The magic money tree is real: Treasury confirms taxes are not needed to fund government spending

Richard Murphy: “What we actually have here is…an admission that the government can create money at will. So the 'magic money tree' exists, as a matter of fact.”

A LETTER from the Economic Secretary of the Treasury has confirmed that the government does not need to raise money from taxation to fund government spending, leading to advocates of increased public investment to declare “the magic money tree exists, as a matter of fact”.

‘The Magic Money Tree’  is a phrase used to justify austerity and to criticise policies which seek to increase public spending. It was widely used by Conservative politicians, including Prime Minister Theresa May, during the 2016 General Election to counter the Labour Party’s manifesto commitments, which included plans for a £500bn increase in capital investment from the public sector.

The argument goes that the government can only spend what it has raised in taxation, with any additional financing having to be raised through debt from financial markets which subsequently has to be repaid. Former Prime Minister Margaret Thatcher famously said “The government has no money of its own. It’s all your money.”

But Treasury secretary John Glen’s 18 July reply to Peter May, a Modern Monetary Theory (MMT) advocate who had written to his MP Ben Bradshaw last year to inquire of the Chancellor as to where money came from, was in contrast to Thatcher’s position.

Glen answered: “While it is theoretically possible for monetary authorities to finance fiscal deficits through the creation of money, allowing governments to increase spending or reduce taxation, without raising corresponding financing from the private sector, there is a risk that money financing could rapidly undermine the stability of inflation expectations.”

The ability of government’s to create new money and spend it into the economy has received increased attention since the policy of quantitative easing (QE) was introduced in 2010 by the Bank of England. QE has seen £375 billion of new money created to buy up government bonds from commercial banks, increasing bank liquidity with the stated purpose of stimulating economic activity, but which the BoE accepts has had the effect of generating rising wealthy inequality and re-inflating asset bubbles.

In total, over $12 trillion of new money has been created in in the global economy since 2010 through QE.

Tax economist professor Richard Murphy, who has popularised the idea of People’s QE, where new government money creation is used on public investment projects to boost the non-financial economy which has laboured under austerity, welcomed the Treasury’s “admission” on his blog.

“This is important,” he said. “What we actually have here is…an admission that the government can create money at will. So the 'magic money tree' exists, as a matter of fact.”

The emphasis in Glen’s letter on preventing runaway inflation as an argument against increased spending through new money creation was picked up on by Murphy, who said the Treasury does not appear to have recognised (or been willing to state) that such excessive inflation can be reined in through tax policy, which he argues is its real purpose, rather than to finance government spending.

“What we have not got is an admission on the role of tax in this equation,” Murphy said. “What that suggests is that the role of tax in controlling inflation has to be the next argument brought to the Treasury's attention.”

REPORT: A Scottish Tax System – Imagining the Future

Murphy, a professor at City of London university specialising in taxation, advocated similar ideas in a paper for the Common Weal think-tank on tax policy in an independent Scotland.

In the paper, Murphy argues for an entirely new approach to fiscal policy based on ‘spend then tax’, rather than the traditional concept of tax then spend, which as long as an independent Scotland had its own currency would allow the government to utilise its monetary power to maximise the resources of the Scottish economy and labour force, with the only restriction being its ability to rein in inflation using tax policy.

Explaining the importance of the spend then tax approach to the independence project, Murphy wrote: “What it demands is that Scotland must have its own currency from the day it becomes independent. This is, of course, the sovereign right of any state. But it is not just a right: it is only by exercising this right that Scotland can be truly independent of any other country”

He continues: “If a country has its own currency then there is technically no limit to what a government can achieve. There are, however, two practical constraints. The first is that the government does not try to create more economic activity than the economy can deliver. To put that another way, they must not try to create more than full employment because that is not possible. And the second is that they must tax sufficiently to cancel enough of the money that the government has created through its spending to ensure that its inflation targets are met.”

READ MORE: Australian economist reviews Growth Commission: ‘Not conducive to the creation of a vibrant, progressive nation’

The City of London Professor was sharply critical of the SNP’s Growth Commission report on the economics of independence published at the end of May, which emphasised tight fiscal constraints which Murphy and others have described as an austerity policy, and advocated use of pound Sterling outwith a formal arrangement with the Bank of England for at least 10 years. He described the report as a “disaster” for the independence project.

Murphy, former SNP MP and economist George Kerevan and Australian economist Bill Mitchell have all argued that the Commission pays little attention to the effect its policy of fiscal consolidation will have on increasing deficits in the private sector, with the potential for both increased consumer and business saving rather than investment (reducing economic activity) and increases in the level of the private debt burden. Private debt in the UK is over 160 per cent of GDP and rising, significantly higher than the prospective public debt of an independent Scotland. As economist Jo Mitchell has found analysing UK Government austerity, “for every £2 billion in public sector deficit reduction, the annual rate at which households have taken on new debt has increased by £1 billion”.

Knowledge of how money created is low, including among the UK’s political class. A survey by Positive Money before the 2017 General Election found that 85 per cent of MPs were unaware that commercial banks created new money every time they issued a loan, while 70 per cent believed only the government had the power to issue new money, despite over 97 per cent of money being created by private banks. MPs have never debated the BoE’s QE policy in the House of Commons.

Picture courtesy of Howard Lake