable with this sit­u­a­tion and may not like it, but then they have every right to exist, but no right to dom­i­nate or manip­u­late mon­e­tary or eco­nomic pol­icy. This should be obvi­ous. That it isn’t is amaz­ing in and of itself. 

    Gov­ern­ments run­ning per­pet­ual deficits is also an even­tu­ally prob­lem­atic eco­nomic sit­u­a­tion as well as the all too preva­lent and clear crony­is­tic cor­po­rate wel­fare prob­lem, and polit­i­cally syco­phan­tic ten­den­cies of polit­i­cal lead­ers also makes such a desta­bi­liz­ing and bloat­ing prob­lem. How­ever, a uni­ver­sal div­i­dend and a rebated back to mer­chants dis­count on prices would have great sta­bi­liz­ing effects on both the busi­ness cli­mate, and make large bureau­cra­cies able to be eas­ily elim­i­nated because unem­ploy­ment insur­ance, wel­fare and even even­tu­ally Social Secu­rity taxes com­pletely redun­dant.

    Here is a post I just hap­pened to make to Mish Shedlock’s blog where I’m ignored almost as much as I am here that explains why the house­hold sec­tor will never run a sur­plus, and in fact has in actual fact run a con­tin­ual macro-eco­nomic deficit…for like sev­eral cen­turies that is obscured largely by Banks con­tin­u­ally build­ing up debt and to a lesser degree gov­ern­ments run­ning deficits:

    http://globaleconomicanalysis.blogspot.com/2014/06/what-effect-would-substantial-hike-in.html?#echocomments

    If you imple­mented a dis­count on retail prices gen­er­ally that was based on the for­mula of the total cost of what was pur­chased in a given period of time (or con­tin­u­ally and daily which would not be beyond our cur­rent cyber capa­bil­i­ties) over the total cost of pro­duc­tion in the same period of time, and then rebated back to par­tic­i­pat­ing mer­chants the entirety of their dis­counts to consumers…it would com­pletely elim­i­nate infla­tion. Retail sale to an indi­vid­ual is where the con­sumer cost­ing sys­tem ter­mi­nally is summed and ends. The addi­tional money in cir­cu­la­tion would have no infla­tion­ary effect because of the dis­count being at retail sale. What it would do is enable busi­nesses to enjoy a per­ma­nently good busi­ness envi­ron­ment while mak­ing more profit and hence need­ing to bor­row less in order to re-invest in their busi­nesses. The macro-eco­nomic effect of this would be much less need to con­tin­u­ously borrow/create as much money as we do now and hence reduc­ing any mon­e­tary infla­tion as well. Money recir­cu­lat­ing in the econ­omy actu­ally adds not a sin­gle ADDITIONAL dol­lar of INDIVIDUAL income because re-cir­cu­lat­ing money imme­di­ately becomes busi­ness rev­enue from which on aver­age 80–99% must be used to pay the ongo­ing costs of busi­ness. Yes, indi­vid­ual incomes are a part of those costs, but as I said not a sin­gle ADDITIONAL dol­lar of indi­vid­ual income is pro­duced by re-cir­cu­lat­ing money. Does a pro­ducer who makes $10,000 profit in a month where he was only mak­ing $4000–5000/ imme­di­ately give every­one a raise? Of course not. In fact today he’s as likely to auto­mate pro­duc­tion or move pro­duc­tion over­seas and pay the help $.30/hr instead of 8, 10 or $15/hr.
    Of course nowa­days, for every enter­prise, labor costs are only an accel­er­at­ingly smaller frac­tion of total busi­ness costs and hence this means that the ele­men­tal mon­e­tary and macro-eco­nomic costs (and hence even min­i­mal prices) in the econ­omy will increase at a higher rate of flow than the rate of flow of INDIVIDUAL incomes. This is why an indi­vid­ual div­i­dend GIVEN to each cit­i­zen 18 years and older would solve this ele­men­tal, empir­i­cal problem…because a gift of money (as opposed to an increase in min­i­mum wage) would not add any addi­tional costs to the sys­tem and hence would not be infla­tion­ary in any way. Then, as per above, the dis­count mech­a­nism reduces prices even fur­ther with the result­ing elim­i­na­tion of retail price infla­tion and the diminu­tion of mon­e­tary infla­tion as well. 

    Of course lib­er­tar­i­ans will want to claim (irra­tionally) that cen­tral plan­ning is part and par­cel of the prob­lem, and with­out the above mon­e­tary and eco­nomic POLICY mech­a­nisms they would be mostly right, but the salient point in the above is that the pol­icy EFFECTS of these mech­a­nisms is INDIVIDUAL eco­nomic freedom.…precisely what lib­er­tar­i­ans SAY they are advo­cat­ing. If the pol­icy cre­ates indi­vid­ual eco­nomic freedom…individual eco­nomic freedom…is what is accom­plished. That’s logic, as in A = A.

    Puri­tans will likely pipe up with the ter­ri­ble­ness of giv­ing other peo­ple money(not them­selves of course because they are supe­rior to oth­ers), but that in actual fact is con­trary to the ACTUAL evi­dence. Free­dom will beget more free­dom. That is the law of align­ment of phi­los­o­phy and pol­icy, and also of hav­ing less cog­ni­tive dis­so­nance with free­dom. You might see a tem­po­rary uptick in idi­ot­i­cally ado­les­cent behav­ior on the part of adults as a result of such a pol­icy, but that would be rel­a­tively rapidly adapted to and the real and free­ing effects of a pol­icy of a uni­ver­sal div­i­dend would be exactly as I and the laws of align­ment and less cog­ni­tive dis­so­nance sow in experiments.…more free­dom and the bless­ing thereof.

  • Bhaskara II

    RE: Taxes are paid exclu­sively by firms.

    I beg to dif­fer. Some one wise told me that peo­ple pay the most taxes and enti­ties pass the taxes to peo­ple.

    Ques­tion: Is the tax on your labor a gross tax or a net tax? Remem­ber money isn´t the only valu­able thing. You give up your time and exper­tise (expense) in return for pay (pre­tax rev­enue.)

    So, I real­ize to you, pro­fes­sor keen, your time is actu­ally price­less. So, lets say one week you can get pro­fes­sor Dirk J. Beze­mer to teach your classes and you pay him 90% of what you get. So, in this trans­ac­tion gross is 100% of your pay and pre­tax net is 10% of your pay. But, the taxes are on gross 100% of pay.

    Cor­po­ra­tions pay taxes on net not gross like indi­vid­u­als. Net is roughly, rev­enue — expenses — depre­ci­a­tion. Cor­po­ra­tions in gen­eral are bet­ter accoun­tants than most indi­vid­u­als. Why is that?

    Do eco­nom­ics pro­fe­sors get a tax break? 

    Data:
    http://factfinder2.census.gov/faces/tableservices/jsf/pages/productview.xhtml?src=bkmk

    State Gov­ern­ment Tax Col­lec­tions: 2013
    2013 Annual Sur­vey of State Gov­ern­ment Tax Col­lec­tions

    Of the many state leve taxes the two lines stand out:
    The United States Col­umn data are as folows:

    Indi­vid­ual Income Taxes 309,637,223 (in thou­sands)
    Cor­po­ra­tion Net Income Taxes: 45,021,252

    State Indi­vid­ual income tax is 6.9 times that of Cor­po­ra­tion NET Income Taxes. Wow.

  • Bhaskara II

    Many pub­licly traded large cor­per­a­tions profit is less than 10%. So if those are taxed at 40% of profit, then the tax is 4% of gross.

  • Bhaskara II

    By the way those MMT, peo­ple I have read, never count your time and stuff, real wealth.

    They are enam­ered with only finan­cial assets and lia­bil­i­ties.

  • Bhaskara II

    More Data com­par­ing cor­po­rate tax to employ­ees and or per­sonal tax:

    http://www.federalreserve.gov/releases/z1/Current/Coded/coded.pdf
    Flow of Funds table F.7 Dis­tri­b­u­tion of National Income:
    in 2013 we have the fol­low­ing vari­ables:
    EC=8859 line 2 Com­pen­sa­tion of employ­ees (bil­lions $)
    CT= 418.9 line line 13 Taxes on Cor­po­rate Income.
    ET={0.45,0.33, 0.20 } Imputed employee rate of taxes paid
    I do not think IVA or sales taxes are included in these num­bers.

    REC=Ratio of Employee tax to cor­po­rate tax = EC*ET/CT

    REC(ET=0.45)=9.5 times cor­po­rate tax paid
    REC(ET=0.33)=7.0
    REC(ET=0.20)=4.2