Why can't countries print money to maintain their budgets instead of using taxes?

Question

Theoretically speaking, developed countries like the US could abolish all forms of taxation (short of taxes on imports, where applicable) and simply print as much money as necessary for the government to operate. This is already partially happening with the expansionary monetary policy. Such a move would save tens of billions of dollars as you could effectively shut down the IRS and save the country billions of hours in wasted productivity.

Has such an approach already been considered? If so, is it at least somewhat feasible in theory?

Answer 1

Society has been there and done that. It fails every time to exactly the extent it's tried (e.g. Germany in the 1920's, Zimbabwe currency).

The inflation aspect is by no means the only drawback.

Consider that printing money means that somebody now has a big pile of printed money. Whoever gets to spend that money gets to do so before it is inflated. As well, they get to spend that money without having to do anything beyond printing it. Or convincing the printer to give it to them. This represents a huge moral hazard. The temptation to hand stacks of fresh new bills to people to get favors is overpowering. The temptation to obtain those stacks of fresh new bills is also overpowering. It typically means that the people who control the printing press also control the country. In every detail.

For a while. Until the point that people can't manage to get enough bills to get food.

If something cannot continue then it will not continue. The only question is how it will stop. Some typical examples of how it stops are revolution, civil war, and war with neighbor countries.

Answer 2

This is both simple ("because inflation") and somewhat hard to answer without resorting to slightly non-trivial economic models.

Basically, if you have high expectation of inflation, you can get past a point of instability in relative simple models like Cagan's model of hyperinflation. What that essentially means is that you can't make any real "tax" income (more properly called seigniorage) that way once people expect to be taxed only that way, except by beating their expectations, i.e. devaluing the currency even faster than they expect!

And what's the problem with hyperinflation? Well, at some point shoe leather costs become overwhelming because people try to avoid holding the currency as much as possible. I.e. tax avoidance becomes currency-holding avoidance in your economy. In an open economy, where foreigners can also hold your currency, those shoe leather costs can be more mitigated (for the domestic economy) by burdening the foreigners if they have no better (currency) alternatives. E.g. one 2015 ECB working paper put the threshold at 2% for the Euro but cited another paper as finding 11% for the USD.

Besides that, there's also the point that taxes can be more explicitly targeted, e.g. you can tax "vices" like drinking alcohol, but causing hyperinflation might do who knows what to the latter. (People who despair might drink more.) Usually this is phrased as inflation being a "regressive tax" but that conclusion requires more assumptions, like for example that richer people would pay more often with credit than poor people would (for example because the rich have more collateral.)

But I'm gonna add here that this is not an either-or proposition (as the question makes it). Governments do sometimes pay a significant portion of their debts with inflation/seigniorage, in the long run, as this data on WW2 debts shows, for instance.

BTW, I should probably mention this concept/terminology distinction, since the Q does start with this assumption...

Inflation tax is the loss that is sustained by the holder of real money balances and non-indexed government bonds due to inflation. [...A]ssuming that the growth rate of money was equal to the growth rate of prices [...] is valid for a static economy. [... However] in growing economies governments can increase money supply by the product of the change in income and the income elasticity of the demand for money to satisfy the demand for higher balances without causing inflation. The newly issued money provides a revenue for the government. This is seigniorage and is quite different in concept from inflation tax.

Answer 3

1. First problem. Due to the reserve fraction of 10%, 90% of the money printing benefit would go to private banks rather than the federal government. That's rather easily fixable. Increase the reserve fraction to 100%. Then the government gets all the seigniorage value. This is called full reserve banking.

   • A side effect of full reserve banking is that banks stop paying interest on demand deposits and instead charge maintenance fees. An option to address this is a government system where the government borrows the money from the banks and pays interest.

2. Next problem. It's not enough money. The United States M2 measure increased only about $1 trillion over the last year. The federal budget was about $4 trillion over the same time period.

3. Printing money has its own costs. It's unclear though how much cost there would be.

4. Now, if you ask why can't they just print another $3 trillion over and above what is needed for M2, the answer is that it wouldn't work. That's where the inflation issue arises. Inflation has two subproblems:

   1. It is an implicit tax on those with savings. It makes savings worth less. But savings finance investment as well as things like retirement, so most countries want to encourage savings.
   2. Inflation is partially a problem of expectations. When people and businesses expect inflation, then they adjust their demands for things like salaries and sales to included the expected inflation. But that creates inflation. This means that inflation increases tend to be chronic. If something creates 5% inflation, it may well create 5% inflation every year. But then if you do the same thing that created the original 5% inflation, that's another 5% inflation or 10%. If you do that every year, inflation goes 5%, 10%, 15%, 21% (because inflation is multiplicative), 27%, 33%, 40%, etc.

To repeat, they don't do it because

1. It takes away banking profits such that ever bank would take a loss under the current way of doing business.
2. There's not enough money to pay the whole budget. An optimistic estimate is 25% and that may be high.
3. If they print too much money, it causes inflation.

One might argue that bankers are all a bunch of fat cats and deserve to make less money, but this proposal doesn't just make them less profitable. They quite clearly become unprofitable. Banks will either go out of business or change how they do business. Free checking will be replaced with fee-based checking. That will affect everyone with bank accounts, not just rich bankers.

Answer 4

Only taxing one thing, whatever it is, doesn't produce a very good tax base. People can avoid doing the thing that's taxed and do more of things that aren't taxed. This not only distorts the economy badly but it also means that the tax rate has to be fairly high to compensate for legal tax avoidance, creating even more of an incentive to avoid the tax.

This might work for a broad consumption tax like a VAT because it's hard to avoid consuming things. It kind of works for property taxes, but tends to seriously penalize people or businesses that require more property (such as farming). There's no way it could work for this kind of tax.

This tax is particularly bad to implement at such a high rate. It is effectively a tax on saving money so you can avoid this tax simply by not saving money. Not saving money is very easy. You can either consume wealth as quickly as you earn it or hold other kinds of investment assets instead of money. So there would be an immediate and rapid death spiral -- as the rate goes up, there's less and less saving, hence less and less revenue, hence a need for a higher and higher rate, and so on.

If you think about it, there's really no need to save money. For many people, they spend most of their income very close to the time they earn it, so they are already avoiding this tax. Wealthier people tend to hold most of their money in non-cash forms such as real estate, boats, airplanes, stocks, and so on. So they would already be avoiding this tax. Who would be paying it?

Quickly, the government-issued currency would simply be abandoned. The government would be printing money that nobody would accept, as happened in Zimbabwe.

Answer 5

Apart from the inflation issue, there’s a more subtle problem. One of the main reasons why government-issued money is widely accepted for payment is that people have to have some so that they can pay their taxes. US taxpayers have to have US dollars, and so you can be pretty confident that you’ll always be able to find someone who will take them from you in return for providing you with goods or services. With no taxes, this wouldn’t apply, and so the inflationary government currency would probably just cease to be used — the government couldn’t spend the money it was printing, because no one would accept it.