This is false. I think you share some common misconceptions about how government spending and debt works.

You have the order of operations backward. The government must spend BEFORE it taxes. This has always been the case in economies with sovereign currency. The government issues its own IOUs with a promise to redeem them for tax credit. Please answer me this: where do the dollars with which we pay our taxes come from?

The federal reserve functions as a public institution and works closely with the federal government in order to fund treasury spending. It does not exist to earn a ‘profit’ but rather to achieve the public goals of low inflation and full employment. The federal reserve must adhere to congresses’ policies in the long run.

I could walk through the t-accounts process of deficit spending but here is the overview. Let’s say the confess deficit spends $100:

  1. Congress authorizes deficit spending of $100 (that is, spending in excess of tax revenue)
  2. The treasury creates $100 of securities out of thin air and sells them at auction underwritten by the fed
  3. Select banks bid on and buy securities at the primary auction. This auction is guaranteed not to fail. The Fed debits the buyer’s reserve account $100 and credits their securities account $100. The Fed also credits the TGA $100 in reserves.
  4. The government spends by debiting the TGA $100 and crediting the reserve accounts of banks who in turn debit reserves and credit the appropriate demand deposits of whomever the government is paying the $100
  5. Depending on circumstances, the Fed buys securities on the secondary market and expands its balance sheet by debiting the bank’s securities account $100 and crediting its reserves.

So, at the end of this process, the federal reserve holds the $100 security and the private sector individual holds the $100 demand deposit. The Fed has indirectly funded the treasury and the private sector’s net financial wealth has increased by $100. The security held by the Fed is government ‘debt’, but this is not really a problem as the primary bond auction can never fail. The government can and will always meet its obligations unless congress prevents it from doing so. Notice that even if the bank does NOT sell its security to the Fed in step 5, it is still holding a government IOU which is effectively a liquid asset and can be exchanged for reserves on the secondary market at any time.

Now, you are correct that tax revenue and bond proceeds ‘flow through’ the TGA, and this gives the illusion that taxes ‘fund’ spending, but this is clearly false when one considers these tax funds collected are prior government spending.

Notice that bond sales too are superfluous to government spending. The federal reserve could simply overdraft the TGA at 0% interest. The only reason we have interest-paying debt is because congress mandates the sale of securities to fund spending in excess of revenue. This is a politically imposed constraint and completely unnecessary.

Again, this does not mean the government can deficit spend to infinity. Too much deficit spending near productive capacity will introduce too many dollars without creating enough real assets and therefore induce inflation. The main function of taxes today is to curtail inflation by redeeming government IOUs. Taxes decrease the private sector’s net financial wealth.

Corporate accountant and former auditor with degrees in philosophy and accounting.

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