Reform of the Federation and housing

Fun Federation fact! The 'Father of Federation', Henry Parkes, was a tenant.

In his final years, Parkes rented 'Kenilworth', one of the 'Witches' Houses' on Johnston Street Annandale.

Now, almost 120 years after Parkes' death, and 115 years after the federation of the colonies as States in a new Commonwealth of Australia, the Federal Government is preparing a White Paper on the Reform of the Federation. As part of the process, an issues paper on 'Roles and Responsibilities in Housing and Homelessness' has been produced – it is well worth a read.

The stated objective of the White Paper is to make the Federation more efficient and effective, simpler and clearer, supportive of increased productivity and economic growth.... and 'to ensure that, as far as possible, the States and Territories are sovereign in their own sphere.'

And that, the Government explains, means 'limiting Commonwealth policies and funding to core national interest matters, as typified by the matters in section 51 of the Constitution.'

Which really is begging the question. Should we assume that making States 'sovereign in their sphere', and limiting the Federal policies and funding to section 51 matters, will actually lead to more efficient, effective government and economic growth?

It strains common sense to treat section 51 as a timeless touchstone of good federalism. There's some very important matters on the section 51 list – for example, taxation (s 51(1)(ii), defence (s 51(1)(vi)), currency (s 51(1)(xii)), banking (s 51(1)(xiii) – and some arguably less important ones too (lighthouses (s 51(1)(vii); astronomical observations (s 51(1)(viii)). And some very important matters are not specifically named on the list: in particular, housing.

Parkes's fellow founding fathers drafted section 51 without the benefit of any special insights into housing policies for the 21st century, or even the 20th century. For what it's worth, Parkes's own ideas about housing policy were indicated in the 1860 report of the Select Committee of Inquiry into the Conditions of Working Classes of the Metropolis, where he recommended that the construction of model dwellings by private capital should be encouraged, by awards of 'medals or diplomas of distinction' – not subsidies.

When section 51 was first drafted, there was no social housing anywhere in Australia, and very little anywhere in the world. What there was a lot of was truly awful housing.

For the first half of the 20th century, State and local governments in Australia made a few stabs at housing reform, but enduring, systemic improvements in the design, construction and provision of housing to households on low-moderate incomes, were achieved only after 1945, when the Federal Government committed funds to State housing authorities through the Commonwealth-State Housing Agreement.

Of course, funding for social housing isn't the only thing the Federal Government does that affects our housing system. As we've often discussed – and the issues paper makes this point too – the Federal Government's tax settings impact hugely on the housing system. In particular, the exemption of owner-occupied housing from capital gains tax, the discounted rate of capital gains tax on other assets (including rental housing), and generous treatment of negative gearing, all operate to direct a lot of private money into the housing system, where it has pushed up prices and distorted the composition of the rental market, to the benefit of those who have already paid for their housing, and to the disadvantage of those who have not.

Now, this is something that the Federal Government does not propose to change, and in terms of the Reform of the Federation process, it passes the section 51 test (being taxation – subsection (1)(ii)).

So one's left with the impression that 'reform' on these terms would really mean the Federal Government continuing policies that benefit people who are wealthy in housing, and pulling out of programs that deliver some assistance to the housing poor.

Could States 'sovereign in their sphere' step up to funding these programs themselves? What if, as the reform process contemplates, there was also a move to address what it calls the 'vertical fiscal imbalance' between the Federal Government and State Governments?

That's a false hope. The difference in the fiscal powers of the Federal Government and State Governments is not one of mere degree (as 'vertical fiscal imbalance' implies), but a difference in kind.

As the issuer of the Australian currency (section 51(1)(xii)), the Federal Government is not fiscally constrained: it can buy anything that is for sale in the currency, can pay any liability that is due in the currency, and never run out of money. Its power to tax is vital to ensuring the acceptance and use of the currency, and the way it taxes is very important to the economic decisions of citizens, but Federal tax revenues don't actually fund Federal spending.

State Governments are categorically different: they are currency users, and as such face financial constraints that really do not apply to the Federal Government.

In our Federation, the Federal Government has, through its position as issuer of the Australian currency, a unique ability to mobilise labour and other economic resources and put them to work for the purposes of public policy. Those purposes should include the provision of housing, homeless services, and other support services and community activities that improve people's lives – and not merely defence forces, lighthouses, astronomical observances and those other matters about which legislative power was allocated to the Federal Government all those years ago.

Real waste

The NSW State Finance Minister, Dominic Perrottet, recently wrote an article on government finances and government 'waste'. The Minister notes all manner of waste – CBD heritage buildings used as government offices, government car fleet maintenance, warehouses of paper records – but he misses the most appalling waste over which governments preside.

 (Russell Drysdale, The Deserted Town Hall)

That's the waste of leaving 219 000 persons unemployed (5.7 per cent of the New South Wales labour force) and a further 303 000 persons underemployed (6.2 per cent). Across Australia, 747 000 persons are unemployed, and 1.05 million are underemployed.

That's a big part of our labour resources not working to capacity – and in many instances, simply standing idle. And that's an appalling waste, in terms of the skills and abilities of these people; their aspirations, dignity and sense of worth; and the additional goods and services that they would otherwise have produced and made available to the rest of us.

Indeed, some of them might have the skills and ability to do office fit-outs, maintain cars, digitise paper and solve other problems that frustrate government ministers and their fellow citizens. In the area of our particular interest, some could help build houses, or repair them, or get activities going in local communities to simply make life more interesting and enjoyable.

All this may be had simply by paying them a wage. The private sector isn't doing it and won't – in fact, it can't, where it also wants to accumulate net financial assets (not to mention pay taxes).

Instead, the money to pay wages for jobs for the otherwise unemployed must come from the non-private sector – in particular, the Australian Government, which should embrace its role in eliminating the waste of idle labour by becoming the employer of last resort (or, putting it more positively, operating a Job Guarantee).

In returning for socially useful work, the Government would pay a living wage, which would thereby become the effective minimum wage in the private sector too. It would make for the economy a buffer stock of employed labour, rather than than unemployed labour, and a mechanism for stabilising wages, other prices, and the currency.

And the Australian Government would pay for this by simply crediting the bank accounts of Job Guarantee employees. The total amount spent would depend on the state of the wider economy – in a recession, when the private sector sheds jobs, the program would grow; and when the private sector is growing, rising incomes and wages would draw labour out of the program – but in any event, the amount spent would be the appropriate amount to maintain full employment. And as issuer of the Australian currency, the Australian Government can always afford whatever is for sale in Australian dollars, including unemployed labour.

The Government's role in the elimination of wasteful unemployment is occluded, however, by misconceptions about the Government and money. The Finance Minister perpetuates them when he writes:

the overarching obligation of politicians is to the taxpayers who fund us. Governments do not actually earn, own or generate any money of their own. Our funds only exist because we tax the labor and efforts of our citizens and businesses. They keep their part of the social contract by entrusting us with this money.  We need to keep ours by using it wisely. [Emphasis added.]

This does not reflect the true position of the Australian Government, and it hardly reflects that of the NSW State Government either (which does not issue currency, and which does spend monies raised by taxation, but which is nonetheless part of a federal system that has placed the power to issue currency with the Australian Government and which gets a bit less than half its funds directly from the Australian Government).

Taxpayers do not 'entrust' money to government. They give it up, more or less willing, as part of participating in an economy with a sovereign currency. Government keeps its part of the bargain by using its special role as issuer of the currency to allow all citizens to participate and contribute, through work, to the wealth of the whole community.

Labour Day

Of course, it's also Labour Day. As a thought for the day we offer a quote from John Maynard Keynes, on employment and government spending. It's as relevant today as when he wrote it, in 1929.

The Conservative belief that there is some law of nature which prevents men from being employed, that it is ‘rash’ to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years.

The objections which are raised are mostly not the objections of experience or of practical men. They are based on highly abstract theories – venerable, academic inventions, half misunderstood by those who are applying them today, and based on assumptions which are contrary to the facts . . .

Our main task, therefore, will be to confirm the reader’s instinct that what seems sensible is sensible, and what seems nonsense is nonsense. We shall try to show him that the conclusion, that if new forms of employment are offered more men will be employed, is as obvious as it sounds and contains no hidden snags; that to set unemployed men to work on useful tasks does what it appears to do, namely, increases the national wealth; and that the notion, that we shall, for intricate reasons, ruin ourselves financially if we use this means to increase our well-being, is what it looks like – a bogy.

Read more about contemporary proposals for a government-funded Job Guarantee in the series of posts, beginning here, at New Economic Perspectives.

NSW Land and Housing Corporation: receipts and payments

Our recent post about the Millers Point social housing sell-off triggered a discussion in the comments section about the NSW Land and Housing Corporation's finances. Let's have a look at LAHC's most recent (2012-13) annual report, and particularly its statement of cash flows (page 31), to find out where LAHC's money came from, and where it went. 

First, the money going in (receipts).

In 2012-13, LAHC received, in total, $1.17 billion from its operating activities and investing activities. Most of this money – $762 million – came from tenants, in the form of rents and other charges (yes, social housing tenants pay money to LAHC, not the other way around).

The next largest source of receipts was sales of property, plant and equipment. Proceeds of sales came to $190 million, of which $152 million were from sales of residential properties.

In third place, government grants to LAHC came to $145 million. Of this, $19 million came directly from the Federal Government, the rest from the NSW Department of Family and Community Services... but at least some proportion of that State money came indirectly from the Federal Government, because it gives the NSW State Government about $400 million per year for various housing-related purposes under the National Affordable Housing Agreement. (And as an aside, Federal government money is not taxpayers' money).

Now, the money going out (payments).

'Property and residential tenancy' payments were the largest category – at $454 million – and include payments for council and water rates ($210 million) and repairs and maintenance ($203 million).

Next largest were payments for the purchase of property, plant and equipment: $265 million. Of this, $115 million was spent acquiring, redeveloping and building social housing.

And then there were payments for administrative and working expenses ($164 million), personnel services expenses ($55 million) and some smaller categories. Total payments: $1.04 billion.

So, at the end of the 2012-13 year, LAHC's total receipts exceeded total payments by $133 million. Add to that $30 million cash from the previous year, LAHC ended the year with $163 million in the bank.

It also ended the year with 1 328 fewer social housing properties (145 248 properties). The total value of its assets, however, was up $2 billion ($34 billion).

Some interesting points:

• Rents and other charges received from tenants ($762 million) were more than enough to cover all payments relating to operating activities ($726 million, being council and water rates, repairs and maintenance, admin, etc).
• LAHC received $152 million from the sale of social housing stock, but spent considerably less ($115 million) on purchases of new social housing stock.
• The Auditor-General elsewhere reports that in 2013 LAHC had a maintenance backlog of $317 million... yet it also had $163 million sitting in the bank.

NSW State Budget 2014: part 2 – where is the money coming from?

In his Budget speech, NSW State Treasurer Andrew Constance said:

0. The money to rebuild New South Wales must come from somewhere. Our best option is to recycle capital from our existing infrastructure. It doesn't place a debt burden on our children, or a tax burden on enterprise.
   

 
Does the NSW State Government need to get its money from somewhere? From the perspective of Modern Monetary Theory, Treasurer Constance is... quite correct.

Unlike the Australian Government, which issues the national currency and so can never run out of it, the NSW State Government does not issue currency. This is a fundamental difference between the Australian Government and each of the State and Territory Governments. The NSW State Government is a currency user, and like other currency users, such as households and firms, the NSW State Government must finance its spending. It does indeed have to get money from somewhere.

Treasurer Constance indicates some of the ways in which the NSW State Government can finance its spending. Like other currency users, the NSW State Government can sell things it owns (the Treasurer's preferred method); it can also borrow money from financial institutions (which the Treasurer does not like doing). However, the NSW State Government has another means of getting money that's not available to households and firms: it can tax.

The NSW State Government uses money it collects through State taxes to finance its spending (unlike the Australian Government). This includes what it spends on interest on the money it has borrowed. It must be kept in mind, however, that the ability to raise money by taxation – that is, taking money from citizens by force of law – makes the State Government, in the eyes of lenders, a very safe prospect (AAA credited rated), and so it can borrow at lower rates than other currency users.

Which is why we find it baffling that the State Government should be so averse to debt that it won't borrow money to grow the stock of social housing... but is happy for community housing organisations to borrow for the same purpose, and will engineer intricate regulatory regimes and private sector consortia to try to make this happen, even though the State Government is innately better able to get cheap debt.  

Now let's look more closely at how the NSW State Government taxes.

The NSW State Budget predicts that for the coming year, 38 per cent of the NSW State Government's revenues will come from States taxes. (By contrast, 43 per cent will come from payments from the Australian Government; and the remaining 19 per cent will come from sales of goods and services, royalties, fines and other incomes.)

(NSW State Budget 2014, Budget Paper 2, Chapter 6)

And here's how NSW State tax revenue breaks down. The big three are: payroll tax (comprising 30 per cent of total State tax revenues), followed closely by transfer duty (AKA stamp duty – 24 per cent), then land tax (10 per cent).

(NSW State Budget 2014, Budget Paper 2, Chapter 6)

As well as raising revenue for the State Government, these taxes affect the behaviour of economic agents – in troubling ways.

Payroll tax is levied on firms at the rate of 5.45 per cent of the wages they pay to New South Wales employees above a threshold of $750 000 pa. Firms pay the tax, but because it increases the cost of putting employees on, it will cause some firms to choose not to put additional employees on, thus reducing demand for labour and hence labour's price – ie higher unemployment and lower wages. Not a happy result.

Transfer duty is levied on purchasers of property at rates applied to the value of the property bought; the rates apply progressively from 1.25 per cent up to 7 per cent on 'premium' properties above $3 million. Purchasers pay the duty, but because it otherwise increases the cost of purchasing a property, it will cause some would-be purchasers to bid less. Insofar as it discourages some would-be speculative buyers, that's a good result, but this effect also applies to other would-be purchasers, with unhappy results. In particular, people who just want to move house – to downsize, or to be closer to work, or to take up a job opportunity elsewhere – get punished by transfer duty, and as a result may not move. This makes the uses of property generally less efficient, contributes to long trips to work, and holds back economic opportunity. On balance, not a happy result.

Finally, there's land tax. Land tax is levied on owners of land at the rate of 1.6 per cent of total assessable land value above a threshold of $412 000 (increasing to two per cent on total values above $2 519 000). Land tax is levied annually, regardless of the amount of income – if any – the owner has derived from the land. This means the burden of land tax cannot be passed on by owners to the users of land (ie tenants), because owners cannot defer the liability while holding out for a higher price to cover it (contrast, say, a sales tax, which is payable only when the sale is made, thus allowing the vendor to hold out).

It also means that owners are encouraged to put land to productive use – or sell it to someone who will. This tends to discourage speculative hoarding and reduce the cost of land, making housing more affordable.

And, by its nature, land cannot be taken out of the jurisdiction or hidden – making land tax hard to avoid – and its supply cannot be reduced.

Finally, keep in mind that the increases in value that land tax gets at are increases that come from the economic development of the community generally (such as developments in transport infrastructure, and developments in uses of adjoining sites). Taxing these increases allows them to be 'recycled' for community use, rather than leaving them to accumulate, unearned, to the land owner.

These are the numerous happy results of land tax... the trouble is that we don't get anywhere near the full benefit of them, because of the defective way in which land tax is applied in New South Wales. Far too much land has been made exempt from land tax: in particular, land used for owner-occupied housing, which accounts for about 60 per cent (by dollar value) of the potential tax base. This undermines the discouragement of speculation in land and makes housing more expensive.

There's other problems too: the threshold is too high ($412 000 cannot be justified as an exemption for low-cost housing) and the increasing marginal rates discourage large institutions, such as super funds, from owning residential rental properties.

The NSW State Government should be making much greater use of land tax, both for the revenue it the Government needs, and the encouragement land tax – properly applied – gives to productive economic activity and housing affordability. The NSW State Government should broaden the land tax base to include owner-occupied housing, reform the structure of the rates, and replace other taxes that burden work and enterprise.

Read the TU's land tax policy here.

What do taxes pay for?

The report of the National Commission of Audit proposes a set of 'principles of good government'. One of them is:

Assure value for taxpayers’ money and ministerial responsibility. Governments spend taxpayers’ money not the government’s money.

(Chair of the Commission of Audit, Tony Shepherd)

This principle reflects the terms of reference given by the Australian Government to the Commission, which state that 'government should have respect for taxpayers in the care with which it spends every dollar of revenue'.

What do Australian Government taxes pay for?

Nothing, actually. From the perspective of Modern Monetary Theory, the Australian Government, as the sovereign issuer of a fiat currency, does not spend money raised by taxes.

The Australian Government spends by crediting the bank accounts of recipients of payments. This is effected by crediting the relevant banks' reserve accounts at the Reserve Bank by the same amount. These credits are accounting entries, created by keystroke.

When a person pays taxes to the Australian Government, they direct their bank to debit their account in favour of the Government and, in doing so, the bank also directs the Reserve Bank to debit its reserve account by the same amount. More keystrokes.

The Australian Government is not constrained by the need to have reserves of gold or another nation's currency at hand before it can spend. It doesn't need those debit keystrokes to happen before it can do the credit keystrokes. If anything, the rest of us need the Government's issuance of currency into the payments system before we can make the payments that discharge our tax liabilities, not the other way around.

Although they don't pay for anything, taxes are crucially important for the Australian Government and other agents in the economy, for a number of reasons.

First, taxes ensure that the Government's money will be used. If you're worried that the dollars in your bank account are nothing more than electronic figments of accounting, be assured that the Australian Government will accept them in payment for tax liabilities. If you don't pay taxes when they're due, you're in trouble. That's a good reason to go out and produce goods and services and get some of that money. And so will other persons, and being able to buy their goods and services is another good reason to get some money.

Secondly, taxation regulates aggregate demand. Taxes take money out of the economy – creating some space for the Government to spend on goods and services without having to bid up private sector spenders, and hence avoiding undue inflation.  

Thirdly, taxation redistributes the spending power of economic agents. Obviously, money is not distributed equally throughout the economy, and taxes take more from some economic agents than from others. Taxes do not redistribute in the sense that the actual dollars taken in tax get paid out again in payments, but they do change what taxpayers individually have to spend, and hence the distribution of spending power throughout the economy. 

Last and not least, taxes affect behaviour. Where an activity comes with a tax liability, people tend to do less of it: think of so-called 'sin taxes' that discourage the purchase of cigarettes and alcohol. And where one activity amongst several similar activities is treated preferentially (that is, it's lightly taxed, or not taxed at all), that activity is encouraged: think of the tax treatment of incomes and housing.

Interest from money in the bank is taxed; a gain in the value of owner-occupied housing is not – so people with money to spare are encouraged to put it into their housing, rather than the bank. Also, gains from capital are taxed at half the rate of incomes earned by work – so people are encouraged to find clever ways of turning their income into capital, such as borrowing to buy a (hopefully) appreciating asset (in particular, rental housing that's appreciating with the help of those owner-occupier who are encouraged to spend spare money on housing).

It should be said, governments have an ambivalent attitude to this function of taxation: as a matter liberal economic principle, rational individuals are best placed to decide what activities they'll undertake, and governments should not try to interfere in the decision – hence the dissatisfaction with 'inefficient' stamp duties, which are levied as a big hit upon the sale of a property, and can discourage people from selling when it would otherwise suit them to do so. By contrast, a tax like a broad-based land tax, levied on the unimproved vale of land, does not interfere with individual decision-making, except to generally encourage the productive use of land.

In any event, notwithstanding these matters of principle, the Australian Government does engage in behaviour-altering taxation a lot, as the distorted shape of our housing system shows.

All these things are what taxes do; what they don't do is pay for Australian Government spending. The Australian Government does not spend taxpayers' money. It really does spend 'government money', and the extent to which it spends that money for beneficial public purposes is a measure of our democracy.

What is a sustainable surplus?

Chair of the National Commission of Audit, Tony Shepherd, laments the widespread criticism of the Federal Budget. He says:

I wish people could... stand back, look at the overall picture of the Commonwealth budget and rather than say 'don't touch me', say 'what can be our contribution to a sustainable surplus'.

The terms of reference for Shepherd's Commission of Audit included that it 'make recommendations to achieve savings sufficient to deliver a surplus of 1 per cent of GDP prior to 2023-24.'

So what is a sustainable surplus?

There's probably no such thing, at least for the Australian economy. Government deficits are more sustainable than surpluses.

First, let's get clear on what a surplus is, and what a deficit is. Each refers to the government's net income over a period (a year). If the Australian Government's income (primarily taxes) is more than its spending, the Government is in surplus; and if its spending is more than its income, it is in deficit.

Of course, one person's spending is another person's income, so if the Australian Government is in surplus, everything that's not the Australian Government (households, firms, other governments) must, by identity, be in deficit.

(This means, incidentally, that rather than saying a government 'delivers' a surplus, it is better to say that it 'takes' or 'extracts' a surplus.)

We can narrow down that broad non-government sector by distinguishing an external sector (ie foreign households, firms and governments) from the Australian private sector.

For any given period, one (or two) of the three sectors can be in surplus – and two (or one) in deficit. Not all of them can be in surplus, or in deficit, at once. Their total surpluses and deficits for the period must net to zero.

In the case of Australia, what we pay to the external sector is nearly always more the income we receive from it (we have a current account deficit). With that in mind, when the Australian Government takes a surplus, the Australian private sector must be in deficit – paying out more than it receives in income.

The Australian private sector can do this by running down stocks of money accumulated in previous periods of Australian private sector surplus (that is to say, periods of Australian Government deficits).

This cannot be sustained for long. Theoretically, if the Government persisted bloodymindedly in taking surpluses year after year, the private sector would end depleting all its net financial assets, then start offering up real assets (houses, cars, the shirt off your back) to the voracious Government. More realistically, financially constrained households and firms would try to shore themselves up individually by spending less and saving more, thus reducing overall income and economic activity.

By contrast, when the Australian Government is in deficit, its spending is not financially constrained, because it issues the currency. With an Australian private sector that is inclined to save Australian dollars and other net financial assets, and an external sector of trading partners pleased to accumulate Australian net financial assets, an Australian Government deficit is the sustainable and appropriate way to promote economic activity.

Is government debt a burden on future generations?

The Treasurer, Joe Hockey, concluded his Budget speech and its agenda of cuts with an appeal to think of the next generation of Australians:

But unless we fix the Budget together, we will leave the next generation a legacy of debt, not opportunity.

As Australians, we must not leave our children worse off.

The Treasurer is talking about government debt. But is it really a burden on future generations?

Actually, no. In this admirably brief and clear article, Robert Skidelsky explains that while fears about one's own debts and legacies run deep, it really is wrong to apply them to government debt.

Says Skidelsky:

the national debt is not a net burden on future generations. Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable distributional consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be canceled or postponed, and houses, hospitals, and schools will not be built. Future generations will be worse off, having been deprived of assets that they might otherwise have had
Read more at http://www.project-syndicate.org/commentary/does-debt-matter#1PgjEUp3Mb2hH1w5.99

the national debt is not a net burden on future generations. Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable distributional consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be canceled or postponed, and houses, hospitals, and schools will not be built. Future generations will be worse off, having been deprived of assets that they might otherwise have had
Read more at http://www.project-syndicate.org/commentary/does-debt-matter#1PgjEUp3Mb2hH1w5.99

The national debt is not a net burden on future generations. Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable distributional consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be canceled or postponed, and houses, hospitals, and schools will not be built. Future generations will be worse off, having been deprived of assets that they might otherwise have had.

There are two sides to a debt. On one hand, it's a financial liability to the debtor. On the other, it's a financial asset to the creditor. That's the same for government debt (issued in the national money, as government bonds), which is a financial liability for the government, and a financial asset for bond-holders (and if you don't own a government bond yourself, you're probably in a super fund that does).

The practice of governments is to issue bonds that pay interest and, as Skidelsky says, this stream of interest income to the next generation of bond-holders, particularly if the Government feels the need to balance it with tax revenues, may be 'disagreeable' as a matter of the equitable distribution of income throughout society.

But the Government, as the issuer of a sovereign currency, is always able to pay this interest: as we discussed recently, it cannot run out of money. And for that reason, the Government could, as an alternative to issuing interest-bearing bonds, simply spend by issuing currency (that is, crediting the bank accounts of payees, via banks' reserve accounts at the Reserve Bank).

Spending, of course, has two sides too. Money spent by the Government is money received as income by the private sector. In the name of 'saving' money (that it cannot run out of), the Budget will reduce income to the private sector by the equivalent of 1.3 per cent of GDP relative to last year; that's $20 billion taken out of an economy that is growing below trend and in which labour is underemployed, and in which there are useful and productive things to be done and investments to be made. But with less money, as Skidelsky observes, less of that will happen, to the disadvantage of future generations.

*

It should be said: the Budget papers do not envisage such a reduction in activity in the wider economy. But if government spending is reducing, the Government's forecast levels of production can only be met by... a huge expansion of private debt. But can households – real households, not fallacious ones – incur much more debt, on top of their already massive burden of past promises to repay?

(Source: RBA Chart Pack – Household Sector.)

the national debt is not a net burden on future generations. Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable distributional consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be canceled or postponed, and houses, hospitals, and schools will not be built. Future generations will be worse off, having been deprived of assets that they might otherwise have had.
Read more at http://www.project-syndicate.org/commentary/does-debt-matter#1PgjEUp3Mb2hH1w5.99

 

Can the Australian Government run out of money?

The Federal Treasurer, Joe Hockey, is worried that the Australian Government is 'running out of money'.

From the perspective of Modern Monetary Theory, the Treasurer's worries are misplaced (he'll still have worries, just not this one). The Australian Government is centrally involved in the creation of Australian money, and cannot run out of it.

For all practical purposes, the money we use in Australia is Australian dollars. Anything that's for sale here can be paid for in Australian dollars, and just about all financial liabilities incurred here are accounted for in Australian dollars.

Australian dollars don't stand for anything else: not gold, for example, and not some other currency, such as the American dollar. (You can buy these things with Australian dollars, but you don't have the right to insist on your Australian dollars being converted into gold or $US, and there's no fixed price for either – it is up to you to find a willing seller and strike a bargain.) At the end of the day, one Australian dollar will always get you... one Australian dollar.

This means there's no necessary limit on the number of Australian dollars in existence. A relative few exist physically in the form of polymer notes and copper alloy coins; very many more exist merely as electronic entries in the accounts of the institutions – the banks, and the Reserve Bank of Australia – that make up our financial system. 

And this is where our money comes from. Money is created when banks advance it to someone; it is, so to speak, loaned into existence by clerks stroking keys on the banks' computers. Apply to a bank and, if you're creditworthy, the bank will keystroke up for you an agreed-upon number of electronic dollars (in return, the bank gets from you a promise: that you will pay, over time, that number of dollars, plus interest, to the bank). These dollars, so created, sit in an account to your credit at the bank, to be transferred to other persons' accounts, in payment for whatever you're buying.

Transfers between accounts at the same bank can be settled by the bank itself. To settle transfers between accounts at different banks, banks participate in the payments system operated by the Reserve Bank. This is effected by banks maintaining reserve accounts ('exchange settlement accounts') at the Reserve Bank. These reserves ensure that payments between banks can be cleared and settled. They, too, comprise electronic dollars – keystroked into existence by the RBA, to the credit of each bank.

If, at the end of the day, a bank needs more money in its reserve account, it can borrow from another bank (in return, the first bank promises to repay the money with interest). Banks with surplus reserves not lent to other banks earn interest on them from the Reserve Bank; these interest payments get keystroked into existence by the Reserve Bank. Alternatively, the bank can borrow reserves from the Reserve Bank's liquidity facilities, which will keystroke up for the bank the necessary dollars (in return for the bank's promise of repayment or transfer of assets).

Alternatively again, it may be that a bank cannot get those reserves, because it cannot make convincing promises of repayment (because its assets are lacking: eg a bunch of loan contracts with people who are a dubious prospect). If things are so bad that not even the Reserve Bank will lend to them, it's game over for this bank. People who have deposits with the bank will be in trouble too – but they may get their money back under the Government Financial Claims Scheme, under which the Australian Government will direct the Reserve Bank to keystroke up for the claimant the appropriate number of dollars in the reserve account of their (new) bank.  

The Australian Government makes and receives payments through the same payments system, using its bank accounts – the Official Public Accounts Group – at the Reserve Bank. To make a payment to someone, the Bank keystrokes a debit against the Government's account and keystrokes a corresponding credit to the reserves of the recipient's bank. The Government receives payments into these accounts too, but it does not need prior receipts for the bank to keystroke up a payment from the accounts. (Note that the OPAG has an overdraft facility – 'strictly limited' by the Reserve Bank, but really that's a limit on government by itself).

There's the polymer notes and the copper alloy coins that the Reserve Bank issues to banks for the purposes of cash withdrawals. When a bank asks for some of these forms of money, the Reserve Bank keystrokes the appropriate debit against the bank's reserve account; and when a bank returns notes and coins to the Reserve Bank, the latter keystrokes a credit to the bank's reserve account.

Ultimately, it is only Government payments that effect a net increase in reserves in the system. Individually, banks may need more reserves (because they've increased their lending and advanced more money to people) or have reserves to spare (because they've reduced the amount they've advanced), and can make transfers amongst themselves with no net increase in reserves; but when the system overall has advanced more money, the additional reserves can only come from the Government keystroking them into existence.

As you can see, the Australian Government creates money – Australian dollars – through its spending, its lending and crediting of reserves to banks, and its issuing of notes and coins, and there's no necessary limit to how much it can create. The Australian Government cannot run out of Australian money. It issues the currency.

You'll also notice that this account has not referred to the Government's ability to impose taxes or issue bonds – and in particular, we've not referred to either taxes or bonds as the source of the Government's money (because they're not). We'll return in future posts to taxes and bonds, and just what it is they really do in an economy such as Australia's.