There are essentially three ways of financing an ambitious Labour Government’s programme of public expenditure. These are through taxation, monetary credit creation, and the issue of debt securities. The sections below explain how each of these three methods works, and their respective limitations. Those limitations mean that, in the end, a Labour Government’s programme will have to be financed by some combination of these three methods. A final section suggests that financial stability should determine the degree to which any of these three methods should be used in financing a Labour programme.
Taxation
The first, and most obvious, way of paying for government expenditure, is through taxation. In most countries this covers the vast bulk of government expenditure. The remainder is the so-called ‘fiscal deficit’ that must be covered through monetary credit creation or the issue of debt securities. A programme of government expenditure in a given period that is covered by tax revenue, is called a balanced budget. Financing expenditure through taxation is a purely redistributive activity: the public in general are taxed and the money is paid back to the public that obtains incomes from government expenditure programmes (public services, health, education etc., and public investment). Business and property-owners then obtain the money as those incomes are spend on consumption goods, rents etc. The idea of a balanced budget is very appealing to Conservatives, because it epitomises the virtues of thrift and ‘living within ones means’ that in their view makes for sustainable household budgeting. This is of course a public virtue that, on the whole, they themselves do not practice, because private means and the possession of wealth allow the rich to live beyond any earned income, and the home ownership so ardently promoted by Conservatives allows increasing numbers of the middle class to generate cash flow from the housing market by realising capital gains. Nevertheless, the government is, in this view, supposed to balance its budget. However, the balanced budget doctrine is inappropriate because it ignores the important part that government expenditure and financing play in maintaining the stability of the financial system, through the provision and absorption of liquidity and risk-free financial assets. This balanced budget approach is often combined with two other doctrines that are founded on political prejudice rather than analysis of the way in which the economy works. The first is that taxation distorts prices, markets and incentives. If this argument is to be taken seriously, then its proponents should be advocating the abolition of the state, and all that that would entail. The possibility of getting rid of all these distortions is an anarchist dream. Even that would not be enough, since it would also be necessary to get rid of all monopolistic distortions of the price system, and that would be difficult, if not impossible, without a state to enforce competition. The policy issue is what distortions (such as free education or environmental protection) improve the functioning of society and the economy. The other, related, doctrine is that taxation is an insupportable burden on business. But this need not necessarily be the case. This depends on the ‘incidence’ of taxation (who pays) and the programme of expenditure. A tax on wealth does not affect profits from production. In no way therefore does it reduce the incentives that profits provide to firms to invest. A tax on wealth that is used to build hospitals creates incomes for firms that build hospitals. Business circles on the whole actually like government expenditure, providing that someone else pays the taxes. The armaments industry is a particularly egregious example of this self-serving attitude towards public finance. Business too benefits from healthy, educated workers, whose capacities have been enhanced by public support, not to mention the subsidies given to employers in recent years through income support. Business also obtains revenues as welfare payments and public employees’ incomes are spent goods and services that the private sector provides. Nevertheless, behind austerity lies the desire to reduce taxes on the rich. In combination with the doctrine of balanced budgets, this means reducing public expenditure. Fiscal austerity is therefore first and foremost a distributional argument. If this distributional argument could be ignored then a Labour Government would have no difficulty. However, the rich have power. The other limitation of taxation is that the ability of a government to extract taxes from the economy (i.e., the ‘fiscal base’) is finite. Major expenditures, such as the war effort in the two world wars of the twentieth century, or financial operations, such as the nationalisations of the coal and steel industries and the railways by the Attlee government, were on a scale that was beyond being financed from taxation. Historically, balanced budgets have been rare. There is moreover a technical reason why government expenditure cannot be wholly covered from taxation, namely because tax revenue does not come in at exactly the same time as the government spends its (our) money. Tax revenues are usually bunched in the first quarter of each calendar year. Arrangements have to be made to finance public expenditure in the period before each New Year. These arrangements are the other two methods of financing public expenditure, monetary credit creation, and the issue of debt securities.
