The Laffer Curve Constraint Upon Modern Monetary Theory

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A little thought about that Modern Monetary Theory. You know, this idea that government doesn’t actually need to tax in order to be able to spend. Instead, just print the money then spend it. The tax is the method of pulling that newly created money back out of the economy in order to prevent the resultant inflation. This only being necessary when the economy is running at full capacity.

There are certain problems with the idea. My major one is a prejudice more than anything else. For the assumption hidden in there is that we actually desire to have more government spending. That having government deciding upon the allocation of more of society’s scarce resources is a good idea. That is a necessary precondition of the idea that the nation will be made a better or richer place by having that more government spending and that’s something I simply do not agree with.

Given the way that government spending is so often value destroying I think we’ll be made richer by having less of it. Take – and please, do take it – HS2. We can show, and I have as have many others, that the finished train set will be worth less than the cost of building it. This makes us all, in aggregate, poorer. Why would we want government to have access to a funding scheme to allow them to do more of this? For that’s the political effect of MMT, to tell the politicians that they can, even should, spend as much as they want to. Bringing ever yet more of life into the orbit of government and politics.

However, to concentrate upon one specific, that Laffer Curve effect upon Modern Monetary Theory.

A central claim is that printing to spend is just great, up to when societal resources are fully employed at which point we don’t get richer by more printing, we just get inflation. This part of the theory has the merit of being true which is unusual in left wing economic arguments. The way to control that inflation is to increase the tax rate, thus pulling back into the central bank that newly created money, cancelling it, and curbing the inflation. And sure, higher taxation can reduce inflation. That’s pretty much straight Keynesian demand management, reduce the deficit (money printing is a method of financing that deficit) and thereby reduce the stimulus to the economy.

However, is there a limitation on what taxation can be? Yes, it’s an implication of the Laffer Curve, isn’t it? That there’s a tax rate which raises peak revenue, if the rate is higher than that then less revenue is collected, lower then less. Among those paying attention the Laffer Curve itself is not in dispute. Rather, it’s what is the tax rate at which the peak is reached is what is discussed.

And yet if it all really is true then that places a limit upon the tax rate that can be used to limit the inflation caused by over-enthusiastic use of MMT financing of government spending, doesn’t it? Because to try to tax more than this doesn’t result in more money being collected and cancelled, but less. That is, we don’t get to curb inflation by trying to tax over the Laffer Curve peak.

Which means that the Laffer peak is a constraint upon the ability to use MMT. Just as, exactly equal to, the Laffer peak is a constraint upon the ability to finance government spending through taxation.

Which does, rather, kill MMT as the great leap from the constraints of taxation as a funding method for government spending. Which is what the entire theory is all about after all, to try to wriggle through those constraints on how wondrous it would all be if the clipboard wielders had unlimited funding. MMT faces the same constraint taxation does, that the Laffer Curve peak renders the process ineffective. Sure, for different reasons, if it’s tax as funding we’re talking about then the peak means there is no more blood to be had from the stone, if it’s tax as an inflation killer then we can’t kill inflation by tax above the peak.

At which point that Laffer peak rate becomes wildly important once again. We can all still argue about what it is but the logic is inescapable, it’s still the limit to how much government we can have.

It’s long been said by MMT proponents that there’s nothing very new about it. Nor anything controversial, it’s just a description of reality. To which we’ve not got to add that it’s not useful either, for the end constraint is just the same. There’s a tax rate which doesn’t collect more revenue but less, which is the same tax rate that doesn’t reduce inflation.

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Jim
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Jim

The logical conclusion of the tax inflation away concept is that you need one simple tax that affects as many people as possible in as quick a manner as possible. In order to affect spending now you need to change tax rates now, not a years time when the tax year changes (which of course is just a hang over from centuries ago). So your tax system would need to be something similar to the interest rate system – which can be changed on a monthly basis. Which makes any tax other than consumption taxes pretty hard to compute. Or… Read more »

Nautical Nick
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Nautical Nick

Hmmm… I’m certainly not supporting MMT, but wonder if the mechanisms might be slightly different. Certainly there will be a Laffer curve in any attempt to curb inflation by restraining the economy by increasing taxation. It will reach a point where increases in tax no longer raise additional revenue, but further increases will slow the economy by persuading people not to undertake so much economic activity. ITSM that this would indeed curtail inflation, but at the expense of crowding out economic activity, the private sector in particular, leaving us with too much central control of economic activity. An even worse… Read more »

Phoenix44
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Phoenix44

The problem is it’s all nonsense. It treats government spending as a special class of spending that is essentially limitless but continues to prevent my spending becoming limitless because I still only get to spend what I produce. So those who value state spending simply because it is state spending gets lots of what they like, but I get the same amount of what I like. And then when they have too much of what they want, I have to have less of what I want via increased taxation. It’s not just theoretically bollocks but also massively unfair. It’s nothing… Read more »

jgh
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jgh

Even if you argue against the existance of the Laffer curve, you still then hit the contraint of 100% of all money. If your taxes are at 100% and you’re *still* not curbing inflation, there’s nothing else you can do – plus your population starves and the economy implodes as people have no money.

Spike
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Spike

Where I thought you were going with this is that there is a Laffer Curve (a point of diminishing returns) for state spending as well as taxation. Frequently in Latin America, it is impossible to “stimulate” the economy but only inspire groaning.

Separately, any collective benefit to government spending is independent of whether an individual elects to work. But liability for taxes falls only on those who choose to work (or invest). And the usual “progressive” tax falls on those who work hardest/smartest/best. The result of this pairing of complementary taxing and spending is obvious.