MMT requires taxation to overcome inflation

The policy upshot of this observation about sovereign currencies is that countries like Japan and the United States are free to spend more. How much more? More than might seem prudent, at least to those accustomed to using debt-to-GDP ratios as a metric of fiscal sustainability (Summers and Furman specifically reject this way of measuring fiscal prudence). MMT advocates and their mainstream colleagues increasingly insist that U.S. deficits are too small, especially relative to the needs of American citizens and the economy in which they live.

MMT has some interesting things to say about taxes. Most basically, it challenges the idea that taxes are linked to spending in any meaningful way. Under traditional ways of thinking, the government collects money through taxes and then decides how to spend it. Under an MMT way of thinking, the government decides how to spend money and then just goes ahead and spends it. Whether the government decides to levy taxes depends on other factors, not on the need to raise money for its spending priorities.

Revenue, in other words, does not constrain spending in the world of MMT. And to be fair, this seems like a pretty good description of the way the United States has been making spending decisions for a while. Sure, thanks to budget rules, there are some limits on what gets spent, and those limits are tied (somewhat notionally) to what tax revenues get collected. But it’s fair to say that in many respects, spending decisions do come first in Washington, with tax decisions playing a secondary role. Hence the deficits.

Under MMT, taxes still have a role to play. Two roles, in fact. First, a government levies taxes to make its sovereign currency valuable. By requiring people to pay their taxes in dollars, the U.S. government guarantees that people will do many other things with those dollars — earn money, spend money, lend money, etc. Taxes make dollars the currency of choice, rather than some alternative like bitcoins or euros.

The second reason a government levies taxes in a world defined by MMT is to control inflation. Because here’s the thing to remember: MMT theorists do believe that inflation is a threat. They understand that unchecked government spending, in particular, might push prices higher. And they endorse the use of taxes to help control those inflationary pressures.

That point is important, if only because one of the most common charges hurled at MMT advocates is that they don’t care about deficits. First of all, that’s untrue on its face: Most of the time, they care about deficits because they like them and want to see them get bigger. But other times, MMT champions care about deficits because they understand that they become inflationary, and inflation needs to be controlled — with taxes.

Problematic Politics

The problem with using taxes to control inflation is that it requires politicians to play the heavy. And to do it quickly. The assumption that members of Congress are willing to play this role — or even capable of it — seems heroic. Lawmakers are skilled at handing out goodies, but they are less good at asking for sacrifice. I’m dubious that they would find the political will to impose heavy tax increases, even in the face of rising inflation. I’m even more dubious that they can do it quickly enough to stop inflation while it’s still gathering steam.

In the past, Congress has tried to use taxes for inflation control, most notably in wartime. But while that worked during World War II (politically, at least), it was much harder during the Vietnam War. And given the “free lunch” ethos that seems to pervade Capitol Hill, I’m skeptical that lawmakers would be able to do the dirty work that they have long since outsourced to the Federal Reserve.

Still, this problem with MMT — its reliance on taxes as an inflation-control device — is a late-stage issue; presumably it would arise only after policymakers had already gone down the road of MMT deficit spending. But what if we return to the watered-down version of MMT that seems to be gaining traction with the Summers-Furman crowd?