Excerpt from Stephanie Kelton
"Can Taxes and Bonds Finance Government Spending?" (1998)
(h/t y in the comments)
Federal Reserves notes (and reserves) are booked as liabilities on the Fed's balance sheet and these liabilities are extinguished/discharged when they are offered in payment to the State. It must be recognised that when currency or reserves return to the State, the liabilities of the State are reduced and high-powered money is destroyed.
The destruction of these promises is no different from the private destruction of a promise once it has been fulfilled. In other words, when an individual takes out a loan, she issues a promise to a bank. Once she 'makes good' on that promise (i.e. repays the loan), she may 'destroy' that loan debt (liability) by eliminating it from her balance sheet.
Thus, while bank money (M1) is destroyed when demand deposits are used to pay taxes, the government's money, HPM, is destroyed as the funds are placed into the Treasury's account at the Fed. Viewed this way, it can be convincingly argued that the money collected from taxation and bond sales cannot possibly finance the government's spending. This is because in order to 'get its hands on' the proceeds from taxation and bond sales, the government must destroy the money it has collected. Clearly, government spending cannot be financed by money that is destroyed when received in payment to the State! [This may be intended meaning of Warren Mosler's metaphor that tax dollars are destroyed when the tax liability has been removed from the record, rather than being used to fund future spending as most assume — th.]
How, if not by using the money received in payment of taxes and bond sales, does the government finance its spending? Notice that the government writes checks on an account that does not comprise part of the money supply or HPM but that as it does, the funds become part of the money supply (M1 if deposited into checking accounts, M2 if savings accounts, etc.) and part of HPM. It is therefore apparent that while the payment of taxes destroys an equivalent amount of money (M1 immediately and HPM as the proceeds go into the Treasury's account at the Fed), spending from this account creates an equivalent amount of new money - both bank money and HPM. Modern governments, then, finance all of their spending through the direct creation of new (high-powered) money.