Why economists have long understood the true purpose of taxes—but rarely say it out loud.
We’re used to thinking of taxes as confiscation. But in a modern monetary economy, taxes function more like infrastructure or insurance: a service that protects the value of money itself. This isn’t a new theory—just a clearer way of stating what’s been understood for decades.
Very accurate and helpful insight. Taxes can serve other purposes - tariffs can provide protection to American producers; "sin" taxes (on cigarettes, alcohol, etc.) can discourage activities with social costs. The government can also impose user charges - FDIC charges on banks, fees at national parks, etc. In an economy with a very regressive income and wealth distribution, a combination of taxes and benefits can simply redistribute some of the cash flow and wealth.
I am in general agreement. A few points. I think in the early 80's and continuing down to the present day, there is an attitude that "deficits don't really matter" and inflation is a problem for the Fed to control with monetary policy (interest rates and quantitative easing or tightening). For a period of time this may have appeared to work (big deficits and low inflation) but over time the interest on the accumulated national debt starts to create a downward pressure on the value of the dollar. The other point is that the US can consume more than it produces without enormous inflation if other countries are willing to run trade surpluses with us. We have just been through this drill and I suspect even now China would be happy to continue to run a very large trade surplus with us. Another point is that a reduction in spending can have the same beneficial effects as an increase in tax revenue. Another interesting problem is suggested by an analysis of alternative measures for the government to generate net revenue. User charges are becoming much more popular at the state and local levels. Confiscation of property is popular in certain other countries and in the United States, the draft and later "selective" service system cut dollar expense by forcing young men to work in the military at below market wages. In a way it made the Vietnam War less expensive in dollar terms. When the draft was eliminated, it became more expensive to wage war - especially on the scale of 500,000 men in theater (the military was requesting an additional 200-300,00 after its "victory" in the Tet offensive). None of our subsequent adventures overseas have involved anything like these numbers. War has become more capital intensive and less labor intensive as the price of labor was allowed to be set by the market. Of course, the painfulness of taxation leads to greater scrutiny of budget expenses and if some discipline is applied to the budget, it is very likely that some wasteful spending will be eliminated. I have always thought that we should consider limiting the federal budget to growing at the same rate as nominal GDP - except in situations of recession, deflation, or extraordinary need for federal expenditures (Covid, WW2, etc.).
Thank you for your comments! You raise many important points - let me address a few where I think the Functional Finance framework clarifies things:
On interest payments and dollar value:
We should be concerned about rising interest payments, but the mechanism is different than what "downward pressure on dollar value" suggests. Interest payments are government spending - they add dollars to the economy just like any other spending. So, the important question is: does this additional spending push aggregate demand beyond productive capacity? If yes, that's inflationary (which would reduce dollar purchasing power). If no, it’s fine.
The solution, if interest payments are excessive, isn't to worry about the amount of debt, but to either offset the spending on interest payments with higher taxation or reduce discretionary spending. Interest payments present the same demand-management challenge as any other government spending.
On spending reduction vs. taxation:
You're absolutely right that reduced spending can substitute for taxation in controlling aggregate demand. Both withdraw demand from the economy (reduced spending directly reduces government injection, taxation withdraws spending capacity from the private sector).
This is exactly why I argue that the real debate shouldn't be "high vs. low taxes" but rather: "What's the right combination of spending and taxation to maintain full employment without inflation?"
On limiting budget growth to GDP growth:
Your proposal sounds reasonable but it is actually too rigid and kind of arbitrary. The right amount of net government spending (spending minus taxation) depends on private sector saving desires and the trade balance, not GDP growth.
Examples:
- Recession: Private sector wants to save more, therefore the government should run a larger deficit to offset that saving, even if GDP is shrinking
- Boom: Private sector dis-saving, therefore the government should run a smaller deficit (or generate a surplus), even if GDP is growing fast
The government’s economic constraint isn't nominal GDP growth - it's real resource availability. The goal should be full employment with price stability, and the budget should adjust to achieve that, not follow an arbitrary growth rule. Simple rules of thumb may make planning easier, but they don’t always produce the best plans.
On trade deficits:
You're correct that trade surpluses from other countries allow us to consume more than we produce. In sectoral balance terms: our government deficit + our private sector surplus = rest of world surplus with us.
This is sustainable as long as others want to accumulate dollar-denominated assets. The constraint is whether this pushes our aggregate demand beyond our productive capacity (causing inflation), not whether we're "living beyond our means" in some moral sense.
On budget discipline:
Your point about taxation creating budget scrutiny is well-taken as a political economy observation. The challenge is distinguishing:
- Destructive austerity (under-investing in productive capacity)
The Functional Finance framework helps here: we should spend up to full employment, tax enough to prevent inflation, and debate the composition (what to spend on, who to tax) based on our values and priorities.
One clarification on scope:
Some of your points (like user fees and confiscation) are very relevant for state/local governments that don't issue currency and thus need revenue. My essay focuses specifically and exclusively on currency-sovereign governments (like the federal government), where the constraint is real resources (inflation), not revenue.
Thanks again for engaging substantively with these ideas.
Very accurate and helpful insight. Taxes can serve other purposes - tariffs can provide protection to American producers; "sin" taxes (on cigarettes, alcohol, etc.) can discourage activities with social costs. The government can also impose user charges - FDIC charges on banks, fees at national parks, etc. In an economy with a very regressive income and wealth distribution, a combination of taxes and benefits can simply redistribute some of the cash flow and wealth.
I am in general agreement. A few points. I think in the early 80's and continuing down to the present day, there is an attitude that "deficits don't really matter" and inflation is a problem for the Fed to control with monetary policy (interest rates and quantitative easing or tightening). For a period of time this may have appeared to work (big deficits and low inflation) but over time the interest on the accumulated national debt starts to create a downward pressure on the value of the dollar. The other point is that the US can consume more than it produces without enormous inflation if other countries are willing to run trade surpluses with us. We have just been through this drill and I suspect even now China would be happy to continue to run a very large trade surplus with us. Another point is that a reduction in spending can have the same beneficial effects as an increase in tax revenue. Another interesting problem is suggested by an analysis of alternative measures for the government to generate net revenue. User charges are becoming much more popular at the state and local levels. Confiscation of property is popular in certain other countries and in the United States, the draft and later "selective" service system cut dollar expense by forcing young men to work in the military at below market wages. In a way it made the Vietnam War less expensive in dollar terms. When the draft was eliminated, it became more expensive to wage war - especially on the scale of 500,000 men in theater (the military was requesting an additional 200-300,00 after its "victory" in the Tet offensive). None of our subsequent adventures overseas have involved anything like these numbers. War has become more capital intensive and less labor intensive as the price of labor was allowed to be set by the market. Of course, the painfulness of taxation leads to greater scrutiny of budget expenses and if some discipline is applied to the budget, it is very likely that some wasteful spending will be eliminated. I have always thought that we should consider limiting the federal budget to growing at the same rate as nominal GDP - except in situations of recession, deflation, or extraordinary need for federal expenditures (Covid, WW2, etc.).
Thank you for your comments! You raise many important points - let me address a few where I think the Functional Finance framework clarifies things:
On interest payments and dollar value:
We should be concerned about rising interest payments, but the mechanism is different than what "downward pressure on dollar value" suggests. Interest payments are government spending - they add dollars to the economy just like any other spending. So, the important question is: does this additional spending push aggregate demand beyond productive capacity? If yes, that's inflationary (which would reduce dollar purchasing power). If no, it’s fine.
The solution, if interest payments are excessive, isn't to worry about the amount of debt, but to either offset the spending on interest payments with higher taxation or reduce discretionary spending. Interest payments present the same demand-management challenge as any other government spending.
On spending reduction vs. taxation:
You're absolutely right that reduced spending can substitute for taxation in controlling aggregate demand. Both withdraw demand from the economy (reduced spending directly reduces government injection, taxation withdraws spending capacity from the private sector).
This is exactly why I argue that the real debate shouldn't be "high vs. low taxes" but rather: "What's the right combination of spending and taxation to maintain full employment without inflation?"
On limiting budget growth to GDP growth:
Your proposal sounds reasonable but it is actually too rigid and kind of arbitrary. The right amount of net government spending (spending minus taxation) depends on private sector saving desires and the trade balance, not GDP growth.
Examples:
- Recession: Private sector wants to save more, therefore the government should run a larger deficit to offset that saving, even if GDP is shrinking
- Boom: Private sector dis-saving, therefore the government should run a smaller deficit (or generate a surplus), even if GDP is growing fast
The government’s economic constraint isn't nominal GDP growth - it's real resource availability. The goal should be full employment with price stability, and the budget should adjust to achieve that, not follow an arbitrary growth rule. Simple rules of thumb may make planning easier, but they don’t always produce the best plans.
On trade deficits:
You're correct that trade surpluses from other countries allow us to consume more than we produce. In sectoral balance terms: our government deficit + our private sector surplus = rest of world surplus with us.
This is sustainable as long as others want to accumulate dollar-denominated assets. The constraint is whether this pushes our aggregate demand beyond our productive capacity (causing inflation), not whether we're "living beyond our means" in some moral sense.
On budget discipline:
Your point about taxation creating budget scrutiny is well-taken as a political economy observation. The challenge is distinguishing:
- Healthy scrutiny (eliminating waste, ensuring value)
- Destructive austerity (under-investing in productive capacity)
The Functional Finance framework helps here: we should spend up to full employment, tax enough to prevent inflation, and debate the composition (what to spend on, who to tax) based on our values and priorities.
One clarification on scope:
Some of your points (like user fees and confiscation) are very relevant for state/local governments that don't issue currency and thus need revenue. My essay focuses specifically and exclusively on currency-sovereign governments (like the federal government), where the constraint is real resources (inflation), not revenue.
Thanks again for engaging substantively with these ideas.