Should We Devote Our Resources Primarily to Teach that “Federal Taxes Don’t Fund Federal Spending”, or that “Congress Should End the Debt Through Overt Congressional Financing?”

Of course, it is better to teach them both these things, but I believe that it is better for now to view teaching about Overt Congressional Financing (OCF) as a higher priority than teaching that “taxes don’t fund spending.” And I believe that most MMT economists and writers will, after due consideration, agree that OCF is the higher priority.

I’ll now point to two examples from MMT economists implying that conclusion. First, here is a short example from Stephanie Kelton and L. Randall Wray, replying to Jared Bernstein’s recent post:

Jared says:

“Krugman’s “finance-ability” point: Krugman argues that self-financing is more inflationary than bond issuance, but he’s not making the above points about MMTs flawed (IMO) assumption that tax cuts could handily deal with accelerating prices. He’s worried about currency debasing.”

Stephanie and Randy reply:

“We can address this one very quickly.  The Krugman point you raise is from 2011. Scott Fullwiler addressed it back then.  But it hardly seems relevant any longer, given that Krugman has since recognized that it makes no difference, economically, whether deficits are bond-financed or money-financed.  And if it makes no difference, then either both risk debasement or neither does. As Kelton and Fullwiler explained in a Financial Times Alphaville blog, the only possible difference is political, and on that front money-financed deficit spending wins out because budget deficits no longer add to the national debt.”

So, Stephanie and Randy believe that “money-financed deficit spending” is preferable to “bond-financed” deficit spending because it has a political advantage. I agree and I think that a world in which the Federal Government uses OCF to money-finance deficit spending is better than our current world in which “bond-financed” spending is our practice.

Teaching people that “taxes do not fund spending” is very important, but if our primary focus is on that, then people who are successfully taught that by us may still conclude that since there is no barrier to bond-financed federal spending to their heart’s content, then they should just go ahead and deficit spend to create the outcomes we seek. That result is acceptable and much better than our current situation in which people believe that the debt is a problem for spending; but it doesn’t create the political advantage one gets from teaching that OCF would not only allow us to

(1) spend for the things needed to accomplish public purpose, but

(2) spend while driving the political forces that have been pushing the debt narrative out of business and

(3) make the reality that “taxes do not fund spending” undeniable; by making it transparent that Congress both commands spending done by the Treasury; and the Federal Reserve’s filling Treasury’s spending account so it can do that spending and also repay “the debt” as it falls due.

And then there is this much longer example from Randy Wray’s book Modern Money Theory. He says:

“We now will look at current procedures to see if there is an alternative to increasing the limit, while allowing the Treasury to continue to spend. . . .

“So let us see how we can untie Uncle Sam’s purse strings while living with current debt limits. It is actually a relatively easy thing to do, requiring only a modest change of procedure”.

So, Randy is for finding ways to untie the purse strings while avoiding changes in the debt ceiling law. He continues

“First we need to review how things usually work. Congress (with the President’s signature) approves a budget that authorizes spending. The US Constitution vests in Congress the power to create money which should mean that the Treasury creates the money used to finance Congressionally approved payments. (emphasis added)

By the way, that’s a normative statement! A Congressional appropriation should, according to Randy, by itself delegate to the Treasury Congress’s authority to create the money to pay for the things Congress has ordered it to spend money on. But that doesn’t happen now, because Congress has created the Fed as its own, and the Treasury’s, banking agent to which Congress has delegated the authority to create the reserves Treasury spends.

What OCF does, of course, is to go one step further. It orders the Fed to create the necessary balances directly in the Treasury spending account upon passage of an appropriations bill, without the Treasury having to do anything further to get the Fed to create the reserves balances necessary for spending. In other words, OCF closes the loop of delegation of the spending authority of Congress to the Treasury, which, it can be argued, is not only sensible, but also embodies the intent of the framers of the Constitution much more closely than present practices.

Continuing on with what Randy says in his MMT primer:

“But in practice the Treasury uses the US central bank – the Fed – to handle its payments. Current procedure is for the Treasury to hold deposits in its account at the Fed for the purposes of making payments. Hence, when it cuts a check or credits a private bank account, the Treasury’s deposit at the Fed is debited. . . .

“To obtain deposits, the Treasury sells bonds (of various maturities). The easiest thing to do would be to sell them directly to the Fed, which would credit the Treasury’s demand deposit at the Fed, offset on the Fed’s balance sheet by the Treasury’s debt. Effectively, that is what any bank does: it makes a loan to you by holding your IOU while crediting your demand deposit so that you can spend.

“But current procedures prohibit the Fed from buying Treasuries from the Treasury (with some small exceptions); instead it must buy Treasuries from anyone except the Treasury. That is a strange prohibition to put on a sovereign issuer of the currency, if you think about it, but it has a long history that we will not explore here. It is believed that this prevents the Fed from simply “printing money” to “finance” budget deficits so large as to cause high inflation – as if Congressional budget authority (and threatened Presidential veto) is not enough to constrain federal government spending sufficiently that it does not take the United States down the path toward hyperinflation.“

In other words, Randy is saying this prohibition is on the Fed to prevent it from running wild by “printing money” as if it is not enough that Congress doesn’t give the Fed itself authority to spend any Congressional appropriations in the first place. That authority is only given to the Treasury.

Randy continues . . .

“So, instead, the Treasury sells the Treasuries (bills and bonds) to private banks, which create deposits for the Treasury that it can then move over to its deposit at the Fed. And then the Fed buys Treasuries from the private banks to replenish the reserves they lose when the Treasury moves the deposits. Got that? . . .  The Fed ends up with the Treasuries, and the Treasury ends up with the demand deposits in its account at the Fed, which is what it wanted all along but is prohibited from doing directly. The Treasury then cuts the checks and makes its payments. Deposits are credited to accounts at private banks, which simultaneously are credited with reserves by the Fed.”

Of course, with OCF none of these gyrations are necessary for the Treasury. All it would have to do is spend the money appropriated by Congress, which the Fed would have placed into its account as soon as the appropriation of the money occurred.

“In normal times banks would find themselves with more reserves than desired so offer them in the overnight fed funds market. This tends to push the fed funds rate below the Fed’s target, triggering an open market sale of Treasuries to drain the excess reserves. The Treasuries go back off the Fed’s balance sheet and into the banking sector. (With the Global Financial Crisis, the Fed changed operating procedure somewhat: it began to pay interest on reserves, and adopted “Quantitative Easing” – see earlier discussion – that purposely leaves excess reserves in the banking system, then pays interest on them. Note that the operational significance of Treasury bonds is that they pay interest, so reserves that pay interest have exactly the same operational effect.)”

A very important point; provided that the Fed pays the same rate of interest on reserves as Treasury bonds would have, Fed-paid Interest on Reserves (IOR) has exactly the same operational effect on the economy. Here Randy is thinking about the direct economic effect of the interest.

However the “operational effect” isn’t the same, if we consider the political effect to be part of that “operational effect,” because the political effect of the Fed paying IOR is very little or nothing, while the political effect of selling bonds along with Treasury spending has been to create “the enormous debt” problem, and enable its use as a rationalization for brushing aside progressive fiscal policies from which most Americans would benefit. Substituting IOR for Treasury debt instruments as the primary instrumentality used for draining reserves out of the private economy makes a “yuuuuuge” difference for the politics surrounding fiscal policy.

One consequence of passing OCF to facilitate federal spending would be that the Federal Reserve would use IOR far more than it does today to target interest rates, and so, it would shoulder the political burden of explaining why wealthy investors are entitled to a return on a risk-free investment from the Government, while the Treasury and Congress would no longer have to shoulder the political burden of the “enormous” debt subject to the limit, which, as the story goes, will doom our children and grandchildren to lives that are poor, deprived, and perpetually anxiety-filled and unhappy.

Continuing with Randy’s narrative:

“And that is where the debt gridlock problem bites. Treasuries held by banks, households, firms, and foreigners are counted as government debt (and nongovernment wealth through accounting identities!) and thus are subject to the imposed debt ceiling. Bank reserves, by contrast, are not counted as government debt. One solution is to just stop the open market sales of Treasuries in order to leave the reserves in the banking system. That is essentially what Bernanke’s Quantitative Easing 2 does: the Fed is buying hundreds of billions of Treasuries to inject reserves back into banks – the reserves that were drained by selling the Treasuries to banks in the first place. So we are getting Treasuries back onto the Fed’s balance sheet, and yet gridlock over the debt limit occurs because there are still too many Treasuries outstanding. If Treasury just stopped selling them, the Fed could leave excess reserves in the banks. As bonds mature, they’d be replaced with reserves. And that would be the end of the “debt problem”. “

And, that is one of the things that Overt Congressional Financing (OCF) would do. When it passes, Treasury could and probably would cease selling Treasury bonds, while continuing to pay off outstanding bond principals and interest as they fall due. And, as Randy says, that is the end of “the enormous debt” problem, including the debt limit problem.

No more debt ceiling crises. No more frantic bargaining at the last minute between Democrats and Republicans to pay off the Republicans to release their debt ceiling-related hostages. No more cuts to valuable discretionary spending to placate the debt ceiling gods; and, no more government shutdowns due to lack of agreement on a debt ceiling deal between the two major parties.

Continuing on with Randy’s exposition:

“ . . . There are two other ways to obviate the need to raise the debt limit: Treasury warrants and large denomination platinum coins. . . . “

I’ll skip discussing the “Treasury warrant” method here, because for legal reasons  (See, Postscript: Rationalization and Obligation) ) I don’t think it works, and explaining why I think this is so would take me off the subject of this post. So, let’s continue with the platinum coin method.

“The second method is to return to Treasury creation of currency – on a massive scale, pun intended. Currently the US Treasury has the authority to issue platinum coins in any denomination, so it could, for example, make large payments for military weapons by stamping large denomination platinum coins. It would thereby skip the Fed and private banks. And since coins (and reserves and Federal Reserve notes) don’t count as government debt for purposes of the debt limit this also allows the Treasury to avoid increasing debt as it spends platinum coins. The coins would be Treasury IOUs but would not be counted among the bills and bonds that total to the government debt. Like currency the coins would be “redeemed” in tax payment, hence demanded by those with taxes due. So that is another finesse to get around arbitrary limits or procedures put on Treasury spending.”

If the Treasury decided to use the platinum coin, I don’t think it would use them to “. . . skip the Fed and private banks.” Instead, I think it would use them to end debt ceiling crises by creating coins with face values large enough to do the spending it needed to do to neutralize the debt limit and enable the spending that had been appropriated by Congress. It might use one or more trillion dollar coins, or even a single $100 Trillion dollar coins to fill the public purpose with enough spending power to make debt issuance irrelevant going forward.

Platinum coins with values of that magnitude would be deposited into the US Mint’s account at the Fed, which would be credited by the Fed with additions to the Mint’s reserve balances equal to the face values of the coins, and then the seigniorage (the difference between the costs of creating the coin and its face value) would be “swept” by the Treasury into its own spending account adding that seigniorage to its reserves. The new (and previously existing) reserves would then be used to spend Congressional appropriations by making payments to people and businesses in the non-government sector including the companies making the military weapons mentioned by Randy.

Continuing with his otherwise correct narrative:

“These proposals just show how silly it is to tie the Treasury’s hands behind its back through imposing debt limits. We already require that a budget is approved before Treasury can spend. That constraint is necessary to impose accountability over the Treasury. But once a budget is approved, why on earth would we want to prevent the Treasury from keystroking the necessary balance sheet entries in accordance with Congress’s approved spending?

The budgeting procedure should take into account projections of the evolution of macroeconomic variables like GDP, unemployment, and inflation. It should try to ensure that government keystroking will not be excessive, stoking inflation. It is certainly possibly that Congress might guess wrong, and might want to revise its spending plan in light of developments. Or it can build in automatic stabilizers to lower spending or raise taxes if inflation is fueled. But it makes no sense to approve a spending path and then to arbitrarily refuse to keystroke spending simply because an arbitrary debt limit is reached.”

So, Randy asks “. . . once a budget is approved, why on earth would we want to prevent the Treasury from keystroking the necessary balance sheet entries in accordance with Congress’s approved spending?” And he sees nothing wrong with “untying the purse strings” by just stopping open market Treasury sales of debt instruments, using warrants issued by the Treasury to the Fed in return for reserves, or using a platinum coin solution to overcome debt ceiling crises and create a situation where the Treasury is enabled to keystroke the spending it has been ordered by Congress to do in appropriations bills.

In suggesting these methods he does not propose that we ought to first prioritize teaching people that “taxes do not fund spending,” and only then place a heavy emphasis on using alternatives to increasing the debt limit to resolve political debt ceiling crises. Instead, he is for using alternative methods to “untie the purse strings”.

Randy continues by considering common objections to procedural changes such as using the procedural changes he identifies in his three methods for “untying the purse-strings “. Let’s consider this one:

Objection: We need the independent authority, the central bank, to constrain “money creation” to finance spending

“Response: As discussed above, Congress and the President first work out a budget. That authorizes Treasury spending. We can come up with alternative procedures to allow Treasury to accomplish that task. A relatively primitive but effective one would be for it to simply print up Treasury notes and spend. Or it can directly keystroke entries into the deposit accounts of recipients, but that requires that Treasury can also keystroke reserves onto bank balance sheets. Since we divide the tasks between Treasury and Fed – having banks “bank at the Fed” – it must be the Fed that keystrokes the reserves. There is no fundamental reason for this; banks could have accounts at the Treasury used for clearing and then the Treasury would keystroke the reserves. But we don’t do it that way.

“So we could have the Fed act as the Treasury’s bank, accepting a Treasury IOU and keystroking bank reserves. But we don’t do that either; we say that although the Fed is the Treasury’s bank, it is prohibited from directly accepting a Treasury IOU. And hence we created complex procedures that involve private banks, the Fed, and the Treasury to accomplish the same thing.”

So what is OCF? It is an alternative procedure to what we do at present that orders the Fed to keystroke reserves necessary to spend appropriations into Treasury’s spending account. If it is enacted, then we will no longer have to teach that “taxes do not fund spending,” because it will be transparent to everyone that Congress funds spending by appropriating the money to spend and then by ordering the Fed, its creature, to complete the act of appropriating the spending money by using Congress’s authority to create the necessary reserves in the Treasury account.

But, more importantly, it will immediately free up the Congress from having to worry about the growing debt as a possible consequence of the “how you gonna pay for it question”. On the other hand, after we teach “taxes do not fund spending”, we still must teach the specific method or methods Congress can use to enable the Fed to get all the reserves Treasury needs to spend its appropriations in the face of the debt ceiling.

So, finally, I think I’ve made the case that Stephanie Kelton and Randy Wray have both argued for alternative methods to raising the debt limit to “untie the purse strings”, and end debt ceiling crises, even though they both know very well that debt ceiling crises are silly from a Modern Money Theory (MMT) point of view and that the debt has no impact on fiscal sustainability or fiscal responsibility because “taxes don’t fund spending.” Instead, while acknowledging that there is no “operational” advantage in using alternative methods to raising the debt limit, or repealing the debt ceiling law entirely, for that matter, they also think that there is nothing wrong with preferring alternative methods if and when they offer a political advantage over the status quo practices of “funding” Federal spending, which make it very difficult for people to understand that neither taxes nor bond revenues fund Federal spending.

It is in that spirit that I have proposed OCF as a priority for progressive action in the coming years. OCF, by removing the debt burden issue, enables progressives to take the additional policy space afforded by our fiat money system for public purpose. This has to be a priority for real progressives.

We need the additional policy space that the 10 – 12% of GDP would give us to solve the enormous problems Americans face. We need it to end austerity. We need it to create enhanced Medicare for All. We need it to create the Job Guarantee. We need it to fight the forces behind climate change and to secure our very survival. We need it for all sorts of other reasons. That policy space is top priority for us.

Getting OCF passed by Congress will get us that policy space. So, educating about it should become top priority for real progressives of all affiliations.

And if, in contemplating whether or not to take the decision to make this so, we regretfully realize that our efforts to educate about “taxes do not fund spending” should take a back seat, then we should also remember that the person who showed us that taxes and bonds do not fund federal spending, was also the person who coined the hashtag #mintthecoin and later referred to minting a $100 Trillion platinum coin as an example of the Government could do.

Why do you suppose she said those things? Because Stephanie Kelton knew very well that alternative methods of “untying the purse strings” would provide us with the policy space we needed to enable fiscal policy for public purpose.

She was right to think that; and for the same reason I propose that the top priority of real progressives now ought to be to push including the language enacting OCF in every appropriations and continuing resolution bill passed by Congress — in order to “untie the purse strings”, “end the debt”, and get that additional policy space we need for public purpose.

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