Even though we have had a book called The Deficit Myth for years, the myth persists. One such myth propagator is Jonathan Portes1, who declared in a recent exchange with Warren Mosler:
It’s completely delusional to think it’s economically feasible/sensible to increase the NHS workforce by a million or so without putting up taxes.
Later, he clarified what he meant:
There is a discretionary political decision to permanently increase the deficit by X% (to pay for public provided health services). What is the impact on the price level?
These remarks are a concrete example of the deficit myth in action. Warren summarised the MMT position in his final replies.
I don’t think it’s delusional. [The UK] institutional structure provides powerful incentives to not spend income, and a transactions-based tax structure that increases liabilities with nominal growth, all of which continuously creates ‘fiscal space’ for deficit spending for NHS
Let’s explain the MMT position again and show where Jonathan is going wrong.
Think like an MMTer
If you’re critiquing MMT and still thinking about money and interest rates, then MMTers will start laughing. Instead, think about how the government provisions itself in physical terms.
Let’s start with the phrase, “increase the NHS workforce by a million or so”. How do we do that using an MMT approach?
We decide what jobs are needed and price them in £ Sterling.
That much should be obvious. The NHS has pay scales and grades positions according to that scale. It’s a take-it-or-leave-it offer. Everybody knows that. MMT understands this process and calls it ’exogenous pricing’.
However, it contradicts a fundamental assumption of mainstream economics: that a mystical auction determines prices solely by market forces. That’s Jonathan’s first mistake: failing to consider how pricing works in the real world.
Now we advertise the jobs and fill them at the predetermined price. How do we know we’ve filled them? Well, the assumption in Jonathan’s message is that government spending has happened. For government spending to happen, there has to have been something to buy. We’ve filled the advertised jobs, and the individuals have worked a month, or there would be no additional wage bill to pay. MMT understands that when the government runs out of things to buy at its stated price, the spending stops.
No hires, no spending, no problem.
If a million people are now working for the NHS, they are not working for whoever they worked for previously.2 Who were they working for before? Almost certainly the private medical industry, which will now have the staff shortages currently plaguing the NHS.
What do we call it when you have less stuff than before due to government action? We call it ’taxation’. The act of hiring away causes the economic effect of taxation. The private sector now has fewer workers and lower capacity.
If the NHS has managed to employ one million people at its fixed pay rates, taxes are high enough. There is no need to change the tax rates to suppress the private sector further.
The switch to government provision will also eliminate intermediate jobs (such as those in the medical insurance industry). If that increases unemployment, we may need to reduce tax rates, not increase them. 3
Enter the Deficit
We’ve hired staff away from the private sector. How will those firms respond?
Post-Keynesian Pricing Theory explains why they are unlikely to put their price up. Drawing attention to a price increase on a regular payment is a surefire way to get it cancelled.
Private medical insurance would be competing against a newly invigorated NHS. Private practices will have staff shortages. Articles will start to appear in the press. Better to stay quiet and hope the customer’s direct debit stays in place.
Given the new political environment, paying a higher wage is unlikely since there is no more income and dim prospects of improvement.
So what happens instead? Let’s use a concrete example.
An experienced band 6 General Practice Nurse earns about £43K annually 4. Once you add Employer’s NI, the total cost is £47K. The nurse ends up with a net salary of £33K after PAYE, and the firm pays over the remaining £14K to HMRC to settle the tax bill.
When a private firm pays the nurse, the government receives tax at the current PAYE rates. The deficit is reduced by £14K, and the total cost to the firm is £47K.
Parliament will vote through additional funding of £47K to allow the NHS to hire the nurse. £33K of that will end up with the nurse as before, and HMRC will receive £14K back as PAYE tax.
Consider the ideal MMT scenario: private medicine throws in the towel; instead, one of the businesses pays back some loans. Firms still receive the £47K income but no longer spend it on a nurse’s salary. Instead, the government receives £12K as corporation tax on increased profit. The remaining £35K partially repays an outstanding business loan.
From this scenario, we can see there is no additional demand in the economy. Yet the deficit has increased by £35K - 75% of the extra government spending.
We get the same result if firms pays dividends or buys back equity, and the recipient holds the payment as a deposit. The effect comes from ’not spending’ rather than paying back a loan.5
Let’s consider another scenario.
Say those receiving the buyback start spending. What then? Consumption attracts VAT, and any profit from that consumption attracts Corporation Tax. This first additional consumption round generates another £13K in tax.
Now we have the dreaded additional demand in the economy. Yet what has happened to the change in the deficit? It has gone down from £35K to £22K - 46% of the extra government spending.
Let’s add another round and another cycle of demand. This consumption round generates another £9K in tax. The deficit declines to £13K - 27% of the further government spending.
So it continues. The more cycles of consumption in the spending chain, the higher the demand and the lower the deficit. Right down to the point where the extra tax taken matches the additional spending.
A significant change in the deficit has minimal impact on demand. In comparison, a lower change in the deficit has a greater impact.
Suppose Jonathan is sure that hiring people for the NHS will cause a widening of the deficit. In that case, it produces little extra demand.
Government spending matched precisely by an increase in the deficit is likely to be deflationary. Far more saving is happening than is necessary.
Conclusion
We can now see where Jonathan is going wrong in his MMT commentary.
The government offers work at a set price. If the government fails to get sufficient tenders and therefore fails to spend the money in the first place, we may need to look at whether taxes need changing.
The economic impact of taxation occurs when resources shift from the private sector to the public sector. Collecting the money needs to happen, but it is of secondary importance.
Additional government spending necessarily causes more tax revenue. That’s how percentages work.
No further physical transactions will have happened if the extra taxation doesn’t turn up. The deficit change will stay high. Consequently, ‘Deficit spending’ 6 has a lower inflationary impact than ’tax-matched’ spending.
There cannot be a “discretionary political decision to permanently increase the deficit”. The change in the deficit is entirely down to the private sector’s response, which, as Warren explains, depends upon the UK institutional structure.
Even if the NHS cannot fill the jobs, we could take a more direct approach. Parliament could transfer private medicine to the public sector, as we did in 1946 with the original NHS Act. This transfer would remove the ‘fast track for the better off’ option and force the better off to stand in the queue with the rest of us. It would reassert the founding principle of the NHS, that it is ‘based upon need, not ability to pay’.
Government has more than just the taxation tool in its toolbox, particularly now the EU no longer constrains us.
So now you know why MMTers don’t get too excited about increased deficits. The additional financial saving it represents has a similar economic effect to direct confiscation.
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For those who don’t know, Jonathan is one of the names on the back of the original ‘full-funding rule’ document, which lead to the current Bank of England regime. The one that is fleecing ordinary mortgage and rent payers while paying banks and deposit holders billions of pounds of interest. The one that has failed to keep to its alleged 2% inflation target 107 times in the last 180 months. ↩︎
Note that we avoid assuming an elastic external labour supply here. Appropriating resources from other parts of the world is how neoliberals have made the numbers add up for decades. The rest of the world has a limited amount of medical resources too and they need them for their own populations. We have to cut our coat to our cloth. ↩︎
“there is strong evidence that at least in the healthcare sector a dollar of government spending buys more care than a dollar of private spending—so shifting toward government as the single payer would produce disinflationary pressure.” How to Pay for the Green New Deal ↩︎
That’s the Monetarist ‘money supply’ arguments dealt with. ↩︎
Deficit spending is a change in government spending matched mainly by an increase in the deficit. ↩︎