Beware Modern Monetary Theory’s damaging potential

Originally published in the Washington Examiner

As the House and Senate budget committees begin the usual process of putting together a federal budget for the coming fiscal year, one of the big unanswered questions is how much they will be swayed by a radical new theory of what the federal budget really is.

Most of us understand that governments spend taxpayer dollars. The “public money” is ours. In theory, this gives our representatives a fiduciary responsibility to spend it wisely on our behalf. When they borrow money, their fiduciary responsibility is to younger taxpayers and future generations who will repay those debts.

Until recently, nobody seriously challenged this common sense. These ideas informed the spirit of 1776, “no taxation without representation,” and are embedded in the DNA of American constitutional government. It’s our government because it’s our money.

All of a sudden, not all lawmakers see it this way. I do not mean that socialists and progressives such as Sen. Bernie Sanders, the new chairman of the Senate Budget Committee, and Rep. Alexandria Ocasio-Cortez are blasé about spending taxpayer dollars. They argue in good faith that social justice, COVID-19, and climate change require massive increases in government spending. Rather, I mean that they embrace a new understanding of government budgets and taxation, called Modern Monetary Theory, which rejects the idea that governments spend taxpayer dollars.

Modern Monetary Theory’s supporters think differently about the federal budget than mainstream economists do, and they think very differently than the Stamp Act Congress of 1765, when the then-British colonists petitioned the king and parliament not to tax them without seating their representatives.

Stephanie Kelton, professor of economics at New York’s Stony Brook University and onetime senior economic adviser to Sanders, explains Modern Monetary Theory in her 2020 bestseller, The Deficit Myth. Since the federal government, unlike a household or business, issues the currency that it spends, Kelton and other Modern Monetary Theory proponents argue that the government can and should spend as much money as markets profitably can use, without respect to tax revenue or the national debt, which could be repaid simply by issuing more money.

Because the government doesn’t depend on tax revenues to finance its operations under this theory, there is no presumed limit on government spending other than inflation, which occurs when too much money is in circulation and causes the currency to lose its value.

Most mainstream economists dismiss and even ridicule Modern Monetary Theory. Treasury Secretary Janet Yellen in the past has said she’s “not a fan” of it, calling proponents “confused.” New York Times columnist Paul Krugman, a distinguished professor of economics at the City University of New York, likens it to “Calvinball,” the absurd sport in the Calvin and Hobbes comic strip that cannot be played the same way twice. His reason is that its proponents make up new laws of economics as they go.

Yet mainstream economic theory struggles to explain why inflation remains so low, even as the Federal Reserve expands the money supply at an unprecedented rate. Since 2009, the federal government has issued trillions of dollars without the inflationary consequences that economists expected. For Modern Monetary Theory proponents, this is the new normal. Time will tell.

Modern Monetary Theory raises political problems, as well as economic ones. Now that radical new economic thinking has come to Washington, it’s time to think through these political implications.

This theory holds that taxation is a policy tool for controlling inflation because taxes take money out of circulation. But how realistic is it to imagine that Congress and state legislatures, after decades of gridlock, suddenly will be able to pass tax bills that effectively respond to monthly changes in inflation? Even if it were possible for Congress to levy taxes for the purpose of effectively controlling inflation, it is unclear whether the commerce clause from Article I, Section 8 of the Constitution authorizes the federal government to do so.

More profoundly, Modern Monetary Theory would undo the economic common sense that has undergirded the republic since the American Revolution. If the public treasury is not our money, it ceases to be “our” government in that important respect.