Health Care Reform, Universal Coverage and Financial “Basics”
A Functional Finance Perspective
August 2008
Alla Semenova*
and
Stephanie Kelton **
* Ph.D. student at the University of Missouri-Kansas City and Partner in
Excellence with the Center for Full Employment and Price Stability.
** Associate Professor of Economics, University of Missouri-Kansas City
and Research Scholar, Center for Full Employment and Price Stability (CFEPS).
A Developing Consensus toward a Health Care Reform
Today, Americans pay for their health care in a number of different ways. They
finance it through skyrocketing out-of-pocket expenditures on health insurance
premiums, deductibles, co-payments, and co-insurance; through the uninsured
paying directly for care; through federal, state and local taxes; through
increased expenditures on goods and services as businesses pass their health
care expenses onto prices; through reduced real wages and declining non-medical
benefits that employers implement via a wage-benefits trade-off (Angell, 2003,
p. 2). However, the recent escalation in the costs of health care has made it
more difficult for employers to pass the costs of increasing premiums onto their
workers. Not so long ago, the average annual cost of an employee family plan was
$5,000. Back then, a 10 percent
annual increase in premiums “meant that the employer had to reduce the rest of
total compensation by $500”, something that “could be done relatively easily” by
increasing nominal wages less than
would be required for a full inflation-adjustment,
or by keeping the
nominal wages constant, thus reducing
the real compensation of an employee
(Enthoven and Fuchs, 2006, p. 1546). But health care costs have risen so much
that, today, a 10 percent increase in premiums adds an additional $1,000-$2,000
to employer’s costs (depending on location and generosity of health care
benefits). Passing these costs on to low- and middle-income workers “requires a
cut in the nominal wage, which
workers fiercely resist. The alternatives are only slightly more palatable: an
increase in the employee’s premium contribution, a larger deductible, or a
higher copayment” (ibid., 2006, p. 1546). Further, as a result of increasing
premium contributions, growing deductibles, co-payments, co-insurance, and
widening gaps in coverage, etc., employee take-up rates for employment-based
insurance have been declining. Given this shrinking enrollment pie, insurance
companies have tried to realize more profit per enrollee – a “strategy that
further exacerbates the affordability crisis and is difficult to defend”
(Schaeffer, 2007, p. 1557). In this “context of decreasing affordability for
employers and employees”, there is a broad concern that employment-based
insurance is no longer viable (Ginsburg, 2008, p. 675).
Moreover, physicians and hospital
administrators are getting “fed up with the present chaotic and costly system of
health care financing” associated with a multitude of health care plans and
insurance companies that they have to work with on a daily basis (Fuchs, 2007,
p. 1544). This multiplicity of
insurers forces health care delivery institutions to spend enormous amounts of
human and financial resources on administration and billing (more than twice as
much as in Canada). Besides, they have to maintain “expensive cost-accounting
systems to attribute costs and charges to individual patients and payers” (The
Physician’s Working Group, 2003. p. 799).
In addition, health care provider institutions hire armies of business
consultants, brokers, coding software vendors, and other satellite businesses to
help them organize and manage the multi-payer health care system (ibid., 2007,
p. 799)[1].
As Fuchs (2007) remarked, there may finally come a time when most physicians and
hospital administrators will admit that: “There must be a better way to pay for
health care” (Fuchs, 2007, p. 1544). In
fact, 15,000 reform-minded physicians, health care professionals and medical
students have already joined a prominent organization committed to a
single-payer health care system.
Realizing the inevitability of a major health care reform over the long-run,
Physicians for a National Health Program (PNHP) have developed comprehensive
proposals for the design and financing methods of a universal, comprehensive,
single-payer health care system in the U.S.
The General Architecture of the PNHP’s Proposal for Universal Coverage
As advocated by PNHP, a single-payer, non-for-profit, universal, comprehensive
health care system would rely on a single
public agency that would organize health care financing. At the same time,
the delivery of health care would remain largely
private, and patients would exercise
a free choice of a provider or a health care facility.
Note that such a system does not
amount to “socialized medicine”. The latter implies government
ownership of health care delivery
institutions. Rather, the universal health care system of the PNHP-type should
be properly called as “social insurance”
because the government’s role would be that of a
payer rather than an
owner and an executive (Bodenheimer,
2005, p. 1431).
As proposed by PNHP, to simplify hospital administration and virtually eliminate
billing (that currently consume almost one third of the nation’s health care
bill), health
care delivery institutions could choose to operate on a global budget received
from the government health care agency[2].
To eradicate the current practice of shifting the costs of capital expenditures
onto the health care bills, such budgets would be used
solely for
operating expenses.
All
capital expenditures would be
financed by the public health care agency. Because health care delivery
institutions would be proscribed from the current practice of allocating their
operating budgets for capital expansion, profit, excessive executive
compensations, marketing, etc., a single-payer global budgeting system would “shift
the focus of hospital administration away from lucrative services that enhance
the “bottom line” and toward providing optimal clinical services in accord with
patients’ needs” (PNHP, 2003, p. 800).
Salaried practitioners would be completely insulated from the financial
consequences of their clinical decisions, allowing them to focus on the
provision of the best possible care in accordance with their patients’ needs
(ibid., 2003, p. 800). Alternatively, health care delivery institutions could
choose to operate on a fee-for-service basis. To simplify administration and
billing, such fees would be billed to the public health care agency via a
simple, computer-based system, according to a negotiated formulary (ibid. 2003,
p. 800). Clearly, a fee-for-service
system carries a potential to be abused, leading to health care spending
inflation. From this perspective, global budgeting is a better way to organize
health care financing. Nevertheless, the experience of Western countries with
universal single-payer systems shows that there are effective ways to curb the
inflationary potential of a fee-for-service system of health care financing
(ibid., 2003, p. 800). .
Clearly, a universal, comprehensive single-payer health care system would
eliminate patient billing, premium contributions, deductibles, co-payments, and
co-insurance, etc. Covering every American for all medically necessary services,
this system would make health care a
right enjoyed by all citizens in
all developed countries.
The PNHP’s Response to the ‘Money Problem’
In the context of a health care reform debate, it is commonly argued that “the
problem with this developing
consensus for universal coverage is money”
(Lemieux, 2003, p. 2, emphases added).
Our nation cannot financially afford a universal health care system, - it
is frequently maintained. Against this
background, the PNHP argue that money
is not an obstacle for a national
health care system in the U.S. The problem is “not the money; it’s the system,”
– as Angell put it (Angell, 2003, p. 2). To begin with, money cannot possibly be
an obstacle for a health care reform in a nation that already spends the largest
amount of money on health care (both in absolute terms, per capita, and as a
share of gross domestic product (GDP)) compared to all other developed
industrialized countries (ibid., 2003). Consider that in 2007, the U.S. spent
$2.3 trillion or 16 percent of its GDP on health care, amounting to $7600 per
person (The National Coalition on Health Care, 2007). U.S. health care spending
is almost twice as high as the OECD average (15.3 percent of GDP vs. the OECD
average of
8.9 percent of GDP in 2006). While the U.S. spent 15.3 percent of GDP on health
care in 2006, health care expenditure in France, Germany, and Canada was between
10 and 11 percent of GDP (2006) (see exhibit 1 below for more details).While the
U.S. spent $6714 per capita on health care in 2006, Canada’s per capita spending
was only $3678, while the OECD average was $2824[3].
Compared to our multi-payer system of health care financing, the nations with
universal (or nearly universal) single-payer systems spend much less on health
care.
Exhibit 1
Source: OECD Health Data, available on
http://www.oecd.org/dataoecd/46/33/38979719.pdf
However, while the U.S. spends the largest amount of money on health care, this
does not translate into better health care indicators. To the contrary, credible
international comparative studies of infant mortality, life expectancy,
immunization rates, etc. show that the U.S. health care system underperforms
single-payer systems on these and other health indicators (Angell, 2003;
Schaeffer, 2007). For example, according to the World Health Organization, the
U.S. ranks thirty-first on life expectancy, thirty-sixth on infant mortality,
twenty-eighth and twenty-ninth on male and female healthy life expectancy,
respectively (Berwick et al., 2008, p. 759).
One of the implications of these comparative statistics is that health care
financing methods (e.g. single-payer vs. a multi-payer system) influence
both health care outcomes and costs.
Because this paper is primarily concerned with the
economics of health care, we will
narrow our further discussion to the relationship between health care financing
methods and health care costs (including their growth rates, i.e. inflation).
Exhibit 2
Source:
Hsiao, 2007, p. 958.
Exhibit 2 above compares growth rates in health care spending (as a percentage
of GDP) in the U.S., Germany, Canada and the U.K during 1970-2004. As Exhibit 2
demonstrates, the countries’ health care spending growth rates
diverged significantly in the
post-1970 period, while the largest growth in health care spending was
experienced in the U.S. According to Hsiao (2007), these developments imply that
health care financing policy (i.e. multi-payer vs. single-payer method) “can
play a major role in containing health spending inflation” (Hsiao, 2007, p.
958). The American multi-payer system financed by the U.S. employers,
government, individual out-of-pocket expenditures, health savings accounts, etc.
seems to carry a much larger inflationary potential compared to (predominantly)
single-payer systems in Germany, Canada and the U.K. (among other nations). As
Hsiao (2007) concluded, a “multichannel public and private health care financing
approach such as that used by the United States is unlikely to contain health
spending inflation” (ibid., 2007, p. 958).
Why is there a relationship between health care costs (and their growth rates)
and health financing policy? Why is
it that a single-payer health financing method is more cost-effective compared
to a multi-payer method? To begin with, this is
not because universal single-payer
systems offer worse and less health care to their citizens. On the contrary, as
was discussed above, single-payer nations boast healthier citizens with longer
life expectancies. Hence, skimping on care is
not the reason why universal
single-payer systems generate a smaller health care bill.
There are several economic reasons behind the cost-effectiveness of a
single-payer health financing method. Firstly, a single-payer system eliminates
the enormous administrative expenses associated with a system of multiple health
insurance providers. “The need for more
than 850 health insurance companies to sell and contract with millions of
employers, underwriting each one, adds greatly to the administrative overhead
costs” (Enthoven and Fuchs, 2006, p. 1541). These administrative costs typically
consume about 11 percent of the
health care premium, “and this does not include the costs to employers to
purchase and maintain health care spending, including armies of consultants,
benefit managers, and brokers” (ibid., 2006, p. 1541). Secondly, a single-payer
system (or universal social insurance) eliminates the expenditures for
advertizing, marketing and sales, etc. associated with a system of competing
insurance companies (Angell, 2003; HNHP, 2003). The
overall expenses associated with
administration, billing and marketing (advertizing, etc) consume almost one
third of the nation’s health care bill (Angell, 2003; Hsiao, 2007, p. 957).
The reason we spend more and get less than the rest of the world is because we
have a patchwork system of for-profit payers. Private insurers necessarily waste
health dollars on things that have nothing to do with care: overhead,
underwriting, billing, sales and marketing departments as well as huge profits
and exorbitant executive pay. Doctors and hospitals must maintain costly
administrative staffs to deal with the bureaucracy. Combined, this needless
administration consumes one-third (31 percent) of Americans’ health dollars[4].
Thirdly, a national, non-for-profit
health care system leaves no place for
exuberant profits made by insurance companies, drug and equipment
manufacturers, health care delivery institutions, and eradicates
exorbitant executive compensations.
According to PNHP’s estimates, out each health care dollar spent in the U.S., no
more than 50 cents actually reaches health care providers (Angell, 2003). This
means that out of $2.3 trillion health care dollars spent in the U.S. in 2007,
$1.15 trillion were consumed by profits, CEO compensations, administrative
expenses, advertizing, marketing, and sales promotion, etc.
Fourthly, as a monopoly purchaser of
health care services, drugs, equipment, etc., a single-payer system becomes the
cornerstone of cost-containment (control), as the experience of Canada and
European countries has demonstrated. For example, as a monopoly purchaser, the
national health care agency can exert substantial price pressure on
pharmaceuticals and equipment manufacturers, paying for their products based on
the costs incurred (excluding marketing, lobbying, etc.) rather than with the
aim of supporting exuberant profits and CEO compensations (PNHP, 2003a, p. 2).
Similarly, a national health care agency would negotiate and establish a
formulary for physician, hospital, and other medical fees, or allocate global
budgets to health care delivery institutions. Notably, global budgeting can play
an important role in cost containment by encouraging efficiency in the use of
health care resources. “In
contrast, relying on private insurance or direct out-of-pocket payment
decentralizes health spending and budget decisions to individual health
insurance plans and patients, respectively. In the latter case, providers can
practice cost shifting and price discrimination among different payers” (Hsiao,
2007, p. 959). They face a lesser
budget constraint and are less concerned about efficiency (ibid., 2007, p.
959).
Besides, unlike private insurance companies that are driven by profit
incentives, a national non-for-profit health care system has a direct interest
in rationalizing resource allocation (both real and financial) in such a manner
that more is spent on preventive care to reduce the incidence of illnesses and
to prevent chronic diseases “from becoming acute problems requiring costly
treatment” (ibid., 2007, p. 958). Viewed
from a patient’s perspective, the current health care system discourages
preventive care by imposing various co-payments and deductibles, etc. on
patients. This especially endangers the most vulnerable – the poor and those
with chronic diseases (NNHP, 2003, pp. 799 – 800).
Further, a single-payer system enables cost-control by moderating the diffusion
of new expensive technology and drugs that are not cost-effective (and in many
cases not really necessary to meet the patients’ needs). As a rule, the
diffusion of such technology leads to health spending inflation as medical
institutions attempt to pass their capital expenditures onto the patients’ bills
(ibid., 2007).
As PNHP argue, a single-payer system is the only way to recapture the enormous
financial and real resources consumed by administration, advertising, marketing,
exuberant profits and executive compensations, diffusion of new expensive
technology, price discrimination, lack of preventive care, etc. associated with
the current health care system. As the PNHP estimated in 2003, the potential
savings on paperwork alone would be enough to provide comprehensive coverage to
everyone without paying more than the nation already does (PNHP, 2003a;
Woolhandler and Himmelstein, 2002, p. 22).
Independent estimates by several government agencies and private sector experts
indicate that NHI[5]
would not increase total health care costs. Savings on administration and
billing, which would drop from the current 30% of total health care spending to
perhaps 15%, would approximately offset the costs of expanded services. Over the
long run, improvements in health planning and cost containment made possible by
single-source payment would slow health care costs escalation. (PNHP, 2003, p.
802)
Similarly, The Institute of Medicine (IOM) Committee on the Consequences of
Being Uninsured estimated that universal health insurance would boost health
care spending by just 3-6 percent (Newhouse and Relschauer, 2004, p. 180).
Against this background, consider that annual health spending inflation in the
U.S. is of the order of 4-5 percent (Aaron, 2007, p. 1630). Thus, universal
health insurance “is not costly” relative to U.S. current expenditures on health
care and their annual growth rates (Newhouse and Relschauer, 2004, p. 180).
As far as American workers are
concerned, a universal health insurance would actually lower their health care
expenses. As PNHP estimated, a 2 percent income tax that would replace
insurance premium contributions, deductibles,
co-payments, co-insurance and other out-of-pocket expenses would be far less
than what Americans pay under the present health care system. Similarly, for
those employers who currently provide decent health benefits, a 7 percent
payroll tax that would replace their current expenses on employees’ health would
be less expensive[6].
Based on such estimates, PNHP argue that the
problem with transition to universal coverage in the U.S. is not financial. A
national health care system would be able to provide a comprehensive coverage of
the entire American population without spending much more than the nation
already does. Rather, the problem is political, institutional, and ideological,
nurtured by a system of special interest groups supportive of the
status quo.
It will be argued in this paper, that an important aspect of the
political-institutional problem is the so called principle of ‘sound’ federal
finance, or an idea that federal budgets should be balanced over the course of a
solar year. It is a belief that
government spending is financed and, hence, constrained by public taxation and
government borrowing from domestic and foreign entities. It is a conviction that
persistent federal deficits and national debt are detrimental to a nation’s
economic and foreign security, and should be avoided.
This ‘sound finance’ framework places
the discussion of a health care reform in a context of “financial basics: taxes
and budgets”- the books have to balance before a national health care reform is
undertaken (Health Affairs, 2008, p.
621). Universal health care reform is ‘unaffordable’, - it is argued, - because
federal budgets have already plunged into deep deficits (Lemieux, 2003, p. 1;
Newhouse and Relschauer, 2004, p. 179). Besides, it is commonly claimed that a
universal health care system would further raise the nation’s health care bill.
As the above discussed demonstrated, this claim is unsubstantiated. To the
contrary, a universal, comprehensive, single-payer health care system is not
costly relative to what the U.S. already spends on health care (while it still
leaves 47 million uninsured). However,
even if (hypothetically), universal
health care largely increased our nation’s health care bill, thus causing
federal budget deficits to rise, -
we will argue, - that this is
not a ‘problem’ for a nation
operating with a sovereign currency in a flexible exchange rate regime.
To understand why this is so, the next section will introduce the framework of
Functional Finance as an alternative approach for the understanding and conduct
of government fiscal, budgetary and monetary policy. It will be argued that
rather than with money the problem
rests with ‘self-imposed’ constrains on government spending, such as a ‘sound
finance’ principle of balancing federal budgets, etc. Further in this paper, an
institutional and accounting analysis of modern government spending, taxing, and
open market operations (i.e. sales and purchases of government securities) will
demonstrate that taxes and bond sales do not serve as a ‘financing’ operation
for the government. Rather, they perform
quire different functions. It will
be argued that the ‘money problem’ imposed by the
dogma of ‘sound finance’ rather than
by the actual availability of finance is
the barrier to universal health care reform in the U.S.
Abba Lerner, Functional Finance, and the ‘Money-Problem’ Fiction
In the 1940s, Abba Lerner presented the
framework of Functional Finance as an alternative to then (and now) dominant
framework of Sound Finance. Both Functional and Sound Finance refer to a set of
guidelines (principles, ideas) that should govern federal fiscal, budgetary and
monetary policy. The central ideas of Sound Finance are well known to
economists, media experts, politicians, and general public.
Firstly, it is a belief that public
taxation provides the federal government with the ‘revenue’ it ‘needs’ in order
to spend on goods and services, and various social programs, etc. Secondly, it
is argued that once tax revenues fall short of the federal government’s
projected expenditures, the government
has to raise taxes and/or ‘borrow’ in order to obtain the extra funds it needs
to carry out its fiscal ‘over-commitments’. The supposition is that such
borrowing is performed via the sales of government securities (e.g.
Treasury-bonds) to domestic and/or foreign entities. The common presumption is
that ‘market forces’ determine the maximum quantity of debt the government can
issue (Wray, 1998). While most
‘sound finance’ adherents would agree that in
some circumstances (e.g. a deep
recession) it is inevitable that the federal government will run into budget
deficits and national debt, they would argue that persistent budget deficits and
national debt must be avoided (Wray, 1998, p. 74). The case of a financial
burden imposed on future generations is commonly evoked here: future tax-payers
will bear the burden of interest and principal repayment on government debt.
Similarly, the dreadful thoughts of diverting taxpayers’ money into interest
payments to ‘foreigners’ are commonly stirred in the public’s mind. To avoid
these threats to national economic and foreign security, - it is maintained, -
federal budget deficits and debt incurred during recessions must be offset by
surpluses generated during economic expansions (ibid., 1998, p. 74).
Indeed, we have become so accustomed to this ‘sound finance’ framework that any
alternative that might be presented to us may seem outrageous and absurd.
However, despite our strong feelings about the soundness of ‘sound
finance’, Lerner did not waver to present an
alternative approach to federal
fiscal, budgetary and monetary policy that he believed was a key to a nation’s
prosperity (which Lerner perceived as full employment and price stability). To
begin with, Lerner was guided by pragmatic ways of thinking about the conduct of
government policy. He believed that government policy should not be carried out
according to long-existing ‘preconceptions’, ‘norms’, or canons of what is
‘sound’ or ‘unsound’, of what is ‘proper’, of what ‘is done’ traditionally’,
but, rather, according to the effects
that the government policy would have on national prosperity (i.e. full
employment and price stability). Guided by these pragmatic, rather than
scholastic considerations, Lerner formulated a viable alternative to the ‘sound’
finance framework. He dubbed it as a ‘functional’
finance approach, rooted in the pragmatic maxim of undertaking government policy
actions “with an eye only to the results
of these actions on the economy and not to any established traditional
doctrine about what is sound or unsound” (Lerner, 1943, p. 39). In other words,
Functional Finance implies “the simple principle of giving up our preconceptions
of what is proper or sound or traditional, of what “is done,” and instead
considering the functions performed
in the economy” by government operations such as spending and taxing, selling
and purchasing government securities, creating and destroying money, etc.
(ibid., 1943, pp. 50-51).
In explicating the central ideas of Functional Finance, Lerner (1943) formulated
the two central pillars of this pragmatic approach. The first pillar is
concerned with the maintenance of full employment and price stability, which
Lerner believed were the primary responsibilities of the government.
“The first financial responsibility of the government … is to keep the
total rate of spending in the country on goods and services neither greater nor
less than that rate which at the current prices would buy all the goods that it
is possible to produce” (ibid., 1943, p. 40). If the total rate of spending is
above this level, there would be inflation, while in the opposite case (i.e. the
total rate of spending is less than that which is necessary to purchase all the
goods and services produced and imported) there would be deflation (ibid., 1943,
p. 40).
How can a federal government maintain the total rate of spending in the economy
at such a level that all the goods and services produced would be purchased?
In other words, how can a federal
government prevent inflation or recession? In
order to prevent recessions, - Lerner argued, - the government can spend more
itself or reduce taxes” (ibid., 1943, p. 40). Clearly, reducing taxes would
stimulate private spending by increasing the disposable income that the private
sector has available to spend. Increased consumer spending would stimulate new
investment, generating additional employment, additional income, leading to
further consumer spending, investment, income and so on and so forth. What is
less understood is that government spending, in particular,
deficit- spending, does not “crowd
out” private expenditure, but, rather, stimulates it by injecting net monetary
reserves into the economy. This is “for the simple reason” that in the case of
deficit-spending “the total value of checks issued by the Treasury to finance
expenditures would exceed the total value of checks written by the private
sector to pay taxes” (Wray, 2000, p. 14). In other words, the government would
inject more money into the economy
than it would drain from it via taxation, thus providing a net injection of
reserves into the private sector and increasing the disposable incomes of
consumers. This net injection of reserves is necessary to close the ‘demand gap’
(i.e. a situation when private spending is not sufficient to purchase all the
goods and services produced) that results from the private sector’s propensity
to save a portion of its income (Wray, 1998, p. 75). As Bell (1999) has put it,
the solution to the ‘demand gap’ problem is “to make it incumbent on the
government to cover the shortfall by spending enough to bring about full
employment” (Bell, 1999, p. 3). The corollary of such spending is a federal
budget deficit.
In the opposite case, i.e. when the level of spending in the economy is too high
(the public demands more goods and
services than can be produced and imported in any given period), this will cause
inflationary pressures. In order to prevent inflation, the total level of
spending in the economy has to be reduced. The government can achieve a reduced
level of spending “by spending less
itself or by raising taxes so that taxpayers have less money left to spend”
(Lerner, 1943, p. 40). The corollary of
such government actions is a federal budget surplus, i.e. a situation when tax
revenues exceed government spending or the “checks received by the Treasury
exceed the value of checks issued by the Treasury” (Wray, 2000, p. 14).
In sum, by increasing government expenditure and lowering taxes when the total
level of spending in the economy is too low; and doing the opposite (i.e.
reducing government spending and raising taxes) when the total level of spending
in the economy is too high, the “total
spending can be kept at the required level, where it will be enough to buy the
goods [and services] that can be produced by all who want to work, and yet not
enough to bring inflation by demanding (at current prices)
more than can be produced” (Lerner,
1943, pp. 39-40).
Notably, the implication of the first pillar of Functional Finance is that
raising taxes is not in any way
related to the government’s ‘need’ to obtain funds in order to finance its
purchases. In fact, increasing
government expenditures are accompanied by
reduced taxation when the total level
of spending in the economy is too low (i.e. there is a ‘demand gap’). Lerner
made it clear that rather than a ‘financing’ operation for the government,
taxation is a demand-management and inflation-control tool. Lowering/raising
taxes will increase/reduce aggregate affective demand to the required level of
spending (i.e. just enough to purchase all the goods and services produced)
removing recessionary/inflationary pressures. In the words of Lerner, when “the
rate of spending becomes too great, then
is the time to tax to prevent inflation” (Lerner, 1943, p. 43).
Taxation, emphasized Lerner, is “never
to be undertaken merely because the government needs to make money payment”
(ibid., 1943, p. 40). As a demand-management and inflation-control tool,
taxation should “be imposed only when it is desirable that the taxpayers shall
have less money to spend, for example, when they would otherwise spend enough to
bring about inflation” (ibid., 1943, p. 40).
Ironically, the usual objection to the Functional Finance framework is that its
implementation will prove inflationary. “Indeed,
this is a standard (i.e. mainstream) argument against expansionary fiscal
policy” (Bell, 1999, p. 7). However, this objection is fundamentally at odds
with the Functional Finance framework the central idea of which is to make it
incumbent on the government to prevent and control inflation. As was discussed
above, this is achieved by increasing taxes (and, hence, reducing disposable
income) when the total level of spending in the economy is too high, thus
causing inflationary pressures. Rather than causing inflation, then, Functional
Finance is on strong guard against it (Lerner, 1943, p. 48). Moreover, as Bell
(1999) notes, the mainstream inflationary argument against Functional Finance
applies to an economy that operates at
full employment (Bell, 1999, p. 7). Yet, Functional Finance applies to an
economy that operates at less than
full employment level. The central aim of Functional Finance is
to bring the economy to the level of
full employment (through government fiscal and monetary policy).
Once the level of full employment has
been attained, Functional Finance precludes
any additional spending (ibid., 1999,
p. 7) because it would likely “cause inflationary pressures – except in the
unlikely case that all additional income represents desired net saving” (Wray,
1998, p. 84). Hence, as Bell (1999) concludes, as a basis for a critique of
Functional Finance, the inflationary argument “is not very compelling” and
“appears to be wholly incompatible with the theory of Functional Finance” (Bell,
1999, p. 7).
As the above discussion implies, Lerner was well aware of the fact that to bring
the economy to the level of full employment, persistent federal deficits would
be required. However, Lerner did not
view them as an economic threat to a nation. Rather, he fully realized that due
to the public’s propensity to save a portion of its income, federal budget
deficits are a practical and theoretical “norm” in capitalist economies. Federal
deficits are required to fill the ‘demand gap’ and maintain the necessary level
of spending (Wray, 1998, p. 82-3). The adherence to this norm is vital for a
well-functioning and prosperous economy. Thus, Functional Finance rejects the
traditional doctrine of ‘sound finance’ or the principle of balancing the budget
“over a solar year or any other arbitrary period” (Lerner, 1943, p. 41). Lerner
recognized that there was no reason to suppose that the attainment of prosperity
in a demand-constrained economy would “necessarily balance the budget over the
decade any more than during a year or at the end of each fortnight” (ibid.,
1943, p. 42). Because “money is a creature of the state”, Lerner argued (1947,
p. 313), the federal government could create as much money as needed in order to
deficit-spend and stimulate the economy by filling the ‘demand gap’.
But, as Lerner noted, the continued application of government deficit-spending
in order to achieve full employment would produce “an automatic tendency for the
budget to be balanced in the long run as a
result of the application of
Functional Finance, even if there is no place for the
principle of balancing the budget”
(Lerner, 1943, p. 42). As was noted above, because government deficit-spending
injects net monetary reserves into the economy, it increases disposable incomes,
stimulates consumer spending, generates new investment, employment and furthers
economic growth (Wray, 1998, p. 84). As private spending and investment keep
growing, the ‘demand gap’ narrows, and government deficit keeps contracting. At
the same time, economic growth keeps tax revenues rising, further reducing the
size of the federal deficit. Ultimately, the budget will be balanced or even in
surplus, even though this is not the
goal, but a by-product of persistent government deficits aimed at attaining full
employment and price stability (Lerner, 1943, pp. 48-9).
This increase in private spending makes it less necessary for the government to
undertake deficit financing to keep total spending at the level which provides
full employment. When … private spending is enough to provide the total spending
needed for full employment, there is no need for any deficit financing by the
government, the budget is balanced … (ibid., 1943, p. 49)
The second pillar of Functional Finance dismisses the conventional notion that
the sales of government securities (e.g. Treasury bonds) are undertaken as a
‘borrowing’ operation by the government once it runs out of tax revenues and
becomes fiscally ‘over-committed’. Rather,
Lerner argued that the government should sell Treasury bonds
only when the overall level of
reserves in the banking system is excessive, threatening to bid the interest
rate below its desired level (via the attempts of the holders of money balances
to lend them out) (ibid., 1943, p. 40). This means that rather than a method of
borrowing, the sales of government securities serve as a reserve- and
interest-rate maintenance operation (Wray, 1998; Bell, 2000). We will further
address this point from the perspective of modern banking and federal finance.
Clearly, the balance sheet effect of the government sales of securities (e.g.
Treasury bonds) is an increased level of national debt. However, this is a mere
accounting effect, that presents “no danger to society, no matter what
unimagined heights the national debt might reach” (Lerner, 1943, p. 42). This
holds true as long as the national debt is denominated in a national, sovereign
currency, with a flexible exchange rate. In this case, the government can always
create money to pay the interest and the principal on its debt (Lerner, 1947, p.
313). Taxation, Lerner argued, must never
be undertaken with the purpose of collecting ‘funds’ in order to ‘repay’ the
government’s debt (Lerner, 1943, pp. 42, 50). Recall that taxation is a
demand-management and inflation control-tool, rather than a financing method for
the government.
Lerner realized that unlike individual’s spending that is constrained by his/her
budget and the ability to incur debt, there are no
inherent financial constraints on the
levels of debt and deficit that a sovereign government can incur.
Because a sovereign government spends by issuing its own IOUs, the only
constraints on its spending can be institutional (e.g. regulations, accounting
rules, etc.). Such constrains are not
inherent financial constraints, but institutional limitations imposed by
people (we can call them ‘self-imposed’ constraints) (Wray, 1998). They are “of
necessity arbitrary” and “can be finessed and changed” (Wray, 1998, p. 84).
However, this is not to imply that such constraints may not be politically
necessary (Wray, 2000, p. 4).
Government might well enact provisions that dictate relations between changes to
spending and changes to taxes revenues (a balanced budget, for example); it
might require that bonds are issued before deficit spending actually takes
place; it might require that the treasury have “money in the bank” (deposits at
the central bank) before it can cut a check; and so on. These provisions might
constrain government’s ability to spend at the desired level. However, economic
analysis shows that they are self-imposed and are not economically necessary –
although they may well be politically necessary. (Wray, 2006, p. 14)
Setting aside these ‘self-imposed’ institutional limitations, government’s money
is “a resource that is potentially unlimited in supply” (Wray, 1998, p. 84).
While Lerner (1943, p. 41) talked about ‘printing money’ in the 1940s, the ways
of government spending have changed since then. Modern governments do not have
to resort to ‘printing’ money in order to spend.
This will be discussed in the following section which analyzes the
institutional and accounting procedures by which the U.S. government spends. At
the same time, we will examine the real functions performed by taxation and bond
sales/purchases in modern nations operating with sovereign currencies in
flexible exchange rate regimes.
Government Spending, Taxing, and Open Market Operations in Sovereign Nations
Firstly, let us clarify the modern meaning of the term ‘printing money’. As Bell
(1999) explains, while the term ‘printing money’ is still habitually applied by
economists, it is used in a metaphorical rather than literal sense: “Economists
typically apply the term ‘printing money’ to the crediting, by the monetary
authority, of the fiscal authority’s checking account as a consequence of
purchasing its debt instruments” (Bell, 1999, p. 4). For example, think of the
Federal Reserve Bank (the Fed) crediting the checking account of the U.S.
Treasury after purchasing Treasury bonds. Rather than ‘printing’ money, this
operation involves a change in a number in the Fed’s computer system showing an
increase in the electronic balance of the Treasury’s checking account at the
Fed. In this way, the government is provided “with a self-constructed spendable
balance” (Bell, 2000, p. 612), while no ‘printing’ of money has actually taken
place. As Bell (2000) emphasizes, the sale of the Treasury bonds to the Fed that
accompanies such money creation “is simply an internal accounting operation”
reflected on the consolidated balance sheet of the government
(i.e. the sum of the Treasury’s and the Fed’s balance sheets with
offsetting assets and liabilities cancelling one another out).
Although ‘self-imposed’ or institutional
constraints may preclude the Treasury from creating all of its spendable
balances in this manner, there are no
inherent financial constraints to prevent it from doing so (Bell, 2000, p.
612).
Once the Treasury makes a decision to spend, it does so by writing a check on
its account at the Fed[7]
(ibid., 2000, p. 604). The recipient of the Treasury’s check will ‘cash’ it at
his or her bank by either withdrawing the money, or, which is more common, by
depositing the check into his or her account (Wray, 1998, p. 77). This increase
in the depositor’s account balance will be accompanied by the Fed’s credit to
the bank’s reserves (ibid. 1998, p. 77). In
this way, the Treasury’s spending provides a net credit of reserves into the
banking system. Note, that before the Treasury spends, the balance at its
account at the Fed “does not comprise part of the money supply or high-powered[8]
money, but that when it does, the
funds become part of the money supply (M1 if deposited into checking accounts,
M2 if into savings accounts, etc.) and
part of the monetary base” (Bell, 2000, p. 615). Thus, government spending
from the Treasury’s account at the Fed “creates an equivalent amount of new
money (M1, M2, etc., and high-powered
money)”, i.e. injects net reserves into the banking system (ceteris
paribus) (ibid., 2000, p. 616).
What if the Treasury decided to spend by writing a check on its account at the
Fed, but there was ‘no money’ in the Treasury’s account? Would the Treasury’s
check bounce? Clearly, this would never happen in the U.S. – a country that
operates with a sovereign currency in a flexible exchange rate regime, with
close coordination taking place between the Treasury and the Fed. “The Fed
would, as a matter of course, offer an overdraft to the Treasury, essentially
lending reserves as necessary”, i.e. in the full amount of the Treasury’s
check(s)[9]
(Wray, 1998, p. 116). Thus, the Treasury does not need to ‘have money’ in its
account at the Fed, as long as the Fed decides to clear the Treasury’s check(s)
by offering it an overdraft.
Because the Fed would always decide
to clear the Treasury’s checks, the implication is that the U.S. Treasury can
spend “before and without regard to either previous receipt of taxes or prior
bond sales” (ibid., 1998, p. 78). As a matter of fact, it would be practically
impossible for the Treasury to consistently carry out its spending in a
different manner. There are several reasons for that.
Firstly, consider that it is impossible to accurately determine in advance the
amount and the timing of tax receipts because they are received and processed
irregularly over the year (Bell, 2000, p. 605). This makes it impossible for the
Treasury to perfectly coordinate its tax receipts and expenditures (ibid., 2000,
p. 606). Secondly, the Treasury cannot, in principle, withdraw taxes from the
economy before it spends first (Wray, 1998, p. 78). Being “the only supplier of
fiat[10]
money”, the government cannot possibly receive in taxes the money it has not
provided to private sector in the first place (ibid., 1998, p. 78). This is
simply “a matter of logic”: “the
public cannot pay fiat money to the government to meet tax liabilities until the
government has paid out fiat money to the public (ibid., 1998, p. 80).
Government spending, then, determines the amount of money that is available to
pay taxes, rather than the amount of tax revenues determining the extent of
government spending, - as is commonly argued (ibid., 1998, p. 81).
As Wray (1998) put it, the “government certainly does not need to have
its own IOU returned before it can
spend; rather, the public needs the government’s IOU before it can pay taxes
(ibid., 1998, p. 116).
Thirdly, one should understand a purely technical (accounting) matter that the
Fed’s notes and reserves are booked as liabilities on the consolidated
government balance sheet, and that these liabilities are extinguished once they
are paid to the state in the form of taxes (Bell, 2000, p. 614). In other words,
once the state accepts its own money in payment of taxes, an equivalent amount
of government liabilities is eliminated from its balance sheet, or simply
destroyed (ibid., 2000, p. 614). More specifically, when demand deposits are
used to pay taxes, the bank money (M1) is destroyed, while “the government’s
money, high-powered money, is destroyed as the funds are placed into the
Treasury’s account at the Fed” (ibid., 2000, p. 615). Viewed from this
perspective, - argues Bell (2000), - the proceeds from taxation “cannot possibly
finance the government’s spending” because “the government must [first] destroy
what it has collected” (ibid., 2000, p. 615).
Clearly, government expenditures cannot be funded by money that is
destroyed when it is received in payment to the state (ibid., 2000, p. 615).
Similar to taxation, the sales of Treasury bonds to the private (including
banking) sector ultimately lead to the destruction of high-powered money (ibid.,
2000, p. 616). This means that neither bond sales nor taxation can be viewed as
a ‘financing’ operation for the government. Rather,
they perform quite different functions. As was discussed above, taxation serves
as a demand-management and inflation-control tool due to its power to remove
excess monetary reserves from the private sector. Draining excess reserves via
taxation reduces disposable income thus curtaining aggregate demand and removing
inflationary pressures.
Yet, there is another function performed by taxation that we have not discussed
yet. Think of why the public accepts the
government’s money which has no intrinsic value (and is not backed by any asset
with an intrinsic value, e.g. a precious metal)? According to the Chartalist
perspective in the tradition of G. Knapp, A. Lerner, L. R. Wray, S. Bell[11],
et al., the
primary reason the public accepts the
government’s currency is because the public’s
liabilities to the government are
denominated and must be extinguished in that currency.
All of us are well aware of those liabilities called taxes. Hence, the
argument is that the function of
taxation is to create the primary
demand for the otherwise worthless[12]
government money. In other words, the
primary reason for the public’s
acceptance of the government’s money in payment for goods and services (both in
private exchanges and transactions with the government) is the need on the part
of the public to obtain the government’s money in order to pay taxes.
… without the tax system to underlie demand, it is difficult to imagine that the
public would continue to use HPM[13]
in private exchanges, and even more difficult to imagine that the public would
sell things to the government in exchange for HPM, if HPM were not needed to
make payments to the government. (Wray, 2000, pp. 9-10)
However, this argument should not be mistaken as an argument about the
only reason for the public’s
acceptance of government’s currency. Clearly, there are other motives, such as
the stability of a currency over time, the trust in the government, etc. that
induce the public to accept and hold a government’s currency. The argument is,
rather, that if the tax system were removed, the government would
eventually discover that the private
sector is no longer willing to accept the government’s money in payment for
goods, services, and assets[14]
(Wray, 1998, p. 81).
In sum, the primary function of
taxation is to create demand for government money. To achieve its purpose, the
“tax burden must be sufficiently great” (ibid., 2000, p. 9). Beyond that,
taxation is used to drain excess reserves from the economy
in order to mitigate inflationary
pressures that would result if the disposable income were beyond the level
required to purchase all the goods and services produced (and imported) (ibid.,
2000, pp. 9-10). Alongside its inflation- and aggregate demand- management
function, taxation serves as a reserve-maintenance tool for the banking system.
Let us now turn to the real function performed by the sales and purchases of
government securities, e.g. Treasury bonds (also known as ‘open market
operations’). Above we mentioned that open market operations perform a reserve-
and interest-rate maintenance function, however, we did not provide a detailed
discussion of this important point. We aim to pursue this discussion below.
Firstly, it should be noted that banks are required by law to hold reserves
against a certain fraction of their deposits (called ‘required reserve
balances’). However, banks earn no interest on reserves held in excess of the
required amount. Therefore, banks will normally prefer not to hold substantial
excess reserves. Rather, they will attempt to eliminate the excesses by trying
to lend them out to each other in order to earn interest. For this purpose, the
‘federal funds market’ is the “market of first resort” (Bell, 2000, p. 606).
How could a situation of substantial excess reserves result within the banking
system? In other words, what could be the source of these excessive non-interest
bearing reserves that the banking system normally does not wish to hold? The
most important source of these excessive monetary balances is government
deficit-spending (on goods, services, social programs, etc). Recall that
deficit-spending injects net reserves into the banking system. This normally
leaves the banks with more reserves
than they need or prefer to hold (Bell, 2000).
While the fed funds market may help some individual banks eliminate their excess
reserves by lending them out, this market cannot help the banking system
as a whole to rid itself of excessive
reserve balances. Rather, the attempts by the banks to lend out excessive
reserves will put a downward pressure on the fed funds rate, ultimately leading
to a zero percent bid (Bell, 2000, p. 606; Wray, 1998, p. 86). However, the
maintenance of a targeted level of the fed funds rate (also known as the
‘overnight lending rate’) is a primary focus of monetary policy. This rate is of
paramount importance because it serves as an “anchor for all other interest
rates” (Bell, 2000, p. 606, citing Poole 1987, p. 11). With a fed funds rate
target set by the monetary authority, it becomes largely non-discretionary for
the Fed and the Treasury to intervene into the fed funds market to prevent the
overnight lending rate from falling below its targeted level when the banking
system is flush with excess reserves. Clearly, to prevent the fed funds rate
from falling below its policy target, excess reserves have to be drained
from the banking system. This is
achieved through the sales of the Treasury bonds which serve as an
interest-bearing alternative to non-interest bearing reserves that the banking
system attempts to eliminate[15]
(Bell, 2000, p. 606; Wray, 1998, p. 86). In order to purchase Treasury bonds,
commercial banks draw on their accounts at the Fed, while the Fed transfers the
proceeds to the Treasury’s account. In this way, the purchases of Treasury bonds
by commercial banks drain reserves from the commercial banking system (Bell,
2000, p. 612).
This analysis clearly demonstrates that bond sales by the Treasury do
not serve as a ‘financing’ operation
for the government. Rather, open market sales by the government “are used to
coordinate deficit spending, draining what would
otherwise become excess reserves”
(ibid., 2000, p. 613). Government securities provide the private sector with an
interest-earning alternative to non-interest-bearing reserves, “allowing the
government to spend in excess of taxation without driving the overnight lending
rate down” (ibid., 2000, pp. 613-4). Another
interesting implication of this analysis is that, contrary to the conventional
view that government deficit-spending
raises interest rates, it actually causes the lending rates to fall
(as far as zero) by injecting excess reserves into the banking system
(Wray, 1998, p. 87).
What about selling government bonds to foreign entities (e.g. banks)? The answer
is that such sales perform exactly the same function as the sales of government
bonds to domestic entities, i.e. they drain excess reserves from the banking
sector by providing an interest-bearing alternative to non-interest-earning
reserves. The sales of U.S. government bonds to foreign banks drain excess
dollar-reserves from the foreign sector. As long as these bonds are denominated
in the U.S. dollars (i.e. our national fiat currency), “they do not entail any
‘risks’ that domestically held bonds do not hold”. The interest on such bonds
“can always be paid through creation of fiat money – just as any other
government spending is financed through creation of fiat money” (Wray, 1998, p.
88).
Now, while government deficit-spending injects net reserves into the banking
system, taxation achieves the opposite effect. When tax-payers write checks to
the Treasury by drawing on their accounts at commercial banks, this
drains reserves
from the banking system (Wray, 1998,
p. 80; Bell, 2000, p. 606). The loss of reserves through tax payments will leave
the banking system short of required or desired reserves. In this case,
commercial banks will turn to the fed funds market to
acquire the reserves they need to
meet their reserve deficiencies. Again, while some individual banks may be
successful in acquiring the extra reserves they need, a
system-wide shortage of reserves
cannot be eliminated through the fed funds market.
Rather, the overnight lending rate will
be bid higher, ultimately exceeding the fed funds target rate.
To prevent the fed funds rate from
rising above its policy target, the extra reserves will have to be
injected into the banking system. To
achieve this, the Treasury and/or the Fed will start
purchasing government securities
from the banking system, thus
injecting additional reserves into the system (Bell, 2000, pp. 606-7).
In sum, government spending/taxation disrupt the desired (or required) reserve
positions of commercial banks by injecting/draining reserves into/from the
commercial banking system. To eliminate excess reserves or alleviate reserve
deficiencies that would normally result from government spending or taxation,
respectively, the banks would turn to the fed funds market – their “market of
first resort”. However, the fed
funds market cannot eliminate system-wide
excesses or shortages of reserves, making it largely non-discretionary for
the government to intervene in order to maintain its fed funds rate target. In
the absence of government draining or injection of reserves, the overnight
lending rate would be bid below or above its policy target, further affecting
all other short-term interest rates (Bell, pp. 606-7; Wray, 1998, p. 78).
Viewed from this perspective, the sales
and purchases of government securities should be considered as monetary policy
operations, rather than fiscal policy operations (e.g. a ‘financing’ method for
the government) (Wray, 1998, p. 86-7). Likewise,
as Bell (2000) has argued, the debate over alternative ‘financing’ methods is
really a debate over the alternative ways of draining excess reserves (i.e.
taxation vs. bond sales) (Bell, 2000, p. 617). While taxation drains excessive
disposable income when aggregate demand is too high, thus causing inflationary
pressures; bond sales drain excess reserves from the commercial banking system
allowing positive overnight lending rates to be maintained (Wray, 1998; Bell,
2000).
A ‘Sound’ Finance Approach Persists
Meanwhile, the ‘sound finance’ approach persists, as economists, politicians,
media experts, students and general public continue to misunderstand the nature
of modern, fiat money, and its implications for federal government’s spending,
taxing, and open market operations. Most economists and policy-makers in
Congress still believe that taxation and the sales of Treasury bonds serve as a
‘financing’ operation for the federal government.
In this taxation- and ‘borrowing’-
constrained fiscal climate, - it is argued, - the nation must face trade-offs
between important spending categories. Due to insufficient
financial (as opposed to
real) resources, - it is maintained,
- the nation has to prioritize between public health care, education, R&D
investment, technological development, public infrastructure, etc.
All of these vital programs cannot be
fully implemented at the same time, - it is argued, - unless “potentially
ruinous deficits” will be generated. The media, academia, and policy-makers in
Congress tirelessly paint to us “a bleak
future of soaring deficits leading to
political and economic crisis” (Aaron, 2007, p. 1623, emphases added). The
nation has become so haunted by these dreadful thoughts of soaring federal
deficits, that some have dubbed them a “fiscal specter” or “a monster at our
door”. Other prominent examples of
frightening rhetoric include D. Walker’s , the director’s of the Government
Accountability Office, warning of a looming “fiscal
cancer” that our nation is about to suffer as a result of
“massive entitlement programs
we can no longer afford” (ibid.,
2007, p. 1623, emphases added). Another piece of rhetoric comes from a Boston
University economist L. Kotlikoff and his collaborator, S. Burns, who foresee “a
government in desperate trouble” (ibid., 2007, p. 1623, emphases added).
The ‘sound finance’ recipe for this budgetary ‘crisis’ is to close the ‘fiscal
gap’ by increasing taxes and slashing government spending. The resulting picture
is scary indeed: the government is “raising taxes sky high, drastically cutting
retirement and health benefits, slashing defense, education, and other critical
spending, and borrowing far beyond its capacity to repay” (ibid., 2007, p.
1623). In this growing discussion of ‘financial affordability crisis’, many have
argued that our government’s commitment to finance Social Security, Medicare,
Medicaid and other public programs is “unaffordable unless taxes are increased
(ibid., 2007, p. 1623-4).
When the discussion of universal health care reform is mistakenly placed within
this context of a ‘constrained
fiscal climate’, then rising taxes, cuts in federal spending and increased
government borrowing seem to be the only solution to cover the 47 million
uninsured Americans. But ‘taxes are already way too high’, - most Americans
would object, while ‘there is not enough spending left to cut’, many
policy-makers would argue (Aaron, 2007, p. 1628; Schaeffer, 2007, p. 1559).
With tax increases and spending cuts not a viable option, the U.S.
government will have to borrow more
and more money (Schaeffer, 2007, p. 1559). But this will threaten our nation’s
economic and foreign security: “A huge deficit, funded by foreign countries,
will be viewed as a threat to the nation’s security. In the absence of draconian
measures (for example, increasing taxes, cutting benefits…), future generations
will have to bear the costs and the social and economic consequences” (ibid.,
2007, p. 1559). The bottom line is “that universal coverage should not be
attempted” because “the books have to balance before the deal can be closed (Health
Affairs, 2008, p. 621).
Ironically, while the experience of Western countries demonstrates that
universal coverage is a key to health care costs containment, the ‘sound
finance’ adherents present it as a source of escalating health care expenses
(Aaron, 2007, p. 1632). While PNHP and other research institutions estimate that
universal, single-payer health care system would cover the 47 million uninsured
Americans without spending any more than our nation already does, the ‘budget
hawks’ claim that universal coverage would cause sky-rocketing health care
expenditures, increased taxes, growing federal deficits, national debt, and cuts
in other spending categories. These claims lead to erroneous projections that
become self-fulfilling prophecies:
After the 2008 election, budget hawks, focused on reducing deficits caused by
Medicare and Medicaid, will begin proposing spending reductions.
Soon thereafter, national security
experts, intend on preventing foreign holders of debt from influencing U.S.
policy, will demand even bigger reductions. Eventually, the two groups will
combine forces to cut health care spending and, in doing so, will determine
health policy for the nation. (Schaeffer, 2007, p. 1559)
Due to this mania to ‘close the fiscal gaps’, as well as other political,
institutional and power factors, the
U.S. remains the only industrialized nation that does not offer universal health
care to its citizens. “We claim we cannot afford it” (Berwick et al., 2008, p.
760). The costs would be too high: an escalating budget deficit and ‘foreigners’
influencing the U.S. policy-making.
A Concluding Response from a Functional Finance Perspective: Is Universal
Coverage Financially Affordable?
As discussed above, rather than a ‘fiscal cancer’ persistent government deficits
are a theoretical and practical norm
in demand-constrained economies (Wray, 1998, p. 75). The size of a federal
deficit is not an issue: it is simply a book-keeping matter. The implication is
that the ‘sound finance’ ‘recipe’ to avoid a ‘fiscal meltdown’ is a
mal-prescription for a non-existing problem. This ‘recipe’ aimed at reducing the
federal budget deficit will certainly lead the economy into a recession as the
‘demand gap’ will widen, reducing investment, employment and economic growth. As
a consequence of the ensuing recession, the federal government will
have to run fiscal deficits to
stimulate the economy and fill the widened ‘demand gap’. As a historical
analysis demonstrates, attempts to balance the budgets were mostly followed by
deep recessions, making deficit-spending inevitable (Wray, 2000).
Secondly, it is mistaken to think that the U.S. federal government can be
financially constrained in a regime of a fiat currency with a flexible exchange
rate. Rather than relying on
taxation and borrowing, the U.S. government’s spending “is always financed
through creation of fiat money” (Wray, 1998, p. 75). Government’s fiat money is
a resource potentially unlimited in its supply. The significance of this is that
the government can take advantage of its unique position in the monetary system
and implement vital public programs, such as universal health care, without
worrying about the availability of
financial resources (Wray, 2006, p. 14). Universal, comprehensive health
care can always be financed by direct creation of new money by the government.
The government can create as much money as needed to finance the nation’s health
care bill. As explained above, this money creation does
not involve the actual
printing of money. Rather, it is
reflected in a change of a number in the Fed’s computer system, showing an
increased balance in the Treasury’s account at the Fed. Any institutional
constraints on government spending are ‘self-imposed’ (vs.
inherent) limitations, and could be
removed given the political will to do so.
While the government should not worry
about the availability of financial
resources, it should certainly worry about the availability of
real resources (e.g. well-educated
health care providers and personnel, quality health care delivery institutions,
medical equipment, laboratories, drugs, technological and research base, etc.).
This is the real issue. While some
have compared money to “the mother’s
milk of health care” (Hsiao, 2007, p. 950), we would argue that it is
real resources that are so vital for
a well-functioning health care system. There are no inherent
financial constraints to prevent the
U.S. government from developing such resources.
Lastly, in the context of a health care reform debate, it has been common to
compare state and federal budgets. While state finances
are revenue-constrained because
individual states do not issue their own currency, this does not apply to the
federal government which can always spend by issuing new fiat money.
When the distinction between state and federal finance is not grasped,
the failure of health care reform experiments in budget-constrained states is
evoked as an argument against a national health care reform:
“universal coverage should not be
attempted”, - it is claimed, - because the “lesson of coverage experiments in
both Massachusetts and California seems to be that the books have to balance
before the deal can be closed” (Health
Affairs, 2008, p. 621). This and similar claims misconstrue the positions of
individual states versus the federal government in the monetary system. The
states need the government’s money to finance their expenditures, and have no
power to create it, relying on taxation and borrowing instead.
In contrast, federal government’s
expenditures face no inherent financial constraints, allowing the Treasury to
spend before and without regard to taxation and/or borrowing.
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Aaron, Henry J. 2007. “Budget Crisis, Entitlement Crisis, Health Care Financing
Problem – Which Is It?” Health Affairs,
Vol. 26, No. 6, November/December, pp. 1622-33.
Angell, Marcia. 2003. “Dr. Marcia Angell Introducing the National Health
Insurance Bill.” http://www.pnhp.org/facts/angellintro.pdf
Bell, Stephanie. 1999. “Functional Finance: What, Why, and How?” The Levy
Economics Institute of Bard College, Working Paper No. 287, November, pp. 1-15.
. 2000. “Do Taxes and Bonds Finance Government Spending?”
Journal of Economic Issues, Vol. 34,
No. 3, September, pp. 603-20.
Berwick, Donald M., Thomas W. Nolan, and John Whittington. 2008. “The Triple
Aim: Care, Health, and Cost.” Health
Affairs, Vol. 27, No. 3, May/June, pp. 759-69.
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[1]
These administrative expenses associated with a multi-payer health care
system consume about one third of the nation’s health care bill (Angell,
2003; Hsiao, 2007).
[2]
Such budgets would be renegotiated on an annual basis, based on past
financial and clinical performance, projected changes in the levels of
services, wages and input costs, proposed new programs, etc. (PNHP,
2003, p. 800).
[3]
OECD Health Data, available on
http://www.oecd.org/dataoecd/46/33/38979719.pdf
[4]
http://www.pnhp.org/facts/single_payer_resources.php
[5]
National Health Insurance
[6]
http://www.pnhp.org/facts/singlepayer_faq.php#raise_taxes
[7] This will increase the Treasury’s liabilities by the amount of the expenditure. These liabilities will be offset by an increase in the Treasury’s assets (in the case of a Treasury’s purchase). Alternatively, if the Treasury issues a payment (check) for some of the government’s programs (e.g. a social security check), this payment will retire some of the Treasury’s outstanding liabilities by the amount of the check issued. (Wray, 1998, p. 77)
[8]
High-Power Money (HPM) is another name for the monetary base, or the sum
of currency held by the non-bank public and banks’ reserves (Croushore,
2007, pp. 460, 451).
[9]
As a result of this transaction, the Fed’s liabilities would increase,
while there would be an offsetting increase in its assets in the form of
the Treasury’s IOUs. Recall that this is “nothing more than an internal
accounting procedure”, while the real result is that the Treasury would
spend “by creating money” and commercial bank reserves would increase as
a consequence of the Treasury’s spending (because most of the Treasury’s
checks would likely be deposited into bank accounts; even if you decide
to withdraw cash and further make a cash purchase, the seller will
likely deposit his sales revenues into a bank) (Wray, 1998, p. 116).
[10]
Fiat money can be defined as “state liabilities issued to purchase
goods, services, or assets or to discharge … liabilities, with no
promise to convert” (Wray, 1998, p. 12) (i.e. no promise to convert
money into other assets, as, for e.g., during the Gold Standard money
could be converted into gold on demand). The primary source of value for
fiat money is the government’s promise to accept it in payment of taxes
to the state. Thus, we can characterize fiat money as money that has
value because the government accepts it in payment of taxes.
[11]
Currently publishing as Stephanie Kelton.
[12]
The cost of producing a piece of U.S. currency is about 4 cents (Croushore,
2007, p. 6). Hence, the U.S. currency’s intrinsic value is close to
nothing. Moreover, the U.S. currency is not backed by any asset that has
an intrinsic value.
[13]
High-Powered Money: see ft. 8 above for a definition of this term.
[14]
Of course, following the removal of the tax system, an “inertial demand”
for the government’s money would exist for some time, because the public
would become so much accustomed to its use in private transactions.
However, eventually, this
demand would disappear and the public would resort to some other form of
currency (Wray, 2000, pp. 9-10).
[15]
The primary sales of bonds are undertaken by the Treasury, while the Fed
uses reverse repos (Wray, 1998, p. 86).