Debt Deflation - Forward Year Tax Receipts

Forward Year Tax Receipts

Recognizing that the federal government issues liabilites (debt) in its own currency and thus can never go bankrupt, another solution is for the federal government to become more like the corporate capital markets with debt issuance at high real interest rates and equity like issuance at even higher real rates of appreciation. The likely candidate for equity like issuance by the federal government is forward year tax receipts. A forward year tax receipt is a receipt for taxes paid in advance that are due some time in the future. Like government debt issuance, forward year tax receipts have a rate of appreciation and a duration. Unlike, government debt, the rate of return is not guaranteed. The realized rate of return is totally dependent on the owner's future income and subsequent tax liability. And so savers are rewarded with a positive real rate of return and debtors can realize an after tax cost of credit that is significantly less. For instance if the federal government sells 30 year debt with a 3% real rate of return and sells forward year tax receipts with a potential 7% real rate of return, then a debtor can realize a -4% cost of credit. At that point inflation is not required nor should it be desired.

And here is the proof from the Fisher equation of exchange:

• = Money Supply (Measured in Dollars)
• = Velocity of Money (Measured in 1 / years)
• = Price Level (Measured in $ / item)
• = Quantity of Transactions (Measured in items / year)
• = Savings (Measured in Dollars / year)
• = Income (Measured in Dollars / year)
• = Nominal Annual Interest Rate
• = Real Interest Rate
• = Inflation Rate
• = Nominal Gross Domestic Product (Measured in dollars / year)
• = Real Gross Domestic Product (Measured in dollars / year)
• = Noninterest Income (Dollars / year)
• = Tax Rate

PQ is normally replaced with nominal GDP. Nominal GDP is simply real GDP multiplied by 1 plus the inflation rate and so.

M under Milton Friedman was considered money supply. However, the federal reserve can "print" all the money it likes - if the credit that it extends does not make it into the private sector then you get no GDP. And so let us say that M (money supply) should be replaced with D (debt in dollars).

What is DV? At first glance DV should be equal to income. You need income to buy the goods represented by GDP. And so:

But not all income is spent, some is saved and some pays taxes. Likewise not all purchases are made out of current income, some purchases are financed with debt. Because the units for GDP (likewise for M*V) are $ / year, we look at the change in debt dD / dt to represent new financing within that year. D represents all previous debt incurred in previous years for reasons that will become apparent.

Income can be broken into two parts, interest income and non-interest income in this way

Then we will make the assumption that all interest income is taxable.

In a closed economy (no foreign trade), the after tax non-interest income per year will equal the savings per year - or put another way savings will always equal investment. What this means is that all other forms of financial liabilities (cash on hand, equities, etc.) are represented in both savings (S) and noninterest income (NI).

Solving the differential equation for D

: Money velocity is equal to the interest rate times one minus the tax rate plus 1.

The interest rate has a real and inflation component, and so breaking up the interest rate into its components gives:

Back to the Fisher equation:

And so the conclusion is simple, if you want to raise real GDP, you raise the real interest rate on government debt (which the federal reserve controls) and / or you lower the tax rate. This works well enough until you run a huge trade imbalance (like with China) that suppresses real interest rates or if you have a great depression type scenario where the inflation rate is severely negative (massive deflation). In the massive deflation scenario real GDP may show growth while nominal GDP would show contraction.

The way to get around both scenarios is to sell forward year tax receipts. A forward year tax receipt lowers the after tax cost of credit in the private sector while not depriving the bondholder of income (Friedman's permanent income hypothesis). This is the problem with monetary policy as it stands now. In a true great depression massive deflation type scenario even tax cuts don't have any traction because if nominal interest rates are 0, lowering the tax rate would have no effect on either money velocity or GDP.

FO = Outstanding Supply of Forward Year Tax Receipts FR = Forward Year Tax Receipt Rate of Appreciation

The next thing we express is how the level of debt is related to the level of FYTR's by some constant of multiplication called L

: This constant L is at the discretion of the federal government, how many FYTR's do they want to sell in relation to how much outstanding debt there is. Obviously there are limits to L based upon how much demand there is for them and how they are priced.

And so back to our finance equation:

Note: One thing to be aware of is that the realizable gains from forward year tax receipts can never exceed the total tax receipts in the same year or

Again, in a closed economy (no foreign trade), the after tax non-interest income per year will equal the savings per year.

Solving the differential equation for D

Again, the interest rate has a real and inflation component, and so breaking up the interest rate into its components gives:

Back to the Fisher equation:

The beauty here is that in a mass deflation scenario both nominal and real gross domestic product hold can be pushed higher by lowering the after tax cost of capital in the private sector. See equations above: even if the inflation rate was say -10%, the FR rate could be set by the federal government to be + 15% - presto real GDP growth, nominal GDP growth, presumably rising employment and deflation to boot.