MMT: What Really Happens to Your Tax Money at the IRS

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

Have you ever wondered where your tax money goes? Does it really pay for the roads you use or fund the social programs you support? The answer might surprise you.

Most of us assume that the taxes we pay are directly used to fund the government, but that’s only part of the story. Modern Monetary Theory (MMT) challenges this traditional view and introduces a new way of understanding how governments with sovereign currencies, like the dollar, operate. Let’s explore what happens when your money reaches the IRS and how MMT offers a different perspective on the role of taxes in the economy.

Key Takeaways

• Where Taxes Go: Learn what happens to your tax money after it reaches the IRS and how it supports government operations.
• Modern Monetary Theory (MMT): Discover how MMT redefines the role of taxes and explains that governments with sovereign currencies don’t rely on taxes to fund spending.
• The Role of Taxes: Understand how taxes control inflation, validate currency, redistribute wealth, and influence economic behavior.
• Debunking Myths: Explore common misconceptions, such as the idea that governments can run out of money or that taxes directly fund all public spending.
• Practical Insights: See how this perspective impacts fiscal policies, inflation concerns, and your role as a taxpayer.

What Happens to the Money You Pay in Taxes?

When you pay taxes—whether on income, payroll, or corporations—the IRS processes these funds and transfers them to the U.S. Treasury. This money is then used to fund government operations such as:

• Social programs like Medicare and Social Security.
• Infrastructure projects and national defense.
• Paying off public debt.

While this explanation sounds straightforward, it oversimplifies the process. The U.S. government, as a sovereign issuer of the dollar, operates very differently from households or businesses. This is where Modern Monetary Theory comes into play.

How MMT Views Taxes and Government Spending

While the traditional view suggests that the government “needs” taxes to finance its spending, MMT proposes that taxes don’t have this direct role. Instead, they serve other critical purposes in an economy.

Key Principles of MMT:

1. Governments Create Money: The U.S. government can issue as much money as needed for its spending, independent of tax collection.
2. Taxes Regulate Demand: By collecting taxes, the government reduces the amount of money circulating in the economy, helping to control inflation.
3. Redistribution of Wealth: Taxation helps reduce inequality and redistribute resources.
4. Incentives and Behaviors: Tax policies can encourage positive actions, such as deductions for home purchases or penalties for carbon emissions.

Why Are Taxes Important in the MMT Perspective?

1. Taxes Reduce Purchasing Power:

When the government collects taxes, it removes money from the economy, reducing the purchasing power of individuals and businesses. This is crucial during periods of high inflation when too much money is circulating.

2. Taxes Validate the Currency:

Taxes create demand for the dollar, as all citizens and businesses must pay their taxes using the national currency. This reinforces the dollar’s value and stability.

3. Taxes Reflect Prior Spending:

In MMT’s view, the government often spends before it collects taxes. For example, it can invest in infrastructure using money it creates, while taxes later help reduce the inflationary impact of the increased money supply.

Practical Example:

Imagine the U.S. government launches a $1 trillion infrastructure program.

• In the traditional view: This money must be raised through taxes or borrowing.
• In MMT: The government creates the $1 trillion needed and later collects taxes to prevent excessive money supply from causing inflation.

Debunking Myths About Taxes and Spending

Myth 1: The Government Can “Run Out of Money”

In MMT, a sovereign currency issuer cannot run out of money because it is the creator of that currency. The real limitation is inflation, not a lack of dollars.

Myth 2: Taxes Directly Fund Public Spending

Although taxes support government operations, federal spending doesn’t depend directly on tax revenue, as seen during the COVID-19 pandemic, when trillions were issued without prior tax increases.

What Does This Mean for You, the Taxpayer?

Understanding the dynamics of taxes from an MMT perspective can change how you view fiscal and economic policies:

• Inflation Concerns: Focus on the impact of government policies on price increases rather than the deficit.
• Fiscal Policies: Support tax policies that align with your values, such as environmental incentives or progressive taxation.
• Economic Resilience: Trust in the government’s ability to handle crises without solely relying on tax hikes.

FAQs

1. If the government can create money, why do we need to pay taxes?

Taxes help control inflation, regulate demand, and validate the currency, while also playing important roles in wealth redistribution and behavioral incentives.

2. What happens if taxes are too low?

Low taxes can leave too much money circulating in the economy, increasing the risk of inflation, especially in a heated economy.

3. Is public debt a concern under MMT?

MMT views public debt as a tool for monetary policy rather than a liability like household debt. The focus is on inflation, not the debt itself.

4. What does this mean for the average person?

For most people, understanding MMT means recognizing that the government has more flexibility to address crises and support economic growth, while taxes serve specific functions such as stabilizing the economy.