The Multiplier Defect

This article discusses the fact that taxation has a multiplier defect, just as government spending has a multiplier effect. Once this is brought into a coherent macroeconomic model, the magical relative benefit of government spending compared to private spending vanishes.

In the standard narrative when government spends money it can proceed to be used in one of two ways; spent or saved by consumers. Of the portion saved, the story goes, it will be lent by banks to the maximum possible. This would be 100% except thank our good government for regulating the banks with a reserve requirement. So the banks will lend 1 – RR. Then the lent portion will be spent by businesses, therefore becoming an income to people. Now we are back at step 1. The people will consume or save. If consumed it becomes an income and as we head through the infinite steps which happen, eventually everything becomes savings held as reserves and this is supposedly the mechanism which ends money creation.

In the first place I could criticize this for being an entirely false story. Foreign currency or loans could be employed if reserves force monetary stagnation in a place. Bitcoin is an example of a currency with no central bank or policy structure to create or enforce reserves in the first place. Lastly, banks certainly do not lend out to their maximum ability. They lend out depending on the availability of good loans to make. Lending, like all business, is opportunity-driven. A dump of cash into the system will produce only a marginal increase of questionable lending, it will not magically produce genuine smart investment opportunities. A flush of smart investment opportunities, however, will lead to a jump in money creation – whether it violates the reserve requirement or not. Bankers are smarter than that.

In the second place I should criticize it for being an incomplete story. Where did government get the money which it spends? From taxes. Yes, I am including the ability to print money in as a tax because I consider, as many do, inflation to be a tax.

Taxes have a multiplier defect. If I had not been taxed a dollar I would have spent or saved it. If I had spent it then it would have become income for someone else who would have spent or saved it. Eventually it would have gotten saved and the bank, supposedly, would pursue its course of lending. By the standard story this would produce a multiplier effect equal to 1/RR, which is the same as the government spending multiplier. It may be harder to detect with inflationary tax, but we have no reason to suspect that the final value of impact would be any different.

In conclusion, once we realize that taxation has a multiplier defect equal to the multiplier effect of government spending, government spending no longer looks like a magical source of economic prosperity. This new conception better reflects our empirical observation that a lassaiz faire economy is more productive. Now once we consider even just a few more facts, which we will do in other articles, we will realize that government spending represents not a neutral reallocation, but a significant opportunity cost, compared to the choices made in an untreated market.

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