A Magical Method in the Money Making Madness

Inflation. No one likes too much of it, though there is some debate as to how much is good and how much is bad.

Inflation is often linked to money creation - though not always, since inflation can also result from supply shortages such as oil. Nevertheless history abounds with money printing experiments that ended up in hyperinflationary failure: Weimer Germany, Mugabe's Zimbabwe, Postwar Hungary and the Crisis of the Third Century being the best known ones.

Injudicious money creation will always create hyperinflation. If the Federal Reserve creates $1 out of thin air the amount of inflation it causes will be negligible. If it creates $1 Trillion the amount of inflation it causes will destroy the economy.

Of course money is created all the time through the fractional lending system. Most of this money is created by the commercial banking system. While some see conspiracies and unsustainability in this process, it has actually worked for millennia. Nevertheless the real heart of the fractional banking system is the role of the Central Bank, which, in the United States, is the Federal Reserve Bank.

Now I'm not going to go into the intricate details of how the system works. If you're unsure of how it works, go to the Wikipedia page. Using this as a basis, however, let me do some funny little experiments as to what injudicious money creation can theoretically do.

So here's graph no.1 showing how the system works in the United States. If we assume that the US economy is worth $1000 in total money supply, it looks like this:

This is, of course, identical to the Wikipedia page's graph.

But now let's begin playing. Let's say Congress and the President and the heads of the Fed suddenly suffer from a collective insanity... even more severe than the one they already have... and decide that they'll fix the deficit by simply creating money out of thin air. Now according to the latest data, the budget deficit is $1.2059 Trillion and represents around 8.11% of GDP. So what would happen if the powers that be decide to just create the money out of thin air, again assuming in our model that the US economy is worth $1000?

I've added the baseline there by way of comparison (the blue line). The yellow line represents the collectively insane decision.

That doesn't look too good does it? You're looking at a huge increase in the money supply and, as a result, a hyperinflationary situation probably similar to anything occurring through history.

But then let's take this even further. Let's say the US has been taken over by an Idiocracy... worse than the current mob... who decide that they'll just forget about taxes altogether and just create as much money as the government needs. Since the US Government represents about 25% of GDP, it would mean that an even greater amount of money would be added to the money supply:

Ouch. And that, my friends, is why money printing on the scale used by the Romans, the Germans, the Hungarians and Mugabe ends in abject failure.

But hang on, what's that thing called "The Reserve Rate"? - Well that's how much money commercial banks are forced to keep in reserve when lending. Adjusting the reserve rate is used by some nations (India and China for example) as a way of implementing monetary policy. If the reserve rate is increased, the money supply drops. If it is decreased, then the money supply is increased.

And so now my friends let me show you some real magic.

Let's go back to the US Government who wants to create money out of thin air simply to pay off the deficit, shown two graphs above, except this time we increase the reserve rate to 18.11%. Why 18.11%? Well it's the 10% reserve rate plus the 8.11% size of the deficit (in relation to GDP). So let's see what the outcome is:

What? Wait. Hang on? Is that possible? You're creating money out of thin air but not affecting the total money supply? Yes. How? By increasing the reserve rate.

Let me say this again: It is possible for large amounts of money to be created by fiat by a central bank and NOT induce inflation only if the reserve ratio is increased accordingly.

So what would happen in real life? Let's say the US Treasury, facing a shortfall in funds, approaches the Federal Reserve Bank for funds. The Fed then creates money by fiat, out of thin air, and gives it (not lends it) to Treasury. Treasury then uses this money to pay the bills. The Fed, however, increases the Reserve Rate accordingly to prevent the inflationary impact of this money creation.

Magic? No. Just a simple change to the equation - a change to the equation that was never thought of by Mugabe, Weimar Germany and others.

Don't believe me? Then do the spreadsheet yourself. Here is a screenshot of what I did with mine.

Long term readers of this blog might notice where I'm going here: My Zero Tax Idea. How would the graph look in the "Idiocracy" situation I described, where taxes are removed and the government is funded purely by money printing, except this time we adjust the Reserve Rate?

Yep. No increase in the total money supply and thus no inflation.

Is this mad? Does this completely misunderstand how the fractional banking system works? Or does this have the potential to revolutionise how governments work? It isn't Quantitative Easing, it's Quantitative Control.

Imagine: No taxes at all, but a completely functional government.

Note: This was discussed back in 2007 at Angry Bear. Megan McArdle at The Atlantic also examined it here. Since the math backs me up (as proven by the spreadsheet graphs), maybe we should seriously consider it?

EDIT: For nations that do not have a reserve rate (such as Australia) the baseline money creation would appear as a straight line going up at a 45% angle. In order for this system to work in countries that have no reserve rate, one must be introduced. This is how it would look:

But then what about nations with large governments? Take Denmark, for example, whose government represents 56.6% of economic output. How would this system react to such a large amount of central bank money? Would the fractional system still work? Yes:

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A blog post with every single category marked (I'm doing this for scribefire)

Zero Tax Economics - the final cut?

(If you're new to this blog you will not understand this post unless you read my original post here. Read also the comments at Angry Bear regarding my proposal here. It was further critiqued at Megan McArdle's blog here. A detailed critique of my proposal was written by Gavin Putland here. I respond to these critiques here. Recently I wrote another blog post which used economic equations here.)

After some correspondence with the former "Cactus" from Angry Bear, I have refined even further my zero tax idea. Mike helpfully pointed out a number of flaws in my reasoning - but was able to confirm that the equations themselves were correct.

Before I continue I need to thank Cactus for writing back to me. He is in the process of moving house and has probably stopped running his consulting business for a while. Responding to my email should have been low on his list of things to do but I've always found him to be quite accommodating to an amateur economist from a "fictional country".

Cactus pointed out that the problem with using the Reserve Requirement is that it is, in essence, a loan that commercial banks make to the central bank. Being a loan, therefore, means that it can be called upon by commercial banks in times of trouble (ie a liquidity crisis). Thus, Cactus pointed out, in order for the government to access the money to use it for general revenue it would mean that the government would be borrowing the money from the central bank.

So the result would be that a reserve requirement would continue to build and be loaned to the government and on and on and on... which means that those who critiqued my proposal in this area are actually quite right when they say it wouldn't work.

Nevertheless I was (and still am) convinced by the basic measures that I had been talking about - namely the hyperinflationary effect of money printing being balanced out by a reduction in commercial bank money creation. I therefore had to find out a different way of doing it, and I have.

The basic thrust of my argument is that if government revenue is to be sourced simply through the process of money creation, then the only way to prevent a repeat of Weimar Germany or Mugabe's Zimbabwe is to constrict commercial bank money creation. I was convinced that the reserve requirement was a way to do this but I am now convinced (thanks to Mike and others) that it would not work. Nevertheless the idea that a balancing-out could still occur, and I have worked out what it is:

I call it the "Fractional Lending Rate".

Commercial banks currently create the majority of money in our economy. Through the money multiplier, fractional reserve banking allows for a small amount of central bank money to be turned into large amounts of commercial bank money. This broad money supply (called M3), while having its basis in the central bank's creation of money, is essentially a result of the activities of commercial banks.

Nevertheless, even though commercial banks have this right given to them - that they can lend out money that they have had deposited with them which then is re-deposited back and then lent out again, thus creating the money supply - it is the central bank that really controls the amount of money created. Through tools like the reserve requirement and open market operations (raising or lowering interest rates), a central bank can alter inflation by removing or inserting money into the marketplace.

So when a bank gets money deposited with them, how much of it are they allowed to lend back out again? In the US, with the 10% reserve requirement, banks are allowed to lend out 90% of their deposits. Here in Australia (and in other parts of the world) the reserve requirement is no longer used, which means that banks are allowed to lend 100% of their deposits.

This is where my "Fractional lending rate" comes in. Instead of being allowed to lend out 100% or 90% of their deposits, the central bank mandates that they be limited to lower percentages. If the "Fractional Lending Rate" was set at 65%, then it means that banks are only allowed to lend out 65% of the amount they have deposited with them.

But what happens with the remainder? If the central bank mandates the FLR at 65%, what happens to the 35% remaining? Is it "given" to the central bank? No.

We need to remember that, in reality, if a commercial bank does not lend out that money, then that money is prevented from entering the money supply, and thus is prevented from re-entering it via the fractional banking process.

Thus while it functions in the same basic way as the reserve requirement or open market operations (it removes money from the money supply), it is neither a "loan" given to the central bank, nor is it a "tax" on money already deposited. It is simply money that has been prevented from entering the money supply.

And what would the equation look like now?

FLR = "Fractional Lending Rate" - the percentage of deposits that commercial banks can lend out (applied to M3)
G = Government Spending
GDP = Gross Domestic Product

Let me give some examples here.

The United States
Current US government spending accounts for approximately 20% of America's GDP. In order for the Federal Reserve Bank to supply the government with all the money needed to run its operations (money which is "created"), then America's FLR will be 80%. This means that commercial banks in America will be allowed to lend out 80% of their deposits. The equation is FLR = 100 - (20/100 x 100) = 80

Australia
Australian Federal government spending accounts for approximately 33% of Australian GDP. The FLR will thus be 66%. FLR = 100 - (33/100 x 100) = 66.

Sweden
Swedish government spending accounts for approximately 55% of Swedish GDP. The FLR will thus be 45%. FLR = 100 - (55/100) x 100) = 45.

In each of the countries I list above, the Fractional Lending Rate will effectively balance out any hyperinflationary effect of central bank money printing upon the money supply - no matter how "big" or "small" that government is. Since Commercial banks will be restricted in what proportion of deposits they can lend out, the effect will essentially be "hyperdeflationary" since it will effectively prevent a significant amount of of commercial bank money creation. Thus the hyperinflationary effect of money creation for government spending will be balanced out by the "hyperdeflationary" effect of preventing commercial banks from lending out significant percentages of their deposits.

When understood along with the money multiplier (see the previous article here) it can thus be proven that, while central bank money will increase, the reduction in the money multiplier will ultimately mean that the Zero tax/FLR process has a neutral impact upon the money supply.

Update 28 June 2008:
Again I get it wrong - the reserve requirement is NOT a loan a commercial bank makes to the Central bank. This means, of course, that the FLR I propose is pretty much the same as a Reserve Requirement on M3. This is problem of terminology and has no impact at all upon the basic idea of my zero tax proposal.

Moreover, the equation should actually be Government Spending as a percentage of M3, not GDP. So it should look as follows:

Zero Tax Economics - The Equation

I've done more thinking about my Zero Tax proposal and, as a result of studying how the money multiplier works in factional reserve banking, I believe that my proposal has a very good chance of working.

To summarise:

1. Government removes all taxes - income tax, sales tax, corporate tax... all of it.
2. Government spending is funded by money creation - seigniorage. The Central bank creates this money for the government.
3. To prevent inflation, the Central Bank increases the Reserve requirement and applies it to M3 - the broadest money supply.
   

The most common critique I had of this proposal was that increasing the reserve requirement would not stop inflation, and that, as time increased, the reserve requirement would approach 100%. These discussions can be found at Angry Bear and at Megan McArdle's blog (the latter with the heading "craziest idea I have ever heard"!).

Despite the fact that this idea is so radical that people think it "bonkers" (as one commentator at Megan McArdle's blog describes it), I have tested the idea against the actual equations contained in the money multiplier - and it works. In other words, it is possible for the Central bank to create money out of thin air to fund government spending and still maintain zero/low inflation with an elevated reserve requirement.

Here is the equation:

RM3 = "Reserve requirement on M3" - the reserve requirement needed to maintain zero/low inflation.
G = Government Spending
GDP = Gross Domestic Product
r = Current reserve requirement on M1
M1 = M1 narrow money supply (currency+deposits)
M3 = M3 broad money supply

To put it simply, when the central bank creates money for government spending, the money created is equivalent to a percentage of GDP. In order to remove any inflationary effects of this money creation, the reserve requirement increases by this same percentage. If government spending is 20% of GDP (as is the case in the USA) then the Reserve requirement on M3 needs to be 20%, plus the reserve requirement already in place on M1.

Now for a short explanation of how the money multiplier works. Here is the equation:



Whereby m is the multiplier and R is the reserve requirement. If the reserve requirement is 20%, then R looks like this:



Which means:



Which in turn means that when the reserve requirement is 20%, then the money multiplier is 5. If the central bank creates $100, then the total amount of money created through commercial bank money creation will be $500.

But when money is created by seigniorage, the amount created at the beginning increases. If we retain the current model of $100 central bank money and a 20% reserve requirement, and then add to it the relative size of the US government (20% of GDP), then we are increasing the central bank money to $200.

So if the reserve requirement increases to 40%, then R looks like this:



Which means:



Which in turn means that when the reserve requirement is 40%, then the money multiplier is 2.5. If the central bank has created $200, then the total amount of money created through commercial bank money creation will be... $500.

Yep, that's right, the same amount as before. Even with creating twice the amount of money, reducing the money multiplier by increasing the reserve ratio ensures that no inflationary pressures will ensue.

As I pointed out before, this taxless system is not a "free lunch" - the tax burden remains in the form of higher market interest rates. Moreover, the larger the government is in proportion to the economy as a whole (Around 20% for the US, 34% in Australia, 53% in Sweden), the higher the market interest rates will be.

As a monetary tool, the reserve requirement has become outdated. Many countries (including Australia) have a zero reserve requirement, preferring to use central bank interest rates. In the taxless system I propose, the reserve requirement would be solely for the purpose of balancing out government spending, which means that current reserve requirements must be dispensed with. This, of course, means that the last part of my Zero Tax equation (the first diagram) about the reserve requirement on M1 divided by M3 can be dispensed with in economies that do not currently run a reserve requirement.

In a simple sense therefore, the reserve requirement on M3 - the percentage amount - is identical to the percentage of GDP that government spending takes up.

Zero Tax II

Gavin Putland, a research officer for Prosper Australia, has picked up on my Zero Tax proposal and published a critique of it. It would be good for you to read his blog article before progressing any further, as much of what I write here will be in answer to his critique.

I need to point out before starting that I had emailed Putland with my proposal and asked him for his response. The reason is that Putland himself has created a theoretical economic system that does away with tax as well. I won't be critiquing his approach since I need more time to understand it, but I would certainly encourage anyone reading this to check out Putland's theory for themselves.

One of the common criticisms of my original proposal is that, in order to keep government funds being created by seigniorage without inflation, the Reserve requirement would have to keep increasing until it reached 100%. This was pointed out by "Leonard" at Megan McArdle's blog. Yet if you read McArdle's blog, you'll see that "Leonard" also advocated the complete abolishment of the fractional banking system, which sort of skews his understanding of how fractional banking works and how my system fits into it. Then again, I'm the one with this crazy idea to abolish all taxes so I suppose we're even in that regard!

The thing about fractional reserve banking is that the amount of money it can produce is infinite. In order to understand it, I suggest readers familiarise themselves with this practical example available at Wikipedia. If the reserve requirement of an economy is set at zero (as it is in Australia) then there is no limit to how much money can actually be created through the money multiplier. Increasing this reserve requirement will result in substantial amounts of money NOT being created as it is multiplied.

This is important to understand. I think Putland (and others) have it in their mind that there is a direct relationship between the money supply and the rate of inflation. In other words, if the money supply is increasing, then so is inflation. If the money supply is decreasing, then deflation results. This is not so.

Inflation and deflation are both monetary phenomena but they are not determined by whether or not the money supply increases or decreases. Rather, they depend upon market forces - namely the market's valuation of money itself. In other words, it is quite possible to have both deflation and an increase in the money supply, just as it is possible to have both inflation and a decrease in the money supply.

The reason is that supply is always balanced by demand. If the demand for money is greater than its supply, then money will become more valuable - and deflation will result. If the demand for money is less than its supply, then money will become less valuable - and inflation will result.

In my zero tax system, I do away with all forms of taxation and replace them with that most horrendous of government sins - the printing of money. Yet rather than create an inflationary spiral, the increase of the reserve rate will remove money from the money supply, thus balancing it out and removing any hyperinflationary effect. Putland and "Leonard" would argue that the increasing reserve requirement would eventually reach untenable levels (100%), this making this system, well, stupid.

My argument is, obviously, that this will not happen. The reserve requirement will be quite high but it is highly unlikely to reach even beyond 50%. The reason for this is obvious - money, by being infinitely fungible, can be easily created and destroyed through monetary policy, of which the reserve requirement has been a part of over time.

How high can interest rates go? Here in Australia at present, the Reserve Bank has a cash target rate of 6.75%. What would happen if the RBA increased rates to, say 10%. What about 20%. Why not 100%?

Of course the RBA isn't going to raise rates that high just for the sake of experimentation. Nevertheless we can make reasonable extrapolations as to what might happen. If the RBA raised rates to 20% all of a sudden, the result would be a severe economic downturn accompanied by a major bout of deflation. The reason for this is simple, by raising rates the RBA has acted to reduce the money supply, and, with demand exceeding supply, money becomes very valuable indeed, which means that the price of goods and services decline in relation to it, which is deflation.

The fact is that the RBA's use of monetary policy can be deflationary if it wants to be. Any central bank, from the Bank of England to the European Central Bank to the United States Federal Reserve, has this power at its fingertips if it wishes to.

It seems ridiculous, therefore, to argue that central banks can't create a deflationary environment. That is, in essence, what Putland and "Leonard" are arguing. The reason I am pointing this out is that, in my zero tax proposal, with the money from seigniorage (money printing) entering the money supply and creating an inflationary environment, it seems illogical to assume that central banks could NOT somehow create a deflationary action that balances it out.

I think that the reason for Putland's critique is that he probably does not understand how fractional reserve banking works. Understanding the money multiplier effect in the context of an economy in which money is bought and sold is essential. My eventual understanding of this effect is the reason why I was able to pull this proposal from the shelf and publish it - previous to that I had no faith that it would work since I had a less than rudimentary understanding of the fractional system.

Moreover, I don't think Putland understands how to describe the problems of my system correctly. For example, he states:

If the tax burden were indeed simply replaced by higher interest, this would be bad enough, because it would encourage hoarding of money and deter productive investment.

Putland avoids the use of the word "deflation" here. Why? What he has described - the hoarding of money - is a classic result of deflation. So, in other words, he is arguing that my proposal would be deflationary. Yet he doesn't use the word.

Notice also this paragraph:

Even in the absence of taxes, such a huge interest margin would be ruinous to depositors and borrowers. Both parties would need to "cut out the middleman", but this would be illegal because the "middleman" also happens to be the tax collector. So the only source of credit would be the underground economy, and life would be "solitary, poore, nasty, brutish, and short."

What Putland describes here is a system in which banks have such control over our deposits that it would be "ruinous" to place our money into such institutions. But what is he inferring here? Is he saying that, by increasing the reserve requirement so high that people would be unable to access their money if they so desire? Since the reserve requirement is a hidden "tax", would that mean that people would be forbidden to take money out of the bank?

If this is Putland's thinking, then he certainly doesn't understand fractional reserve banking. The fact is that, even in today's environment, if everybody went to the bank to withdraw their money the result would be complete disaster. It is called a bank run.

Yet why would people under my system be worse off? I have said nothing about the rights of people to withdraw their money from the bank, nor did I say anything about preventing this from occurring. The reserve requirement only applies to money that the bank has in its deposits. If a bank has $10bn in deposits, and if the reserve requirement is 10%, then $1bn has to be held in reserve. If the bank loses a lot of customers and deposits fall to $9bn, then only $900 million should be held in reserve.

If Putland has a theoretical problem - what would happen if people wanted to remove their money from banks whose reserve requirement exists as a deflationary measure to balance out government seigniorage - then he should be worried about our current system. Yet in our system people have money in bank deposits and are happy to have them. The fact that a high reserve requirement exists or not is not the issue.

Moreover, Putland fails to understand that, with the natural increase in market interest rates that would result in my proposal, households and businesses would actually see bank deposits and other savings accounts to be quite attractive. As interest rates go up, the entire economic system rewards those who save, which means that many people would increase their rate of savings (insofar as inflation is controlled; higher inflation would lead to less savings). All in all, households and businesses would not view banks and their deposits any differently under my system as they do now.

Next, Putland quotes "Jeff", a commenter at the Angry Bear web page which discussed my proposal:

If you make the banks sit on more and more cash each month that they are not allowed to use it is the same thing as a tax.

Basically you have created a source of money in your money printing to fund the government, and you have created a sink for money with the reserve requirement. It is the same as if that money the banks are not allowed to touch had gone to the government, and the government had not printed money. So if such a system could ever balance you would have simply replaced the current tax system with an effective tax on bank deposits.

There is much in Jeff's statement that is true. My zero-tax economic system is not a free lunch. Government spending has to be paid somehow. I am not proposing a magic tax-free utopia. What I have done is, according to Putland, is a "tax/interest trade-off". All I have done is replace taxes with higher interest rates. Yes, that is what I have done. Guilty as charged. Yet I would still argue that my proposal is fairer because it affects the entire market (and thus affects the rich more than the poor, which means that its effect is essentially progressive rather than regressive) and is more efficient because it does away with an entire section of the economy dedicated to tax collection and avoidance (government tax departments, tax accountants, tax laws, tax lawyers, etc). Moreover, the resulting increase in money supply and reserve requirement will need far less resources to achieve than the current tax system.

It needs to be pointed out that in the system I am proposing, the entire government is funded by seigniorage (money printing). There are no other forms of revenue. The reserve requirement cannot be considered a tax because it is not spent. Instead, it is held at the central bank. But then, of course, there is the problem of whether or not such reserves can be sustained - what would happen if people wanted to take out their deposits and thus remove these reserves? Again, the problem is simply identical to a bank run and the same question could be asked of our current economy today. What I am pointing out is that the behaviour of depositors and lenders is not going to suddenly take a peculiar turn if this system is enacted.

Another problem with Putland's critique is that he has not taken into account the effects of zero tax upon the economy. He says, for example:

the burden of the tax on bank deposits would be passed on to customers in the interest margin — that is, the margin by which the interest paid by borrowers exceeds that paid to depositors.

Of course my proposal has negative effects. High market interest rates would be a natural result. Yet he is unable to realise that, even with such negative effects, there are positive ones. With no taxes to pay, households have more money to spend. A person may owe more money, but they also have more money. Certainly interest margins, which occur naturally in banks, will be affected. Yet Putland does not take note of the changed financial circumstances of households and businesses - namely, that they have more money as a result of zero income tax. To be sure, this increase in income sounds inflationary, but the increase in interest rates will ensure that the majority of this extra money will go into savings rather than spending, with the increased size of bank deposits being affected by the increased reserve requirement to the point where the money multiplier results in price stability.

If this system is used in a real economy, I am certain that an ever-increasing reserve requirement will not be needed. Nor will the system result in hyperinflation or deflation, assuming that the reserve requirement is set at a level whereby monetary supply meets monetary demand.

Zero Tax Economic System

Over the years I have come up with some crazy ideas and schemes. Every time I do, however, I discover that someone has been there first. I came up with the idea of a Democratic system of government that selects politicians randomly and without the need for political parties and elections, but then discovered that someone else had come up with it first. I invented the Zero Unemployment Economic System but then found out that I had simply come up with a Socialist version of Milton Friedman's Negative Income Tax theory. As yet I have yet to find anyone advocating my idea for Absolute Price Stability before I did.

Now I've come up with something else - the Zero Tax Economic System. It's been running around in my mind for about 5-6 years now, but the reason why I never published anything about it was simply because I had no faith that it would work. To be honest with you, I'm still not certain that it would work, so if you do find holes in it I won't get too embarrassed.

The reason I'm publishing it now is due to some conversations I've had with a friend over the nature of the Monetary system and recent stuff I have read about SIMPOL and their ideas of monetary reform. As a result of my thinking through this, I have come to understand a bit more about Fractional-reserve Banking, as well as the Reserve requirement that has sometimes been used as part of a central bank's Open market operations.

In a nutshell, here is my idea:

1. All taxes are removed - income tax, sales tax, company tax... everything.
2. The government creates the money it needs via seigniorage (printing money).
3. The Central bank then controls inflation by increasing the Reserve requirement of bank deposits (on M2 and maybe M3).
   

Simple isn't it? In years gone by it was my understanding that when a central bank intervened in the marketplace it either issued bonds or paid them back. I wasn't really aware of the Reserve requirement - the percentage of deposits that banks must hold at the central bank - or any other tools of monetary policy.

Of course the idea of a government simply printing the money it needs without worrying about tax intake is hardly new. Everyone with a smidgeon of economic understanding knows that this sort of activity leads to the "H" word - Hyperinflation. Suddenly everyone then becomes an expert in the history of Weimar Germany (although Zimbabwe is another good place to start these days).

What I'm suggesting, though, won't result in hyperinflation. This is because I still have faith in the ability of Monetary policy and Central banks to recognise inflation and to act accordingly (except, most saliently, the current US Federal Reserve Bank board, who obviously need Paul Volcker to be chairman again). The complete removal of all forms of taxation, followed by wholesale money creation, would inject massive amounts of money into the economy. But for every dollar, or pound or Euro or Yuan that is created, the central bank can remove by increasing the Reserve requirement for bank deposits. This balancing act will remove the hyperinflationary effect.

I can see three benefits of this system.

The first benefit is efficiency. Without the need to collect tax, entire government departments can be eliminated, removing the need for a massive bureaucracy to maintain the government's tax revenue. Instead, the government simply gets the money created by the central bank. This efficiency would also be felt in the private sector, with no tax accountants and lawyers required by companies and corporations. Obviously some level of unemployment would occur as accountants and lawyers and bean counters look for work, but that would be easily solved over time. With less time spent on adhering to tax laws and finding loopholes, the economy will benefit.

The second benefit is that government revenue is indirectly raised from the broadest possible base. This proposed system does not really create money from nothing - the raising of the Reserve requirement of bank deposits balances out the seigniorage. This means, in effect, that the tax burden is still there - it's just that it has transferred into the marketplace in the form of higher market interest rates, which affects the entire economy.

The third benefit of this system is that it accommodates those who wish for "small" government as well as those who want the government to have a larger role in the economy. Obviously the amount of money the government spends will determine how high the reserve requirement of bank deposits becomes - the smaller the government, the lower the reserve requirement will be and the larger the place the free market has; the larger the government, the higher the reserve requirement will be and the free market will have a smaller place in the overall economy. Put simply, this zero-tax economic system can work for both conservative and progressive sides of politics. In the end, the argument between these two political sides will no longer be about government revenue and taxation, but government spending and market interest rates.

Since I've had other economic ideas, how would this idea fit in with my other models - the Zero Unemployment Economic System (ZUES) and Absolute Price Stability?

With ZUES, all that would happen is that each employed person would continue to receive two incomes - one income from his/her employer (which has no minimum wage requirements) and the universal income from the government that all people would receive equally (which is a form of negative income tax). But rather than this universal income being sourced from higher levels of tax revenue, the income is merely created by seigniorage, with the amount determined by formula. The central bank then modifies the Reserve requirement to control inflation.

With Absolute Price Stability, the Central bank would set the Reserve requirement at such a level as to keep inflation at zero. Moreover, I would argue that banks should not get any interest paid at all on these reserves by the central bank which, in a zero-inflation environment, means that banks would neither directly gain nor directly lose from having to keep money under the central bank bed.

Update 22 January 2007:
I have just discovered that a lengthy discussion of this article occurred at Megan McArdle's page at The Atlantic.com.