Does the US government need to collect taxes in order to spend?

Does the US government need to collect taxes in order to spend?

For years now I have posed this singular question to people. Almost everyone answers, “Yes, of course!” They are wrong. The answer is no.

Even the seemingly best educated and most accomplished people in our country do not seem to understand how our financial system works. Corporate executives, engineers, doctors, lawyers, and even most bankers simply don’t get it. In my opinion, this singular issue is one of the most critical things for you to understand in our world today. Unfortunately, most simply do not. And that includes many politicians on both sides of the aisle.

What I’m about to explain may be difficult to get your head around because, on the surface, it doesn’t appear to make sense. It took me a long time to understand.

How can we spend money we don’t have?

There is absolutely no operational limit on the amount of money the US Federal government can spend. Read that last line again. The next time you hear someone say that America is on the brink of bankruptcy, take a deep breath and realize they don’t actually know what they are talking about.

Let's unpack this. In our own lives, we know that money must first be earned before we can make purchases. Of course, we can buy things with credit, which is a form of debt that at some point must be paid back. Towns need to collect our money through property taxes to pay for roads, schools, police, and other essential services. States must collect money through sales taxes and/or income taxes in order to provide things like healthcare and transportation. So, it would stand to reason that the Federal government is no different… but it is.

The Federal government can create its own money. This is why a default on our national debt is impossible, unless we simply decided not to repay it. US debt is denominated in US dollars. Existing debt can always be repaid with newly created money.

On September 11th, 2001 I was a grad student at Columbia in New York City. The tragic events that day dramatically changed how I understood the world politically.

At the same time, I was reading an economics textbook written by Ben Bernanke, future Chairman of the Federal Reserve, and taking a class on Monetary Policy—a real snoozer that was lightly attended by my classmates. Little did I know how that would profoundly change the way I understand the world economically.

Fast forward to 2008. As world financial markets plunged, Ben Bernanke led the charge to massively increase our government debt by printing hundreds of billions of dollars to combat the risk of deflation. He implemented an emergency monetary policy technique called “Quantitative Easing” (QE), which we are still living with today.

In short, we created an obscene amount of money–literally with strokes on a keyboard—and used that new found money to buy the very government bonds that we were issuing. Yes, we effectively borrowed money from ourselves. It was a radical idea at the time, but entirely possible because of how our fiat monetary system actually works.

This absolutely does not mean there are no consequences for excessive government debt. Regardless of our individual political affiliations, we know that being wasteful is not good. Just because we have the ability to spend money doesn’t mean we should. Waste and misallocation of resources has become a cancer in our government.

It is said that capital flows where it best treated. In order to attract and retain capital our country needs growth, productivity, low taxes, and stable inflation. When the outlook deteriorates, capital held in dollar denominated assets may be sold and reallocated elsewhere. As such, the exchange rate value of the dollar is effectively the governor of the system. During recessionary periods, temporary increases in government spending may be helpful to the economy, by partially offsetting reduced economic activity in the private sector. However, permanent increases in government deficit spending may lead to excessive debt levels that bring higher inflation. This can have a very negative effect on our economy and the dollar.

Politicians today have hijacked our economic system. They are debating spending plans that will cost trillions of dollars with no real understanding of how the underlying economic system actually works. These astronomical amounts would have made even Chairman Bernanke blush just a decade ago. Politicians are being told the first part, that we can in fact operationally spend as much as we want, but fail to comprehend the second part, that there can be major negative consequences.

You are probably reading this and asking yourself whether there is anything you can do about it? The short answer is YES. Start by calling your US Senators and Congressional representatives and asking them this simple question, “Does the US Government need to collect my taxes in order to spend money?” If they either don’t know the answer or cannot explain the consequences, then it’s time to vote for someone else to represent you in Washington.

Lincoln Power is a financial analyst and private investor who has been trading complex securities across global capital markets for over two decades. A graduate of Columbia Business School and College of the Holy Cross, he writes about politics, economics, and American culture.