Where Does Government Get Its Money From?

An earlier post detailed different sources of government funds. I am going to list any possible source here. If you think of more, let me know and I’ll add it.

  • Tax revenue. This is the most obvious. Government sets a tax policy, people pay their taxes, and government has money.
  • Fines and penalties. Government writes a law with a punishment of a fine or a penalty, and collect money from offenders with the threat of even more punishment.
  • Fees. Government provides a service that only government can provide, and charges a fee to cover the costs.
  • Borrowing. Government promises to repay loans at a healthy interest rate. This is really a future tax, since one day those loans will come due, and that generation of taxpayers will pay the bill.
  • Raiding funds. This is not so obvious, but here’s how it works. Government collects money for something like Social Security and rather than put it in a bank account, they spend it, leaving IOUs behind. This is really government borrowing from itself. Social Security and Medicare were used for this purpose. There is no money in these accounts, and we can never pay enough taxes to finance it.
  • Revenue. Some governments engage in economic activity. The money government earns from this is revenue.
  • Printing. Government has the power to print money, and can raise money simply by creating it.

Let’s examine the effects of the various money-raising policies. Before we do, let’s talk about economic growth.

Why do economies grow? When people have profits, there is only so many things they can do with the extra money.

  1. Invest. Investments are used to expand or start businesses. This means hiring more people or lowering the costs of production.
  2. Pay off debt or investors. When there is no obvious investment opportunity, then it is time to pay off people who invested in you or pay of debts.
  3. Buy things. These things may include necessities like food, water, shelter, and medical care, but it may also include luxuries like yachts and mansions and servants. However, in no case is the money wasted, since it ends up in the hands of companies and people.

Here’s a quick example to show how a single $1 bill can turn into a million dollars. Consider a candy bar bought with a $1 bill. The store earned $1. Those earnings get split, and perhaps that $1 is sent to the distributor of the candy bars. The distributor uses that money to buy candy bars from the manufacturer. The manufacturer uses it to buy the chocolate and sugar and cream and nuts. These, in turn, are likely bought from a distributor or direct from the farms. Every step of the way, that $1 bill is counted as revenue for each of those companies. When the money gets spent on labor (as it always ends up), then people have more money to spend on things like candy bars. In this simple mechanism, a single dollar bill is counted as revenue, wages, or income several times over.

Consider the above two facts, let’s consider what effect government has on the economy.

If taxes are high: Economic activity is hurt by taxes since people have less money to spend, and certain economic activities are discouraged with tax policy. Those businesses with low margins may disappear altogether. In addition to this, companies and people will flee to governments with a better tax policy. More importantly, consider all the economic activity that would’ve occurred if taxes hadn’t eaten away at the income early on.

If taxes are low: There is little impact on the economy, and the economy is additionally rewarded by companies and people fleeing other places with a high tax rate.

If fines and penalties are reasonable: People are discouraged from breaking the law, but breaking the law isn’t the end of the world. An entrepreneur who breaks the law can get back to work the very next day, hopefully on something that doesn’t break the law. In some cases, people will count the fine or penalty as a cost of doing that particular kind of business, and so the law is ignored if there is strong economic incentive to do so.

If fines and penalties are too stiff: People are scared of breaking the law, to the point of being overly cautious. A single violation, no matter the intent, can lead to the complete ruin of a person’s life. The activity is completely forbidden, even if there is a strong economic incentive to do so anyway.

If fines and penalties are too light: People will consider it a cost of doing business and take action appropriately. For instance, if a parking ticket were only $1, they would never pay the parking meters.

If fees are set appropriately: Government can continue providing critical services forever. If there is more demand, they can meet that demand by acquiring more resources with the additional revenue. If less, they can scale back their operation.

If fees are too high: People avoid interacting with the government, even when they legitimately should.

If fees are too low: People may interact with government when they don’t need to, and there may not be enough money to supply the demand for the service.

With fees, it’s important to consider the true cost of the service, and have the user of that service bear the burden. This way, the service is used in exact proportion to its usefulness to the people.

Borrowing money. There are legitimate reasons to borrow money. A nation at war, for instance, has no option but to win that war or cease to exist. This means using whatever resources it can obtain to use against their enemy and in national defense.

However, borrowing is always a bad idea with a strong negative. When you borrow money, you are not only paying more for what you get than if you used you own money, but you are also enslaving future generations to pay for your lifestyle. In our country, you have to pay off your debts before you die. You can’t tell the bank that your kid or your grand kids will pay off your loans. However, government is free to make this kind of deal, and it is very wrong.

When someone suggests borrowing money, ask them this:

  1. Would our nation cease to exist if we didn’t have that money?
  2. Is it fair to have future generations pay for this, when they have no say in the matter right now?

Borrowing money also has a significant economic impact. Loans are an economic good just like apples and cars. There is a supply, and there is a demand. If the government bids for loans, then people who cannot bid higher cannot obtain loans. If the government borrows too much money, then there is no loans available for the private sector. This has a devastating effect on our economy since people’s ability to borrow is limited by the government’s largesse.

Raiding funds: Of all the evils a government can do, this is the worst. Here’s how it works.

  1. Setup some program where people pay for something—anything—and the government can sit on the money for a while. Examples include Social Security and Medicare.
  2. When people pay, rather than set the money aside, immediately spend it on something else. Leave an IOU, and tell everyone that the books are balanced, even though they are not.
  3. When the money is finally needed, collect the money from taxes and pay it out.

Any corporation or individual who would attempt such a thing would rightly be sent to jail for fraud. If a company setup a retirement plan and spent all the money collected for retirement, what should be the punishment?

And yet, this is what the government has done with all of its programs. The kicker is that when the time comes that they need to raise taxes to pay for the promised money, they are simply going to tax the very money they pay with! This is why Social Security is taxed today.

Revenue. In a broad sense, revenue, for government, is all the money received. However, in the rest of the world, revenue is money received for provided goods and services. This is what is in the cashier’s till at the end of the day at any retail store in America.

Although it seems perfectly legitimate for government to compete in the free market by providing its own goods and services to compare with what the people could provide themselves, it comes with a heavy price. See, when two businesses compete, they have to increase quality and quantity while lowering prices to win the competition. Government, on the other hand, can simply regulate away the competition, or use public money to subsidize itself. It’s hardly a fair competition.

We should, as a people, prevent our government from competing in any area where the private sector is quite capable of providing the goods and services itself. This will ensure that we aren’t being taxed on the one hand to subsidize a government business who turns around and sells it back to us.

Anytime the government is in charge of an economic resource, we are guaranteed that that resource will be mismanaged: overpriced and of a uniform low quality and quantity.

Printing. Another way governments can raise money is by creating it from thin air. That’s right, governments have the power to create currency.

There are a couple of problems surrounding the printing of money, problems that don’t make sense unless the principle of the value of money is explained.

Money is valuable. It may be more or less valuable than it was yesterday. If it grows in value over time, that is, the same dollar today would buy more than yesterday, then we experience what we call deflation. If it decreases in value, then the same dollar will buy less than it did yesterday and we call that inflation.

Think of these words describing the prices of goods. If prices are getting bigger and bigger because money is worth less and less, then it is like a balloon being inflated with more and more air. If prices are getting smaller and smaller because money is worth more and more, then it is like a balloon being deflated with less and less air.

Both inflation and deflation are evil. Ideally, money would always be worth the same amount today, yesterday, and forever. However, because money is constantly changing in value, we have to keep resizing whether a price is good or bad, even though it may be the same price.

The evil of inflation is that stores raise their prices higher and higher. Those people who are on fixed income see their buying power shrink and shrink. Those with money in their pillow see that money diminish in value. You must take your money and invest it or lend it for it to keep its value. You had better buy things right now while you can still afford it rather than wait for a while. And worst of all, if you can get a good rate on a loan, your best hope is to borrow as much as you can and hold onto that loan for a long time, provided the inflation rate is near the interest rate.

The evil of deflation is different. Prices go down and down. People on a fixed income find their buying power is increasing. Those with money are better left sitting on it, rather than investing it or lending it out. Borrowing money is an absurd idea, unless you can get a negative interest rate. Economic investment is strongly discouraged, and outright impossible since no one is investing and no one is buying.

Inflation and deflation occur naturally in response to economic conditions.

Over history, we have, as a human race, observed that as economies expand, the money supply must expand with it, otherwise we suffer deflation. On the other hand, if the money supply increases too quickly, we suffer inflation. If you have to choose between the two evils, inflation is preferable to deflation.

Given that, governments have learned that they can print money during a period of economic growth and help their economy by doing so. As long as they don’t print too much or too little, the economy can keep growing at a healthy rate, with no negative consequences.

This means that as long as the economy is growing, the government has free money, money that doesn’t cost the taxpayers a dime and that actually helps the taxpayers.

If this is done right, it is certainly possible, especially with the knowledge of economics we have today, to have a federal government that not only collects no revenue, but has a surplus of money it can freely give to the states. Yes, we can have a system of government that governs so well it can print its own money to pay its own bills.

Let me repeat this:

If this is done right, the government can print exactly enough money to maintain a steady money supply to meet the needs of the growing economy and thus fund all of the necessary activities without taxing a single dollar.

What would such a government look like?

  1. A very lean budget. Money is spent only on things that only government can provide, such as the court system, the police, and the military.
  2. Complete non-interference in economic matters. Government provides no goods or services except those only government can provide.
  3. No charity or entitlement programs. Charity and entitlement programs are run by the people and churches, not the government. Money is collected voluntarily, not by force.
  4. Government prints its own budget. The budget matches the economic growth, and the government prints every bill it spends.
  5. Government reacts to inflation and deflation. The government reacts to inflation by printing less money. If it still needs money for core critical services, it must levy a small tax to collect it. If deflation occurs, government rapidly prints more money and spends it or loans it out.

The Founding Fathers understood this principle while the vast majority of the American people did not. They built a government that could do exactly what I outlined above. The House of Representatives is the most sensitive body to inflation and deflation and the least controlled by the banks. They also have complete control over the budget and the printing of the money, with the Senate’s approval, of course.

How can we get there from here?

  1. Demand an immediate end to government charity and entitlement spending.
  2. Demand complete non-interference in the economy.
  3. Demand that government, including the military, be downsized and made more efficient.
  4. Demand a severe cut in the tax rate, with surplus money being refunded to taxpayers.
  5. Demand an end to the Fed, and that congress writes a bill every year determining how much money to print according to the people’s observation of inflation or deflation.

9 Responses to “Where Does Government Get Its Money From?”

  1. booboo Says:

    this is fantastivc information keep it up

  2. John M. Drummond Says:

    Although it was alluded to in the paragraph re “candy bars”, no specific mention was made about how the government makes money by GIVING IT AWAY. From your example, every dollar goes through numerous hands, and at least in theory, every one of those hands pay tax on that dollar. If each of those “hands” pay only 15% tax, and that dollar goes through only 10 hands, the Fed earns $1.50 on each dollar given away. (In actuality, that dollar goes through far more than 10 hands but has successively reduced value along the way.) For this reason economist are largely in agreement that investments in infrasture are high on the list of ways to jump start an economy and will return to the government far more than the amount invested, as per your candy bar example.

    • Jonathan Gardner Says:

      Except for what you are describing didn’t save the Japanese economy.

      And here’s food for thought: If you want the money to end up in the economy, why take it out of the economy at all? Cut taxes, stop spending, and people will spend the money they earn anyway.

  3. blithe701 Says:

    Amazingly described,Sir!Anyway I got some doubts.
    When we say that some governments are engaged in economic activities what exactly are we implying here?
    Are we saying that the primary aim of a government is not to make profits rather to help improve the social and economic status of the society?Or
    Are we trying to suggest that any government necessarily has to make some money besides collecting all forms of different taxes to keep it going and help it bring forward more pro-people policies and subsidies during various plans?
    Please explain me this thing that has been bothering for quite a long time in reference with both a socialist and a capitalist government.

    • Jonathan Gardner Says:

      The key question you are asking is, “What are governments good for anyway?”

      The answer is that governments are really only good for protecting individual rights. Beyond that, they are the worst idea ever. Meaning, there are better ways to achieve the ends you desire besides government, if the ends include something beyond protecting individual rights.

      It is true that when government limits itself to simply protecting rights that everything in society improves. However, that is not the primary intent of government. It is a side effect of having a good society and a good, limited government.

  4. Sahil Jakhar Says:

    Thanks for this Sir.
    I have a question and that is When Govt. receive Tax by the means of their Tax Policies, sometimes they have to refund the money along with the interest and sometimes this interest is huge. So the interest paid by the Govt. is a loss to the Govt. or Govt. invest the money in different sectors to generate revenue ? This may sound like a stupid question but I felt so oblivious while I was thinking about this in a particular context.

    thanks in advance.

    • Jonathan Gardner Says:

      Generally, when people overpay taxes, or rather, government over-collects taxes, there is the part that government has to refund and the part government keeps. The interest they would pay along with the refund is nominal, meaning, not really that important. If it reflects inflation or the interest rate, then it would’ve been what any reasonable person would expect to get back on it.

      The idea that government “invests” money is absurd. Let me explain why.

      When a normal person invests, they give the money to someone else expecting to see a large rate of return, with the downside being the risk associated with that. However, they also get the added benefit of having a voice in how that money is used.

      This is different than a loan, which does not give the lender any kind of voice in how the money is used, unless it becomes clear that the borrower cannot repay. If the borrower cannot repay, then the lender usually has some kind of recourse, such as taking control of the remaining assets.

      When the government says it is “investing” some money, ask these two questions:

      * What rate of return does it expect to get on its investment?
      * What percentage control of the company is it getting?

      If it talks about some kind of benefit to society but not an increase in value, then we should call it what it really is: charity. It is the same sort of “investment” that a rich person makes when they build a hospital or a homeless shelter. They are really giving the money away for some nobler purpose.

      If it is putting money into a company and expecting some kind of return on it, then ask what percentage control the government is taking. The issue here is that government has available to it some methods of control that regular people do not have, such as nationalization. And the concern is that having the same organization designed to kill people and put them in prison run your businesses might lead to innocent people getting killed or put in prison, or the guilty going free. We have all sorts of problems when we have a judge sitting on a case where he has a financial interest in one side winning the case, so we should have the exact same concern when the government has an interest in one company succeeding over another.

      Instead, what government should focus its efforts on is creating a safe environment where free markets can thrive. Rather than try to build industry by “investing”, it should create business-friendly environments where entrepreneurs large and small feel confident and comfortable. Government should focus on finding bad guys and punishing them rather than focus on trying to help the poor. When you put bad guys in prison, then the poor will be free to create their own future rather than be manipulated by bad guys, and the rich will be free to pour their resources into industry and charity rather than hiring security guards and lawyers.

  5. Michael Says:

    You almost understand how the monetary system works. You are closer than most. However almost understanding will not get you where you want to go. If you really want to understand go to Warren Mosler’s web site.

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