“Functional finance” is a “heterodox” or “nonmainstream” economic theory that was originally developed by Abba Lerner in the 1940s. It’s best known today in one specific form of it called Modern Monetary Theory (MMT).
In this form, functional finance has recently begun to have a big effect on the UBI debate—in two polar opposite ways. Some people exaggerate the repercussions of MMT to argue, or at least imply, that the government can spend all it wants on UBI or anything else without ever raising taxes or borrowing money as if there were no physical limits to government spending. Other people refer to MMT while arguing that any effort to maintain a livable level of UBI is unsustainable. This post explains what you need to know about functional finance to understand its implications for the feasibility of UBI. I’ll discusses UBI’s sustainability with reference both MMT and mainstream economic theory in a later post.
MMT is closely associated with the proposal of a federal job guarantee (FJG). Like an income guarantee, a job guarantee would greatly expand of government support for low-income people. But because the two proposals expand support in very different ways, FJG and UBI supporters often find themselves arguing against each other rather than against people who oppose any major expansion of government support for low-income people.
The basic idea of functional finance is that all things that are physically possible are financially possible. It stresses the obvious fact that taxes don’t actually “finance” federal government spending. The central bank has the power to create money out of thin air and does not need to “get the money” to spend on UBI or anything else. Nor does the Central Bank need to “borrow” money to “finance” spending when it runs a budget deficit. Money is regularly created and destroyed by the Central Bank and by the private banking system.
Governments that have full sovereignty over their currency are never short of the cash they need to do anything. For example, U.S. states, which cannot create currency, can be short of dollars, but the U.S. federal government, which can create all the U.S. dollars it needs to buy anything priced in dollars, can never be short of dollars. We usually say the government can just “print” the money it needs, but even that is an exaggeration. Most money is created electronically—literally out of thin air or even thinner electrons.
It is possible to take the observation that taxes do not finance spending too far. If taxes and borrowing aren’t needed to “finance” spending, one might suppose we could get rid of all taxes, print up all the money we need to pay off the national debt, and increase government spending as high as we want on whatever we want including a UBI of 5 times the poverty rate. Unfortunately, this combination of policies not physically possible. It is not financially possible either. It would create more demand for goods than our economy is capable of producing, and it would set off a hyperinflationary spiral.
Although we don’t need to “get the money” to “finance” spending, we do need to make resources available to produce the things we want to buy with government spending. In other words, even if the government doesn’t need to “finance” spending, it needs to “resource” spending. Financial mechanisms—such as taxation and borrowing—are the government’s primary tools to resource spending. Non-financial tools such as regulation are also useful.
The functional finance approach does not reduce the need to consider the cost of UBI or any other government policy. It does not significantly change the calculation of the cost UBI. It does not allow us to introduce a UBI as large as we want without introducing any new taxes. It does suggest different ways to think about how best to use financial and nonfinancial tools to resource UBI.
Paying down the debt, increasing government spending (including transfers like UBI), and decreasing taxes all create “expansionary pressure.” That is, they allow people to buy more goods, which is likely to cause people produce more goods or to raise the price of the goods they’re now selling or a little bit of both. Expansionary pressure can be a good thing: the private economy usually generates contractionary pressure on its own, causing it to underutilize its resources including human resources. Some amount of government stimulus is necessary to keep the economy working at full capacity and maintain full employment.
But government stimulus is not always good thing: too much or the wrong kind of expansionary pressure causes inflation, and too much inflation is counterproductive. Although taxes are not necessary to “finance” spending, they are a very good tool to counteract any excessive inflationary pressure expansionary policies might cause.
Although functional finance is usually considered a nonmainstream school of thought, most of what I’ve said so far is uncontroversial and rather obvious to anyone who has studied macroeconomics.
There are several differences between the functional finance approach and the mainstream approach. Mainstream economists are well aware that it is possible to “finance” government spending by money creation without either raising taxes or borrowing money, but they tend to believe that virtually any government money creation causes inflation rather the increased production. Even when the economy needs a stimulus to counteract a significant recession, mainstream economists usually recommend government borrowing equal to the size of the deficit.
Functional finance economists stress that “fiscal space” is usually exists. That is, unused resources are available in the economy—unemployed workers, empty storefronts, unused factories, and so on. If so, a government stimulus can increase production without increasing prices and no new taxes or borrowing are necessarily to counteract that expansionary pressure. If the government introduces new taxes and borrowing when they aren’t needed, they counteract the expansionary effects of the spending and prevent the economy from reaching full employment.
Mainstream economists tend not to think of available fiscal space at all, or they tend to think that it is small or nonexistent except during deep recessions, or they tend to think it is structural in nature so that expansionary policies will cause inflation even if unused resources are available.
Virtually all functional finance economists would agree that most governments have erred on the side of creating too much contractionary pressure—accepting higher than necessary unemployment and unnecessarily low government spending.
One of the most important features of functional finance is the recognition that not all government spending is equally expansionary and not all taxes are equally contractionary—as mainstream economists tend to presume. For example, a tax cut or a transfer payment given to a wealthy person who is likely to save most of it can be less expansionary than a transfer payment or a tax cut give to a low-income person who is likely to spend all or most of it.
Different spending programs demand different resources which might be in greater or lesser supply at different times. Different types of taxes and different borrowing strategies have different effectiveness in making the right resources available. Given this recognition, the size of the government debt and deficit are not what’s important. “Functional finance” gets its name because it recommends that fiscal and monetary policy target full employment and price stability instead of the size of the deficit, the debt, or the money supply as most mainstream macroeconomists recommend. Under functional finance, the size of deficit, the debt, and the money supply (if there is a thing we can call the money supply) would be whatever numbers worked out to reach full employment and stable prices—given the other goals of government spending.
Comparisons of actual GDP with potential GDP show that fiscal space does tend to be available. In that case, we could introduce some level of UBI without increasing taxes. But consider six reasons we still need to be aware of the cost of UBI in dollars.
First, the available fiscal space is highly variable depending on the state of our complex macroeconomy. If the goal of UBI is to make sure everyone has enough to live on, we wouldn’t always want it to vary in size with the availability of fiscal space. UBI has some automatic variability as people move from being net contributors to net recipients during recessions. But automatic stabilization is an area where FJG can do better. During recessions, more people seek a guaranteed job; when the economy is nearer capacity, fewer people seek a guaranteed job.
Second, if we introduce a livable UBI with no new taxes whatsoever, its gross cost and net cost would be the same, and we would be pumping $2 trillion to $6 trillion worth of expansionary pressure into a $20 trillion economy every year, far outstripping any reasonable estimate of the available fiscal space during any time except for a very severe recession (see also). Such an expansionary stimulus might have been possible during the downturns of 2009 or 2020, but it was definitely impossible to do every year in between without some contractionary policy to resource UBI and counteract the inflationary pressure it creates. Taxes are probably the best such policy.
Third, if we introduce UBI with at least enough new taxes to make the net cost (see this and that) relevant, it is far less likely to exceed the available fiscal space, and if it does exceed the available space, it will do so by a far lower amount than if we introduce it with no new taxes whatsoever. Therefore, any excessive expansionary fiscal pressure the UBI system might create will be easier to counteract with contractionary fiscal policies. If we’re treating UBI this way, we need to calculate its net cost.
Fourth, even if there was more than enough available fiscal space to resource a high and stable UBI year-after-year without any new taxes or borrowing, UBI is not the only thing the government could do with that fiscal space. It could use it for healthcare, education, housing, transportation, the police, the military, and of course, the U.S. governments’ favorite thing to do with any expansionary policy: enrich wealthy campaign contributors. We need to know how much UBI costs to weigh it against other things the government might do with the available fiscal space, and make the case that this is a good, cost-effective thing to do with the government’s available resourcing tools.
Fifth, “Fiscal space” is not a limit on the amount of spending that is possible. It is the amount of spending needed to employ the available unused resources. If the government wants to expand public sector resource use more than that, it needs to discourage private sector spending to free up the necessary resources. If the government ever does adopt functional finance, the available fiscal space will probably be quickly taken up by popular spending programs. If so, the case for UBI will then have to be made in more traditional terms: given that we begin at capacity, and that UBI costs $X, what are the best tools available to free up enough fiscal space to resource $X of new spending without creating inflation? Those tools are likely to be taxes targeting the wasteful or inflationary spending of wealthy people.
Sixth, UBI is likely to be more inflationary than many other spending policies. Net beneficiaries are all relatively low-income people who are likely to spend a larger portion of the money they receive from the government than higher-income people. The higher the UBI, the more likely people are to respond by demanding higher wages and better working conditions.
The reason we want to introduce UBI is so that low- and middle-income people can buy more goods—a lot more goods if we want a UBI high enough to eliminate poverty and give individuals the power I’ve talked about throughout this book. If we want those goods to be available, either we have to produce more goods than we are currently (which, environmentally speaking, might be a mistake) or we have to get higher-income people to purchase fewer goods. Taxes are the best tool we have to get higher-income people to spend less. Borrowing works too, but borrowing has other effects that we might want to avoid, most especially the promise to pay interest to wealthy bondholders for a long period in future, increasing economic inequality, and—to the extent that bondholders spend the interest they receive on goods or physical assets—injecting new inflationary pressure into the economy over that period of time.
Almost anyone who’s inclined to consider UBI, probably thinks that higher wages and better working conditions for the lower 60% of people is a good thing, but they also need to recognize that higher wages and better working conditions need to be resourced. We measure the cost of resources in money.
For all of these reasons, even in light of functional finance insights, we still need to estimate the cost of UBI; and we need to be just as much or more concerned with the question of how to ensure the resources net beneficiaries will consume are available.[i]
[i] This blog posts is a prospective chapter of my upcoming book on UBI. It draws on my impressions of mainstream economic theory and of functional finance theory. I gain these impressions from my study at the City University of New York, from teaching the history of economic thought at New York University and Georgetown University, from discussions I’ve had with MMT economists ever since I worked at the Levy Institute back in the 20th Century, and from books and articles. These include L. Randall Wray’s Understanding Modern Money: The Key to Full Employment and Price Stability, and Stephanie Kelton’s The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy–but my take on MMT and the language I used to describe it is different from theirs.