As a supplement to my article from earlier regarding the operational reasons why federal taxes are not revenue, today, I wish to briefly touch on further operational realities of federal taxation and bond sales and why they are veils that only obscure the underlying reality of how federal spending works.
The first and most pernicious of these veils surrounds taxation. “Federal taxes are revenue for the federal government” is the mantra. That’s a lie. One way that the illusion is made to seem real is through the assistance of tax accounts. The US Treasury maintains what are called TT&L accounts in various commercial banks into which, ‘tax dollars’ can flow. These accounts are altogether unnecessary, forcing some dollars collected in taxation to run an obstacle course prior to being destroyed, and that obstacle course only serves to reinforce the belief that government is actually spending tax dollars. In short, it is a ritual that the federal government chooses to perform prior to destroying what it has collected in tax. Since the public assumes that actual US dollars (High Powered Money or “HPM’) are held in bank accounts, which is totally false, the public is assured that if the federal government is depositing ‘tax dollars’ into a bank account, it must necessarily be doing so for a reason: it is going to spend those dollars. Wrong.
What is not mentioned is that the Treasury maintains operating accounts at the Federal Reserve which sit outside of the private banking system entirely. HPM sits in reserve accounts held at the Fed. When the Treasury withdraws dollars held in TT&L accounts, HPM (government money) is debited from those commercial banks’ reserve accounts and is destroyed by deleting HPM from the private banking system entirely, leaving the private sector with less HPM to settle transactions, or in laypersons’ terms, leaving the private sector fewer US dollars to spend.
When the HPM held in reserve accounts drops, the Treasury’s operating account then rises, recording the destruction of HPM through taxation. The US dollars destroyed are now accounted for. Nothing more. Again, keep in mind that the shifting of dollars (HPM) between reserve accounts does not add or subtract US dollars from the banking system. However, when the Treasury debits these reserve accounts, the dollars are subtracted; when the Treasury spends, dollars are added. So, then, if the federal government is spending these tax dollars held in TT&L accounts, why remove the reserves entirely from the banking system to its operating account first before spending? Why not just do like all other entities do and spend from their bank accounts held in the private sector?
Dollars collected in tax cannot be and simply are not spent by the federal government. If the Treasury did not remove these dollars from the banking system, major problems could arise. We will see exactly why this is. First, let’s look at bonds; tie the nonsense together and lift the veil so we can see precisely what is really going on.
Bonds are another ritual providing the illusion that borrowing to fund spending is required for the federal government. Bonds serve as a veil to mask how the federal government really spends. The Treasury is forced by Congress to issue bonds by placing them up for auction. Private entities then buy these bonds, and the amount of dollars used to buy bonds are then recorded in securities accounts, which are savings accounts held at the Federal Reserve. If $5 million in bonds were sold, $5 million is then recorded in securities accounts held at the Fed. If we now recall how reserve accounts work, this means that $5 million in reserves once held in reserve accounts shifted over to savings accounts and so, there is now $5 million less for the private sector to spend. The Treasury then spends by going into various individual bank accounts, crediting them, and HPM is injected into reserve accounts. When it does this, reserves held by the various banks at the Fed then rise again, thus replacing the HPM removed from reserves through bond sales. At this point, you should now be thinking, “What a totally absurd waste of time. Why not just spend?”
Instead of doing its job and just spending dollars into the non-government sector, the federal government first “prepares” to spend. Like someone with Obsessive-Compulsive Disorder, it must perform a series of rituals. After performing this complex, unnecessary series of rituals, only then can it do what it could have done anyway without the rituals and feel safe that no misfortune will befall it. Now then, back to the tax question.
So, here’s the Treasury removing HPM from reserve accounts, effectively reducing the amount of US dollars available for the private sector to spend. Why then remove the dollars?
People fail to understand that both the Treasury and the Federal Reserve work together. They are the Consolidated Federal Government. The Federal Reserve, in addition to being the central bank, must also conduct monetary policy, which is the setting of a target interest rate and then defending that target. Sometimes, a bank will be short of its required reserves. Instead of going to the Fed and getting them, it seeks to borrow reserves from other banks who are willing to lend them their excess reserves. Competition for reserves between banks drives down the overnight rate, which in turn affects the Fed’s target rate. If the Fed doesn’t wish to lose control of monetary policy, it must use treasury bonds to drain off the excess reserves. The Fed goes into a reserve account and destroys HPM, replacing it with a US Treasury bond, thus effectively draining off the excess liquidity and defending its target rate.
When the Treasury taxes, it deletes HPM from reserve accounts; thus, the HPM held in reserve accounts drops. When the Treasury spends, it adds HPM to reserve accounts; and so, HPM held in reserve accounts rises. Were the Treasury not to remove HPM from the banking system and instead spent the “tax dollars,’ plus continued to deficit spend, then HPM held in reserves would rise system-wide. The competition for excess reserves between banks would then drive the overnight rate down, forcing the Federal Reserve to drain off the excess to maintain control over its target rate. If such a situation persisted, eventually the Fed would have to intervene continuously until it ran out of bonds, thus necessitating the Treasury to issue bonds on a persistent basis so the Fed could drain off the excess reserves. A way to avoid such a ridiculous scenario is if the federal government destroys HPM, which it does! So, when the Treasury removes tax dollars from tax accounts and destroys HPM, it is doing nothing more than assisting the Federal Reserve with its mandate to conduct monetary policy. Like the Fed, it destroys HPM, performing a reserve drain, so the Fed doesn’t have to.
This reserve drain called “federal taxation’ conducted by the US Treasury then allows the Treasury room to continue spending.
The reality is this: The Federal Reserve could maintain a zero interest rate policy and the federal government could stop issuing bonds and just spend dollars into existence and tax them out of existence, which is precisely what it does right now. Bonds and tax accounts only obscure the reality.
In short, bonds and tax accounts are a sham; they are rituals designed to hide the fact that the federal government can always issue US dollars easily, harmlessly, and willfully without the need for bonds or taxation as revenue and that the federal government also taxes US dollars out of existence. Bonds are issued exclusively to establish and maintain a particular interest rate that the federal government wishes to see.
However, treasury bonds, in the political context, are nothing but corporate welfare. Congress demands that the Treasury issue bonds because bond markets and corporations demand them. These entities then use public funds to manage their risk and engage in speculative investments.