Rules were meant to be broken
The budget. Performative theatre. Either a £22 billion blackhole left by the previous government and hidden from the OBR, or fiscal rule fiddling and unprecedented taxing, borrowing, and spending. The truth is, neither of those things.
The budget's public service focus was really about the NHS and schools, but transport at least got a mention. For rail, the TPE upgrade, East West Rail, funding to begin the tunnelling to Euston (carefully worded), some pothole money for roads, and a bit more for the Metro Mayors. But nothing about HS2 north of Birmingham, nothing about Euston itself, and no meaningful carbon-reductive electrification programme (electrifying Wigan to Bolton and parts of East West Rail is unlikely to get us to net zero while continuing to freeze fuel duty and
putting rail fares up).
Rachel Reeves had previously said, 'if we cannot afford it, we cannot do it'. She could afford what she did promise by way of a £40 billion tax hike, mostly from employer's national insurance contributions, but also by changing her fiscal rules that serve to define what's affordable.
Before the election, Reeves's fiscal rules were the same as the Tory fiscal rules. They, she said, were immutable, like gravity or the strong nuclear force. But she somehow defied the laws of physics to break one of them after the election, changing the basis on which national debt was calculated. It would allow her to include more government assets in the calculation, giving Reeves at least another £50 billion of spending power, not all of which she has deployed immediately.
But she has kept other fiscal rules which she said would become the 'rock of stability at the core of [her] Budget'. One, that the national debt must be falling as a proportion of GDP by the end of this parliament. The other, that day-to-day government spending must be covered by tax revenues.
The truth is, Labour's mission to invest in public services, including in transport, is neither constrained by a public finance blackhole, nor funded by an unprecedented tax hike. What it is constrained by, is the very notion of public money, and her remaining, arbitrary, fiscal rules (just as that same notion and those same rules did in relation to public services under the previous government), because together, these limit investment to the political cycle rather than the economic one.
If we actually had a proper understanding of the nature of public money and how the government acquires it, we would not only be able to avoid all the political am-dram, but maybe get some public services which truly meet our needs.
We are told the government is like a household
The Guardian published an article at the start of April last year entitled, 'Outdated and misleading: is it time to reassess the very concept of money?', based on an extract from Stuart Kells' book. In the article, Kells talked about the widespread misunderstanding of money and how this misunderstanding is not peripheral or inconsequential, driving how well (or not) citizens hold their governments to account. Let's take Reeves's controversial £22 billion blackhole as an example of this misunderstanding.
We all understand the idea Reeves sells us, that government is just like a household, in constant need of an income, financially constrained. If it overdoes it with the credit card, there will be a reckoning. It is saleable because it is our lived experience.
We are asked to believe that the income Reeves bases her spending plans on (indeed all
Chancellors base their spending plans on) comes from us. The notion being that:
- a government cannot spend anything into society (on us) until it has first received the money from society (us again), mostly through taxation;
- if government does not take in enough taxation to fund its spending, it has to borrow, again from society (yes, us too); and
- once government finally spends into the economy using our money, this allows society (still us) to earn enough of it back to either be taxed or borrowed from all over again.
An eternal spin cycle. The original money laundering if you will. As Kells puts it, it is 'the idea of money continually circulating...in a closed system'. This idea feeds the narrative that there is only so much public money to go round, hence the blackhole, which then justifies the tax rises, the rule changes, and more borrowing.
But that blackhole (in fact, a combination of a failure by the previous government to report all ministerial budget spending (about £9.5 billion) and a failure by the new government to explain that the rest is some of its new spending) is as empty an idea as the hole itself. That is to say, there is no blackhole because public money does not come from taxation or borrowing. I'll say that again. Public money does not come from taxation or borrowing.
Only when you look at the actual mechanics of government funding and accounting, do you realise where it does come from (1)
The real mechanics of government spending and accounting
The government does not store tax receipts in, or wheelbarrow out withdrawals from, a vault at the Bank of England. Instead, the government maintains on a server somewhere, something called the Consolidated Fund – a giant spreadsheet – a record of account of all government revenues (such as tax) and expenditures (such as public service spending).
When you pay your tax to HMRC, other than a record of it being made in the Consolidated Fund, that money is actually extinguished. As Kells describes it, that tax money is 'vaporised'. Except for the record it ever existed, that money disappears into thin air, which is also out of what it is created.
So, in what must be one of the great modern ironies, taxpayer's money stops being taxpayer's money the moment the taxpayer pays his/her taxes to the government. For this reason, we should really stop using the term 'taxpayer's money' when we talk about public money. When public money is spent, there is never any cost to the taxpayer. At the very best, you might say 'taxpayer's money' is a proxy for ensuring value for money.
When the government wants to spend – invest in the public services Reeves wants to invest in, say – provided doing so is authorised by Parliament (there is a law allowing the spending), a debit record is made in the Consolidated Fund, but there is no actual withdrawal. Instead, the Treasury orders the Bank of England to credit relevant accounts it holds with commercial banks for on-payment to pay for the stuff being invested in.
In other words, when public money is to be spent, it is created just like the words in this article, by tapping away at a keyboard. And just like the words in this article, as far as money is concerned, there's plenty more where that came from. An unlimited amount in fact. The government doesn't need our money at all for spending. In fact, the government spending has to come before the taxation, as the money has to be in the economy in the first place to then tax it away.
So, if the commonly understood view of taxing and spending is the same money in a washing machine on a spin cycle, the truth is closer to a running bath: the money pours from the government's tap into the bath (the economy) to eventually disappear down the plughole forever when the government taxes it back.
Equally fallacious is the idea that if tax doesn't pay for stuff, then borrowing must. It isn't borrowing at all. Why would a government that has the legal authority from Parliament to credit accounts for all of its spending (to create money from thin air, to print money if you prefer) need to borrow?
Issuing bonds, or gilts, is simply a means of exchanging cash or bank reserves for an IOU equal to that cash plus some interest. The original true purpose of issuing bonds was as a means of managing interest rates, but since the government decided to pay interest on Bank of England reserves about 15 years ago, it doesn't even perform that function now. The sole remaining function of issuing bonds these days appears to be to offer a relatively safe government investment scheme for pension funds, institutional investors and our trading partners. The government could decide to stop issuing government paper tomorrow if it wished.
Because of the misconception that Reeves is spending our money, or borrowing it, she has to incur unnecessary opprobrium raising taxes and 'borrowing' more, while at the same time falling short on making truly game-changing investment in our public services.
Nothing can be said to be certain, except death and taxes
The orthodoxy about taxation and public money is so indoctrinated, I'm sure many in political life and the media parrot it without thinking. But I'm sure enough of them know the truth while maintaining the pretence.
Ultimately, perhaps politicians believe if it is understood taxation does not pay for public spending, then the public will just demand the earth, and perhaps more dangerously, even question the need for taxation at all.
But let's get another thing straight. Taxation is important. Essential. Taxation drives demand for the currency (you can't pay your taxes in cryptocurrency, Tesco vouchers or buttons, only Sterling), and so this puts value in our pocket. It regulates inflation and behaviours, and at least used to, and so could again, prevent wealth inequality and undue political influence. So Franklin's famous saying about death and taxes still holds.
None of this is to suggest there is a blank cheque either. There must be natural, human and other resources available to spend public money on, as too much spending chasing too few resources will drive inflation. And our reliance on imports, and how our economy and currency is perceived, do indeed place a constraint on our fiscal headroom which cannot be discounted (just ask Liz Truss).
When government accounting realities are revealed to people, their minds literally break. It does not compute. It simply cannot be true because it is a law of nature that governments need our money to spend. Economists, including those who publicly acknowledge that this is not true, seem to become preoccupied in curves, models and impenetrable economese discussing the consequences of government accounting reality, rather than considering whether it might first be important for the general public to know where money actually
comes from, and why they are really taxed.
Because, if enough people understood that public money comes from thin air and not taxes, it should turn all the dialogue about public money on its head. Not only should it create legitimate questions about what we tax, and how much, as well as what we pay for, but it should also move us away from the interminable ideological delusion that there is not enough money, which drives the twin blights of needing to play Robin Hood, and the haves thinking they are paying for the have nots. That sophistry pervades all political thinking – sophistry which has had an oversized impact on our voting choices in recent history perhaps more than in any other time. Indeed, 40 or so years of taxing the wrong people and income, not wealth (not just here, but globally) has created a sense of failing politics, governments, and even democracy itself. Putting up tax on national insurance contributions and inheritance tax on agricultural land isn't going to move the needle on that disaffection.
The remarkable mobilisation of public money during COVID, and the almost universal digitalisation of cash, has started to reveal something of the truth about money, and by extension, public finances. But for now, when it comes to public spending, it remains that we put ourselves in unnecessary, arbitrary constraints because we misunderstand what the real constraints are. Reeves's fiscal rule change is another example of how there is little science around any of that, except perhaps the political science that drives the political choices each
government makes.
This is not to say there should not be some guardrails, but they should be there to calibrate spending to the economy – to pace the inputs to drive the right outputs without driving prices up. Put simply, we should spend not according to how much tax the government takes or can 'borrow', but according to what is appropriate for the economy and the country's needs. We should tax not according to what we think is needed to pay for what society requires, but according to what delivers the most equitable, sustainable society.
If we understand the truth, we might appreciate that there is no blackhole in our public finances, only in our thinking, and the things we hold ourselves back from fully investing in.
