Garth Brazelton's key argument is as follows:
So what purpose does taxation at the federal level serve? Well, largely it's to modulate private spending demand. (I would argue a secondary but significant purpose is income redistribution to regulate economic inequality) When taxes rise, resources are taken from me, Indiana, and other entities that have limited funding sources because we don't control our own currency. Because of that, our spending demand shrinks. Contrarily, when taxes fall, resources are given to me, you, and Indiana, and our demand to spend some or all of that money rises. The fact that the government has changed the taxation level at the federal level need not have any bearing whatsoever on the federal decision to spend - it effects the private decision to spend greatly however, and in that way, regulates spending demand and inflation. This is a fundamental difference between the US government compared to individuals and States (and even the European Union countries like Greece that also do not have control of their own individual currency).This is a restatement of Functional Finance, which was developed by the economist Abba Lerner (for a longer discussion, see my primer).
However, in the comments Ramanan countered:
Imagine a economy with the government expenditure about $15 and average tax rate around 15% and the GDP around $100. And another with $20, 20% and $100. And both at near full output. For the first to have government expenditure at $20, it may have to wait for a while for productive capacity to go higher while the government increases expenditure from $15 to $20 over time. The other route is increase average tax rates, so that the government can spend more. So in that sense taxes fund expenditure. There is no need for making counter intuitive claims that taxes do not fund expenditure and so on. [emphasis added -BR]In other words, the Modern Monetary Theory version of Functional Finance is just "word play".
What Are The Operational Differences?
I do not think the observation that taxes do not "fund" expenditures is just word play. However, I do not think verbal argumentation will lead anywhere, rather we have to look at the operational differences between the points of view.
I now return to the article "Functional Finance vs the Long Run Government Budget Constraint" by Nick Rowe (which he wrote almost exactly three years ago, when this dispute previously rolled over the blogosphere).
Functional Finance says you only use taxes if you want to reduce Aggregate Demand to prevent inflation. The Long Run Government Budget Constraint says you use taxes to pay for past, present or future government spending. They sound very different. They aren't.The important dispute is about the long run government budget constraint, not the legalistic details of monetary operations. If the long run budget constraint holds, then taxes have to be used to pay for spending - eventually. And the mainstream view is that the budget constraint is binding.
There's a general principle in economics: first you eat the free lunches; then you look at the hard trade-offs. Functional Finance says "first eat the free lunches". The Long Run Government Budget Constraint says "then look at the hard trade-offs".
That's the underlying kernel of truth in Abba Lerner's Functional Finance (pdf) [see also his book The Economics of Control (pdf)]. And I don't know of any mainstream macroeconomist who would disagree. [emphasis added - BR] You use taxes only so you don't have to print money. When you get to the point that Aggregate Demand is high enough, so you start to worry about inflation, you use taxes to finance past, present, or future government expenditure precisely because you don't want to print more money and make inflation higher.
The economists who drove the development of Modern Monetary Theory reject the long run budget constraint, as they argue that the assumptions are too restrictive. (For example, Bill Mitchell on The Billy Blog has written extensively about this.) I am in agreement; the long run budget constraint to my eyes looks to be either trivial or wrong. It does not act as a binding constraint within models that properly model fiscal policy within a welfare state.
And once the governmental budget constraint is rejected, the concept of taxes paying for spending is nebulous. There is a large gap between spending and taxes, and the gap grows in line with the economy.
Importantly, the effect on demand depends upon the form of the tax. Although many free market economists will probably disagree, I argue that taxing poor people has a much greater impact on demand than taxing the rich or corporations. If the weight of the aggregate tax burden was shifted back towards corporations and the wealthy*, the government would need to raise more money in order to have the same effect on demand. (And Japan is about to find this out the hard way with its sales tax hike - again.)
Therefore, the government cannot judge its fiscal stance solely by the amount of money it raises by taxes, it also has to consider the mix of taxes. Such a statement world be hard to reconcile with a simplistic view where the role of taxes is solely for financing expenditures. As such, I do not view the argument as being just a question of semantics.
* Although income taxes are mainly paid by the rich, payroll taxes (such as Social Security) are an extremely important de facto tax that are mainly paid by the broad working population. Deductions for government pensions are only disguised taxes, as I discuss here.