February 26, 2020 / 3:49 PM / a month ago

Breakingviews - Hadas: Wealth tax offers low-risk test of MMT

LONDON (Reuters Breakingviews) - Modern Monetary Theory is flavour of the month in American political economics. Wealth taxes are also in style. The second is a good way to test out the first.

Democratic 2020 U.S. presidential candidate and U.S. Senator Elizabeth Warren (D-MA) speaks at a "It’s Our Time: Women with Warren" campaign event in Charleston, South Carolina, U.S., February 24, 2020.

A little background is needed to understand why. Start with the ambitious claims of MMT. Actually, it is best not to start with the proponents’ most prominent idea, that large-scale government borrowing can help the economy. That statement is still controversial, even though the British economist John Maynard Keynes is widely lauded for saying as much in the 1930s.

Stephanie Kelton – professor at Stony Brook University, leading MMT populariser and adviser to Democratic party front runner Bernie Sanders – relishes big shortfalls. The title of her forthcoming book, after all, is “The Deficit Myth”.

However, MMT recognises that big fiscal deficits do not always do much good for the economy. Additional money in the system is wasted if it is basically invested in existing financial assets or used to pay for imports – the former pushes up prices, and neither enables investment for U.S. companies to improve their productivity or employ more workers to add to domestic consumption. The money created by the deficits run by the current administration in Washington may be going nowhere helpful. In that case, it will not help U.S. growth, and could create problems, especially when interest rates on the new government debt increase from current low levels.

The most daring argument of MMT, and of Keynes for that matter, is not actually about the potential harmlessness of large amounts government debt. It is about the positive role of well-spent money in the economy.

In brief, MMT claims that there is often not enough money circulating to realise all of an economy’s potential. In particular, governments cannot do their job well when they only redistribute money that is already circulating in the economy. Only by spending money that did not previously exist can they engage in the big projects that produce jobs for the hard-to-hire and infrastructure for the distant future.

Are Kelton and her fans right? The debate is interesting but inconclusive. It would be good to test the MMT thesis about the power of money without taking the risk of smothering the economy with government debt.

The simplest technique of debt-free government monetary expansion is printing money. More technically, substitute government money-creation for government borrowing. That is effectively what quantitative easing did. However, when central banks turned existing financial assets into new cash, the government had no control over how the newly created money was spent. Most of it stayed in the financial system, doing little economic good.

More direct money-printing makes sense, but is politically taboo. Kelton certainly does not play it up in promoting MMT. A wealth tax provides a more politically acceptable way for the government to spend more without borrowing more.

Of course, the idea of the government annually extracting a percent or two, or six, of the net wealth of the ultra-rich is controversial, especially among the ultra-rich. But it has now almost entered the Democratic party mainstream, largely thanks to publicity from Gabriel Zucman, an economics professor at the University of California at Berkeley.

Senator Elizabeth Warren, a presidential candidate who Zucman has been advising, wants a wealth tax primarily for political reasons, to crimp the power that is currently concentrated at the tippy top of the American wealth pyramid.

For example, if 6% of Michael Bloomberg’s fortune had been drained away every year, he would be worth a lot less than the current Forbes estimate of $62 billion. The fortune might even now be small enough that the entrepreneur and former New York mayor would have second thoughts about self-funding a multibillion-dollar presidential run.

While Warren is not much interested in the monetary effects of a wealth tax, they could be significant. After all, this extraction would effectively reverse what Keynes called the paradox of thrift. The British economist worried that when too much money goes to repay loans or buy financial assets via saving, an economy’s aggregate demand suffers because too little money is left over to pay for investment, consumption and hiring. By forcing the liquidation of financial assets, a wealth tax forces de-thrift, adding to the pool of circulating money.

It’s not easy to estimate the scale of the likely monetary stimulus from any particular level of wealth tax. The rich will try to dodge it, and some of the money it brings into circulation may eventually go back into economically unproductive savings.

Still, suppose the Warren campaign website’s estimate that her proposal will raise $3.75 trillion of additional tax revenues over a decade proves about right. If all of that money comes out of the sterile financial-asset part of the economy and stays in the fertile earn-and-spend portion, it will be the monetary equivalent of increasing the federal deficit by about 1.5% of GDP every year.

By the standards of some MMT enthusiasts, that might not sound like a big increase. But it is large enough to provide a significant test of the theory that more government spending can be good for the overall economy. And it would be debt-free.


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