Modern Economy, 2011, 2, 142-152
doi:10.4236/me.2011.22019 Published Online May 2011 (
Copyright © 2011 SciRes. ME
Abstract Nature of Money and the Modern Equation
of Exchange
Mieczysław Dobija
Department of Management , Cracow University of Economics, Cracow, Poland
Received February 11, 2011; re vi s ed Fe bruary 28, 2011; accepted March 25, 2011
The essence of money economy reveals an abstract triad: capitallabormoney, where capital is an ability
of doing work, labor is a transfer of the capital to products, and wages receivables correctly define money
earned by the employees. The only proper money creating process is through labor. Money is a certification
of work done; therefore labor is always self-financing. Using this theoretical framework, Governments can
eliminate budget deficit, reduce direct taxes and unemployment while avoiding inflation. If the compensation
paid in the public sector comes from the funds collected by taxation the economy works as a scarcity ma-
chine. In the reshaped economic system the Central Bank directly transfers salaries earned by the public sec-
tor employees to their bank accounts. Then the budgets are balanced, the direct taxes are limited, and the
public debt no longer grows. The modern equation of exchange involves labor productivity as a fundamental
economic ratio.
Keywords: Capital, Labor, Money, Central Banking, Labor Productivity, Equation of Exchange, Budget
1. Introduction
The recent comprehension of capital and its nature opens
up a new way to perceive economic matters. Capital, the
most important economic category, which has been stu-
died for decades [1-3] has at last been described as the
abstract capability of doing labor. It is worth noting that
in order for an object to have the ability to work, it has to
have the ability to exist. This short definition requires
extensive explanations that have been given by the au-
thor of this paper [4] and others. In relation to the pro-
phetic Ch. Bliss’ opinion [1] “(…) When economists
reach agreement on the theory of capital they will shortly
reach agreement on everything (...)” it is simply the un-
derstanding of labor as the transfer of capital to products.
Then the last question arises about the perception of
money. Money is the third part of the triad capital—la-
bor—money and it correctly arises as confirmation of
labor done; that is to say, the work receivables. The
above triad is absolutely abstract and each deviation
leads to error. Therefore, money cannot be seen as coins
or other material artifacts.
The model of capital explains its dynamic nature and it
is deeply set in the fundamental laws of reality, those P.
Atkins [5] recognized as “driving the Universe.” The
model of capital Ct is as follows:
Ct = C0epte-stemt, p = E(s) = 0.08 [1/year]
Here t—is the coordinating (calendar) time measured
by chosen cyclical movements, particularly of the Earth.
The factor ept is the factor of natural potential growth of
capital determined by the constant of potential growth p
= 0.08. The factor e-st is the thermodynamic arrow of
time; where s is the rate of spontaneous random diffusion
of the initial capital C0. The factor emt is an influence of
human labor and management, which can offset to some
extent the natural diffusion of capital s. In addition, labor
changes potential to real growth.
The discovery of the constant of potential growth re-
minds us of the Physiocrats idea. The truth is that by
labor (m) the dispersion (-s) is diminished so that the (p)
becomes a source of income. Much estimation was made
in many economic fields to establish the value of the
constant. It was estimated on the capital market as the
risk premium [6], as the return on a company’s assets [7],
and human capital computations [8-11]. The constant
plays a significant role in different economic estimations
and in establishing discount rates as well.
Copyright © 2011 SciRes. ME
The constant also plays a significant role in formulat-
ing the model of employee capital measurement and the
derived models of consistent compensations. The basic
relation established is L = p × H(p), where L—denotes
basic constant pay of an employee, and H(p)—denotes
human capital of the employee.
Since a non-material artifact may be seen as money, a
new equation of exchange ought to be introduced. It is
each individual experience that we earn money as work
receivables doing labor as employees and that we then
exchange our work receivables for products. The modern
equation of exchange depicts this undeniable fact. The
introduction of the new equation comes before critics of
the theory of money and the monetary equation of ex-
2. The Equation of ExchangeThe Heart of
Discerning money as coins or other material artifacts
yields the well-known equation of exchange. Accepting
the relationship between the output of an economy and
the number of coins (N) in the hands of economic agents,
one can write the equation GDP = N × V, where V de-
notes velocity of circulation. Then, introducing the vari-
able of inflation, the equation is as follows:
GDP = GDPR × (1 + i) = N × V,
where GDPR denotes real GDP (current GDP valued in
past-year prices), and i denotes inflation. The main con-
clusion stemming from the above equation is well known;
the level of inflation is closely related to the number of
coins. The reshaped equation is 1 + i = N × V/GDPR.
Since coins are now replaced by cash money (banknotes
produced from paper and lent to commercial banks or
chosen financial institutions under the supervision of the
central bank), the N is replaced by the amount of money
M. Of course, there are some complications in measuring
M, hence we experience a sequence of M, M1, M2,....
Thus, the well-known monetarist equation of exchange
is as follows:
GDP = GDPR × (1 + i) = M × V
Here M is the amount of money circulating with ve-
locity V. Here appears a fundamental difference between
the coins equation GDP = GDPR×(1 + i) = N × V, and
the equation GDP = GDPR×(1 + i) = M × V with the
variable M. The first equation is subdued by limitations
of reality. Nobody can produce coins from nothing, by
fiat. Instead, the second equation with variable M is the
theory, which admits that money is created by fiat. This
is a fundamental error against the natural laws of reality,
which charges fatal monetarism and economies.
Using such eerie concepts as basic amount of money,
we may decrease inflation, but only by destroying the
economy. Thus, the language used by monetarists is
filled with expressions like overheated economy (we
need and should cool it down), shock therapy, restrictive
monetary policy, and so forth. Followers of quantitative
“theories” of money possess an ample arsenal of means
and numerous “merits” in “cooling the economy down”;
in other words, causing unemployment and decreasing
the standard of living.
The bad effects of monetarism for an economy are
much greater. Monetarism is the reason for budget defi-
cits, taxation of fair pays, and unemployment. It changed
our friendly world from a natural eight percent potential
for growth [12] to a kind of economic imprisonment. In
a normal world, without false monetarism, labor is the
source of money. The more productive the labor is, the
more money there will be in the hands of citizens. In-
stead, we are in a world governed by the rule of “we
cannot do it since we do not have money.” The most im-
portant drawback to economic theory concerning money
is extremely serious. The present theory of money is not
a kind of science because it admits that the ability of do-
ing work (capital, energy) is created ex nihilo. The law
of energy conservation has been commonly accepted as
fundamental law [5] since the second part of the 18th
century, and the creation of capital is unfeasible. The
central banks are not able to break this fundamental law
either. But its action creates chaos in all economic mat-
ters. The correct view is the only one. Money arises as
evidence of work done; as work receivables.
3. The Triad: Capital—Labor—Money
Accomplishing labor creates two economic categories:
products (where capital transferred by labor is concen-
trated) and work receivables, which is the accounting
record of the value of work done, as illustrated in Figure
1. The last category is our money, and it is exchanged for
goods. Money is the essence of the money-goods econ-
omy, which can be capitalistic or socialistic, free market
or not. The right opposition to money—the goods econ-
omy—is a barter economy. The latter also involves an
economy with coined money, that is to say some material
artifacts as the “means of payment.”
Figure 1. The triad: Capital—labor—Money.
Copyright © 2011 SciRes. ME
When an employee transfers his/her human capital to a
product in the process of labor, the transfer related to the
work compensation (which should be fair) is also deter-
mined. Then money appears as a category of a wage re-
ceivable and consequently, with the duality principle, as
a payable. Therefore, in line with the duality principle,
the employer has adequate liability (payable). Let us note
that the category of receivables requires a measurement
of value with an abstract account unit. This is possible
since all these categories: capital, labor, work receivables,
and payables are measured by the same abstract unit of
measurement. It is a money unit and a labor unit as well.
Plenty of research exists where authors are skeptical
about a positive meaning of the present theory and prac-
tice of money. R. W. Garrison [13], who represents the
contemporary Austrian School of Economics, expresses
a moderate opinion that:
“...Unavoidably, the medium of exchange is also a
medium through which difficulties in any sector of the
economy—or difficulties with money itself—get trans-
mitted to all other sectors. Further, the provision of
money even in the most decentralized economies is—not
to say must be—the business of the central authority. ...
Money comes into play both as a source of difficulties
and as a vehicle for transmitting those difficulties
throughout the economy.”
The present state of knowledge concerning monetary
unit is clearly expressed by A. V. Banerjee and E. S.
Maskin [14], who wrote:
“...Money has always been something of an embar-
rassment to economic theory. Everyone agrees that it is
important; indeed, much of macroeconomic policy dis-
cussion makes no sense without reference to money. Yet,
for the most part, theory fails to provide a good account
for it. Indeed in the best-developed model of a compete-
tive economy the Arrow-Debreu framework—there is no
role for money at all. Rather than there being a medium
of exchange, prices are quoted in terms of a fictitious
unit of account, agent(s?) trade at those prices, and that is
the end of the story...”
The present state of the art concerning money is com-
prehensively described by T. G. Buchholtz [15]. In the
chapter X, where the author discusses Milton Friedman
and the monetarist battle against J. M. Keynes, one can
find a paragraph arriving at the essence of money as fol-
lows: “What is money? Anything can be money, includ-
ing shells and beads; cigarettes often serve as money in
prison. In today’s macroeconomic lingo, we follow the
Federal Reserve Board definition of money supply. The
most popular measure is called M1...” How does some-
one know that money is material and that we expect a
supply of money? The author continues: “Why would
anyone be foolish enough to argue about the money
supply? Wrong. ... If the amount of money over- whelms
the capacity to produce goods, consumers, with more
money to spend, bid up prices.”
Figure 1 shows that money is the final part of the triad:
capital—labor—money. Money arises as an abstract
category of wage receivables that come into existence
after accomplishing work and making adequate account-
ing entries. Money is immaterial. Human labor is natu-
rally measured according to the unit of labor so it is a
money unit as well. This is common knowledge for all
employees who work and feel every working hour, who
often feel tired transferring their energy (human capital)
through labor, and who sometimes do not get an equiva-
lent exchange for these transfers.
This point of view allows us to overcome old habits
resulting from seeing the monetary system as based on
metal or bimetal or even as paper money. The creation of
money by the central banks for use by commercial banks
is a fact, but not a natural one. It is beyond the scientific
approach since it violates the conservation principle.
From one side, the employee’s work and earnings repre-
sent an equivalent of labor (transferred human capital),
and from the second side an institution creates money by
Recently a group of thinkers (B. Lietaer [16], D.
Rushkoff [17], and others) raised the problems with the
present money system to propagate the concept of an
open source currency. D. Rushkoff explains “...Open
Source or, in more common parlance, “complementary”
currencies are collaboratively established units repre-
senting hours of labor that can be traded for goods or
services in lieu of centralized currency. …So instead of
having to involve the Fed in every transaction—and us-
ing money that requires being paid back with interest—
we can invent our own currencies and create value with
our labor…”
Open-source currency is a progressive concept that
correctly conceives money as tightly related to labor. It is,
however, not satisfactory since we do not need comple-
mentary money to make our tough existence easier. We
need, rather, ultimate knowledge about the essence of the
money-goods economy. What is money in particular?
The answer is clear. Our money is our work receivable.
Our money arises as confirmation of work done and it
represents the value of labor transferred by laborers. The
real transfer of human capital into products occurs only
in the labor process. Therefore we say that labor is al-
ways self-financing.
Adam Smith [18] wrote that “…What is bought with
money or with goods is purchased by labor as much as
what we acquire by the toil of our own body. That mon-
ey or those goods indeed save us this toil. They contain
the value of a certain quantity of labor which we ex-
Copyright © 2011 SciRes. ME
change for what is supposed at the time to contain the
value of an equal quantity. Labor was the first price, the
original purchase-money that was paid for all things. It
was not by gold or by silver, but by labor, that all the
wealth of the world was originally purchased; and its
value, to those who possess it, and who want to exchange
it for some new production, is precisely equal to the
quantity of labor which it can enable them to purchase or
command…”. 1
Regrettably, these right words have not changed eco-
nomies to a natural state, where labor produces money so
that labor is self-financing. The phenomenon of self-
financing is extremely advantageous for economies. It
means that governments need not raise money to fund
the public sector’s payroll. Instead of collecting funds
through taxation, an authorized government agency (the
reformed central bank) ought to make appropriate trans-
fer entries in the commercial bank account of the em-
ployees. The only constraint is the size of the public sec-
tor, as the paper explains [12].
The self-financing of labor means that labor is an ex-
clusive process that may produce money as evidence of
labor performed and represented by the laborer’s receiv-
able. In the case of a company, its products need market
approval; in other words, the company needs to make
a sale. In the case of public sector units, their activities
do not need market approval. Instead, these activities are
subject to a set of standards and procedures, like those
required of public school teachers. To be a teacher, an
individual has to accumulate his/her human capital to
determine an adequate ability to perform labor—in this
case, the tasks of a teacher. While teaching, he/she trans-
fers his/her human capital to the pupils, who gain value
as future workers in society.
The fundamental inaccuracy of current economic the-
ory is concentrated in the central bank’s activity. This is
not the fault of some central bank officers. The line of
thinking that the economy needs institutions to create
money, and the suggestion that money can be something
material is absolutely damaging. Therefore, economies
operate on the basis of, “we can do nothing since we
have no money.” As an alternative, economies should
operate according to the statement “we can do it since we
have qualified employees and adequate knowledge.”
This is the road to the peaceful welfare of the state and
the world. Sciences and techniques provide a firm basis
for this and similar opinions.
The central bank operating in the present theoretical
environment blocks natural productive resources existing
in the economy. The central bank’s production of money
creates the following obstacles:
It violates the fundamental principle of energy
conservation, therefore economics does not adhere
to scientific rules;
It blocks many advantages resulting from the self-
financing of labor;
It forces governments to raise taxes;
It reduces demand;
It causes inflation and economic crises; and
It causes unemployment.
Therefore, current money creating procedures lead to
financial instability. This is why stock market valuation
can grow at a much higher rate for many years than the
natural average rate of growth determined by the con-
stant p = 8%. Consequently, sooner or later, an adjust-
ment to the long-term rate of return is unavoidable.
There are more drawbacks resulting from the present
state of money affairs. However, the ones just pointed
out suffice as a premise for the principal reform of the
central bank’s role. It is crucial for economic stability.
Activists of the American Money Institute refer to a
speech made by Congressman Wright Patman2, Chair-
man of the House Committee on Banking and Currency
for over 16 years [19], who said significantly:
“I have never yet had anyone who could, through the
use of logic and reason, justify the Federal Government
borrowing the use of its own money...I believe the time
will come when people will demand that this be changed.
I believe the time will come in this country when they
will actually blame you and I and everyone else con-
nected with the Congress for sitting idly by and permit-
ting such an idiotic system to continue.”
The defect in understanding money leads to growing
budget deficits and an expanding public sector. But the
public sector cannot be financed entirely by growing
taxes. People in a democratic country will not agree to
pay for misunderstandings of the economists and politi-
cians. What’s more, they cannot afford to pay ever
greater taxes. Therefore, economies become what D.
Rushkoff called scarcity engines [17]. The more devel-
oped the economy, the greater the deficit, as is the case
in well-developed states like Germany and France. Of
course, budget deficit can be an issue of incorrect man-
agement, but we have considered well-governed coun-
4. The Wage Equation of Exchange and
Control of Money Stability
The most important way of controlling inflation is by
not allowing a decline in the labor productivity ratio Q
determined as the quotient of real GDP (GDPR) to total
1A. Smith, An Inquiry into the Nature and Causes of the Wealth o
ations. Edwin Cannan, ed. 1904. Library of Economics and Liberty,
Retrieved June 23, 2010.
2Retrieved June 23, 2010 from the World Wide Web of the American
Monetary Institute.
Copyright © 2011 SciRes. ME
compensation W of employees. If Q = GDPR/W is con
stant or, better yet, is growing, then inflation is under
control. Moreover, inflation can grow if 1) the public
sector is too big compared to the private sector, or 2)
credits taken from commercial banks exceed adequate
limitations. Therefore, policy makers can simultaneously
apply two tools. The first is determining the upper limit
of credit; the second is determining the size of the public
sector that cannot exceed the sum of compensation de-
termined by the labor productivity ratio Q. To determine
the adequate amount of credit, we introduce the wage
equation of exchange.
Having understood economy as a constant flow of
capital, we reach the most essential Figure describing the
dual nature of the money-goods economy. The essence
of the money-goods economy is the existence of two
streams: the stream of products and the stream of money.
The source of those two streams is labor of human capi-
tal; but the stream of products arises as a result of a
composition of labor costs and assets of various kinds,
while the other stream consists of receivables and partly
credit money. This stream is created by a sequence of
accounting entries recorded and transferred into the
banking system. A constant confrontation between the
products and the stream of money takes place in the
market; as a consequence of this confrontation, the value
of exchange is determined. This exchange leads to the
equation of exchange of money for goods and vice versa
(Figure 2).
In the process of exchanging goods and money, basic
economic values are shaped that characterize the econ-
omy; in particular, the Gross Domestic Product, labor
productivity Q, and the inflation index. Measurement of
these values is based on the performance principle;
therefore, it is done according to market value. When we
look at it from an accounting perspective, we can talk
about the dynamic balance of the goods and money
economy, in which the above variables are revealed as a
result of a given market configuration and the goods-
money exchange. The exchange process is illustrated by
Figure 2, which in turn enables the formulation of an
exchange equation.
The bottom of Figure 2 shows that it is human beings
who set in motion the labor process. We consider not an
individual but human capital denoted by letter H, which
can be precisely measured in economic terms, and the
percentage (u) of human capital H determines market
pay (W = u × H).
The left side of the Figure shows the process of pro-
ducing goods and services. Labor costs (W) composed
with various sorts of assets make final products (P)
measured in historical costs before confronting with
money claims of payable holders (please check). The
relevance of the amount of labor used in a particular in-
stance to the market accepted amount is tested in the
marketplace. The process of production is modeled by
the natural (not econometric) production function, which
can also serve as a determinant of wage productivity Q.
Therefore GDPR can be introduced as product GDPR =
W × Q, and, as shown by M. Dobija [20], we can use the
Q = GDPR/W = exp[AF/H] = exp[AFp/L] = exp[TF]
where: A—end-of-period value of assets, H—human
capital, L—constant basic pay (L = p × H), p—the con-
stant of potential growth (0.08), T—technical equipment
of work, F—level of management.
The right side of Figure 2 shows not material streams
but a stream of records arising as a result of pay receiv-
ables considered from the employees’ point of view or
pay liabilities considered from the State’s point of view.
The State and the banking system are responsible for
a smooth exchange of money for products that match the
expectations of money holders. The banking system’s
role is also the creation of credit money (parameter k) in
a way that is adequate for the economic requirements.
We shall see later that that process should depend exclu-
sively on real wage productivity. It depends to some ex-
tent on parameter (a), which reflects society’s attitudes
and degree of poverty (or wealth).
The upper box shows the constantly accomplished
exchanges: money for products and vice versa. This is
the essence of the monetary economy—that the records
of wage receivables are exchanged for goods. Despite the
fact that these receivables change owners and play the
role of the most desired assets, they still remain as li-
abilities of the state system. This process can be roughly
described by the equation of exchange. Obviously, more
money in respect of the bulk of goods and higher prices
would lead to higher inflation. However, pay should be
in accord with the value of labor. This is the only correct
conclusion stemming from the above considerations.
The wage equation of exchange arises by natural alge-
braic depiction of Figure 2. Assuming that market me-
chanism does equalize the value of streams of money and
products, the following equation can be written and called
‘the wage equation’:
GDP = GDPR × (1 + i) = W × Q = MK
= a × W+(1 – a)W/(1 – k) = W × K(a,k),
where GDPR—denotes real GDP, and i—denotes infla-
The following condition stems directly from the above
equation of exchange:
W × Qr × (1 + i) = W × K(a,k),
where Qr denotes real work productivity (Qr = Q/(1 + i)).
Hence we obtain condition; if i = 0, then K(a, k) = Qr,
Copyright © 2011 SciRes. ME
Figure 2. The market mechanism equalizes the stream of products and the stream of money. Source: M. Dobija, “Wage,
Money and Accounting: Theoretical Relationships,” Argumenta Oeconomica Cracoviensia, No. 2, 2003, pp. 27-50.
so that real labor productivity determines variable K(a, k),
and the possible size of credit.
The money stream can also be quantified as the func-
tion of wages (W). Wages paid to employees split into
two lesser streams. The first stream has measure a × W,
(0 < a < 1), and tends to be directly on the market with-
out a banking system. The money stream can also be
quantified as the function of wages (W). Wages paid to
employees split into two lesser streams. The first stream
has measure a × W, (0 < a < 1), and tends to be directly
on the market without a banking system. This means that
the exchanges are done immediately. Parameter (a) ar-
rives at this part of wages that is exchanged for products
directly, without becoming a bank deposit that can be
used for credit action. The parameter can be interpreted
as welfare or poverty level and saving propensity. The
second part of the original stream of wages (1 – a) × W
firstly feeds the banking system and enables it for credit
action. Then it is amplified in the banking system (credit
money creation) and flies into the market linking earlier
Copyright © 2011 SciRes. ME
with the first sub-stream. Some part of this stream
(which is not disclosed on the Figure) is not used by the
banking system as a basis for credit creation because of
the mandatory reserves system and the requirements of
current accounts conditions. We omit reserves in the
present considerations so that the formula is as follows:
MaW k
 
where k denotes a parameter of the credit money creation.
The total stream of money is therefore equal to:
 
ak a
The problem of determining a right value of credit
money creation parameter k (that minimizes the level of
inflation) can be solved by using a fragment of the equa-
tion of exchange as follows:
GDPR × (1 + i) = W × K
Solving for variable (i) we obtain formula:
where Qr = GDPR/W is real wage productivity.
Assuming a condition 0iKQr  we can find the
value of the parameter k that minimizes the inflation lev-
el. Using the equation:
We obtain the equation:
Thus the wage multiplier (Figure 2) is equal to:
 
Qa a
The ultimate opinion is that the stream going through
the banking system can be increased to a level W (Qra)
or in the rearranged form to GDPR(1 – a/Qr). The size of
the credit depends on the wage level (W), welfare level
(a), and the productivity level as well.
To keep control over the money supply should only
mean adequate compensation systems as well as a pre-
cise feasibility study with respect to investment projects
that involve debt financing in particular. Constant pays
should be determined on the basis of employees’ human
capital as discussed by M. Dobija [8,9], and I. Cieślak
and M. Dobija [10]. As is proved, constant pay equal to
the established human capital in line with formula L = p
× H, guarantees that employees’ human capital is pre-
served. A level less than p = 8% would lead to its depre-
ciation. Further research by W. Kozioł [12] has shown
that total compensation, which also includes premium
pays and fringe benefits, attains a level exceeding 10%
of employees’ human capital.
5. Elimination of the Budget Deficit of a
Well-Governed Country
In the case of the private sector, employers have to cover
the costs of labor and other costs by sales inflows. On the
other hand, in the case of the public sector, the employer
(the state) does not need to have inflows in order to pay
for labor. State officers have to confirm contributed labor
and appropriate entries that transfer money to commer-
cial bank accounts. Labor done is the real transfer of
workers’ capital, and salaries paid in money are merely
affirmation of this fact. Therefore, as stated by M. Dobija
[21], “The government can spend money, which it does
not own and does not need to give it back, under the
condition that is able to see that labor finances itself and
money arises as the result of work.” The current state of
affairs is far from the correct approach presented here.
Government organizes a tax system to pay for labor in
the public sector, which is what hurts the economy by
diminishing demand and causing a budget deficit.
If a public school teacher (productivity coefficient 3/4)
taught pupils for a month (180 hours), he/she would ob-
tain an entry confirming his/her receivables for an
amount of 135 currency unit. There is no question where
the money would come from for the teacher’s salary;
there is no need to collect tax to pay for the teacher’s
work. Government, as a supervisor of the public sector,
is authorized to issue adequate compensation. Such an
approach opens up the possibility of reshaping the eco-
nomy to a much more prosperous state than is possible
under the current system. A canon of the future economy
is self-financing of labor and avoiding the taxation of fair
pay; this means the pay that is consistent with the human
capital of the employees. Under the new proposed sys-
tem, one can expect a better relationship between supply
and demand, a more correct market valuation, and, of
course, the disappearance of the budget deficit.
The economy can be balanced and it can get rid of the
budget deficit upon implementation of the fundamental
changes in conceiving and controlling the monetary sys-
tem and the way the public sector is financed. The pre-
sented ideas lead to principal reform of the central bank.
The main new function of this institution is to make
payments for labor performed and accounted for in the
public sector. It is the only correct process of money cre-
ation since economy is a collection of capital flows that
are set in motion by natural forces and labor.
Copyright © 2011 SciRes. ME
How the proposed reform could improve an economy
is illustrated by the computations in Table 1. The case
concerns the Polish economy in 2010. The ratio of the
cost of labor in the private and public sectors is esti-
mated3 at 8:2. The Q is estimated on the basis of Table
Poland, like many other countries, suffers from a lack
of funds for public works, despite urgent needs and ca
13% unemployment. Most salaries and wages are low so
the politicians cannot raise more taxes. There are other
problems hindering progress. Children outside towns walk
to their schools on roads used by heavy trucks. The re-
cent great flood caused an estimated loss of ca 12 billion
PLN. This loss would have been smaller if the country
had been better prepared. A large part of the Polish
workforce is employed abroad (ca two million) and a lot
of young people plan to go abroad in search of work. The
injection of the European Union’s subsidies has helped
to improve the economic conditions somewhat.
The proposed reforms illustrated in Table 1 would al-
low Poland to undertake the required public works valued
Table 1. The proposed reforms.
Description of variabl e Present system Reformed
1 Labor productivity ratio
(optimistic) 2.0 2.0
2 Estimated real GDP
(optimistic) 1 300 billion* 1 300 billion
3 Estimated compensations 650.0 billion 650.0 billion
4 Compensation in the
private sector 520.0 billion* 520.0 billion
5 Compensation in the public
sector (20%) 130.0 billion 130.0 billion
6 Budget deficit (planned) 52.2 billion -
7 Inflow from pay taxation 36.0 billion -
Offsetting the budget
deficit and the pay tax by
self-financing of labor
- 88.2 billion
9 Funds for public works
(130.0 – 88.2) - 41.8 billion
Limit of credit: W ×
(Q2009 – a), a = 0.85
(rough estimation)
Actual value
was 612.0 bil-
lion in 2009
682.5 billion
11 Inflow of central bank
income ca 5.0 billion 0.0 billion
12 Interest on public debt ca 32.0 billion
13 Subsidies from European
Union ca 32.0 billion ca 32.0 billion
*Name of currency unit is PLN, Additional information
at 16.2 billion PLN (21.2 - 5.0). Then unemployment
would go down and demand would be higher. Public
debt would start to diminish, along with the high level of
interest now paid, which is an enormous burden to the
Polish economy. The country would find a path to bal-
anced development.
It is common knowledge that taxation is unavoidable.
But the truth is it is the labor and natural forces, not taxes,
that originate wealth. A tax less economy is conceivable
in the light of labor self-financing. The first step in re-
shaping the present economy should be to apply the labor
self-financing principle to the public sector. This would
open the source of financing for assets and other aims.
Then, the second step would rely on adjusting the exist-
ing tax system towards significantly decreasing or even
cancelling direct payroll taxes. This is an important step
since taxation of income makes employees poorer and
decreases the purchasing power available in the economy.
This, in turn, badly affects entrepreneurship.
In the light of labor self-financing, the needs for funds
from taxation are genuinely limited. Tax funds are re-
quired for some other aims, excluding compensations, in
the public sector such as:
Financing of construction and acquisition of assets
being obligatory in the public sector;
Financing of the maintenance of assets in the pub-
lic sector;
Financing of subsidies for mothers raising children;
Financing medical care for children;
Financing the social safety net and care;
Financing foreign military and other foreign opera-
Subsidies for mothers raising children can be justified
by the fact that they are directly forming new human
capital by performing tiring labor. It is beyond discussion
that the effort should be recognized and rewarded. Mo-
thers and children need a source of existence. In addition,
Table 2. The estimated ratios Q for 2006 – 2009.
Country 2006 2007 2008 2009
USA 3.458 3.470 3.560 3.500
Japan 3.069 3.093 3.186 3.433
UK 3.204 3.517 3.444 3.082
Switzerland 3.534 3.645 3.748 3.650
Switzerland 3.290 3.380 3.389 3.276
Republic 1.873 2.204 2.355 2.210
Poland 1.881 1.992 1.854 1.869
China 1.415 1.512 1.685 1.762
Source: Own estimation following the paper [20].
3The ratio was verified with Department of Finance Policy, Analysis
and Statistics of the Ministry of Finance, Poland.
Copyright © 2011 SciRes. ME
mothers should compound some money for their pension
funds. The remuneration of mothers is one of the factors
that determine how developed a country is. This problem
is complex but it can be solved through the self-financing
phenomenon. However, in the beginning, a safe solution
is to finance this labor from tax funds. The pay should be
consistent with the theory of human capital. This means
it should be close to a minimal legal wage.
It is common knowledge that labor in the public sector
is less efficient than it is in the private sector. This is,
however, not a law or a principle. Efficiency depends
much on the self-awareness of the officers and supervi-
sors, and generally depends on the quality of the institu-
tional capital. The State may legislate that health care for
children and youth belongs to the public sector. The di-
vision between the public and private sectors can vary
over time, influenced by models accepted by policy
makers. Government can choose the less efficient variant,
preferring to fulfill some of the social aims. For instance,
prisoners while less productive, should have an opportu-
nity to work because that helps them to rehabilitate and
readjust to society’s standards.
6. Indispensable Reform of the Central Bank
The entire financial system of the state could change
significantly for the better through the application of
labor self-financing, provided that the principal role and
functions of the central bank would change. Adjusting
the monetary system to the fundamental principles of
reality requires principal changes to the procedures of
“money creation.” To think of “money creation” is gen-
erally incorrect since nobody can create money repre-
senting value as nobody, in reality, can originate energy
as far as we know. Therefore, the one important point of
the reforms is to extinguish cash money. The cash money
should be a relic of the period when money was not re-
lated to labor because money was not perceived as the
legal receivable of work done. Cash money could be used
for a transitional period as a form of work receivable,
which an employee keeps on hand instead of keeping it in
the bank account. In any case, in the first step, the central
bank would have to stop issuing any new cash money.
Figure 3 shows the structure of the reshaped financial
The road to a deficit-less economy leads through the
essential reforms of the central bank. After transforma-
tion this institution would become a positive and indis-
pensable one. The reformed economy requires fulfilling
two additional functions. The first is to control produc-
tivity both in the private and public sectors—de facto con-
trol over inflation and over stability of the exchange rate
to some extent. The second responsibility of the central
Figure 3. The reshaped financial system.
bank is entirely new; it is to pay for the wages and sala-
ries of the employees in the public sector. The central
bank would be the only institution authorised to transfer
wages and salaries to these employees’ accounts held in
commercial banks. An additional function related to the
two mentioned above is the control of remuneration in
the public sector and its consistency with the valuation of
human capital.
The main changes of public finances, including central
bank reform, are listed as follows:
Removal of the cash money and definitely putting
an end to its existence. Bank deposits, credits re-
lated to deposits, bank accounts, and cards facili-
tating access to the accounts are the most essential
parts of the new money system;
Essential change of the role of the central bank into
a government agency responsible for controlling
labor’s productivity in the economy. The agency is
responsible for payroll services for the public sec-
tor, namely, payment of employees’ earnings to
their accounts in the commercial banks;
The central bank no longer creates fiat money for
commercial banks. This government’s institution is
not a bank, but an agency authorized to control the
adequacy of commercial banks’ equity capital and
reserves and compliance with liquidity standards. It
neither purchases nor sells securities. It does not
earn income. This is the only institution authorized
to transfer the public sector pays to accounts in
commercial banks. Its independence concerns only
evaluation of the labor productivity ratio;
Commercial banks operate under the supervision of
the reformed central bank or other government
agencies that control the assumed capital adequacy
and highly standardized level of liquidity;
The achieved and planned level of labor productiv-
ity is the principal budgetary constraint;
The sum of salaries that can be paid out in a period
in the public sector is determined as a function of
labor productivity Q;
Interest rates and exchange rates are exclusively
shaped by free market exchanges;
Growing labor productivity in the economy is the
Copyright © 2011 SciRes. ME
only source of increasing salaries in the private and
public sectors;
Control of inflation means maintaining pay consis-
tency with the value of labor and not permitting a
decrease of ratio Q. This ratio ought to have a grow-
ing tendency;
A fair basic pay is consistent with the value of em-
ployees’ human capital. In addition, compensation
involves a premium pay and other fringe benefits
having their source in companies’ income;
Taxation of basic fair pay is removed. Taxation
would make it unfair.
The key benefits of these changes come from the fact
that the government doesn’t need to raise funds from
taxation in order to pay for public sector employees. The
ability to pay fair compensation is no more limited by
collected tax. Then one can expect a more efficient mar-
ket, less unemployment, and a balanced economy.
7. Obligatory Liberating of Fair
Compensation from Tax Charge
A deficit-less economy should also assure fair compen-
sation for all employees. Minimal constant pay (L = 0.08
× H) does not allow for depreciation of employee’s hu-
man capital. This means that a couple has the required
resources needed for the cost of living of a four-person
family, and children can obtain a parent’s level of pro-
fessional education. Therefore, we have to assure that
taxes will not change fair constant pay to unfair pay. The
phenomenon of labor self-financing helps to find the
right solution.
The problem of liberating compensation consistent
with employee’s human capital can be solved by differ-
ent modes. However, in order to maintain simplicity and
integrity of taxation, a good idea is to use a high tax-free
threshold. Namely, pay below the threshold is tax free.
Income over the threshold and less than maximum fair
pay is taxed at a low rate. The income over fair pay de-
fined by human capital valuation is taxed at a higher
progressive rate.
Pays less or equal to average pay (threshold)—tax
Pays greater than threshold pay—insubstantial tax-
ation with constant rate. The basis for taxation is
the difference between pay and threshold pay;
Pays greater than maximum fair pay but less than
the upper limit-taxation with growing rate. The ba-
sis for taxation is the difference between maxi-
mum fair pay and threshold and pay and maximum
fair pay;
Pays greater than the upper limit—taxed at a high
steady rate.
Illustration. An employee who earns €10 000 per
month would be charged 6.6% tax. This amount is com-
puted as follows. Assumptions: €4000—tax-free thre-
shold, €7000—maximum fair constant pay. Tax rates are
respectively 10% and 12%.
Zero percent of €4000 = €0.
Ten percent of (€7000 – €4000) = €300
Twelve percent of (€10 000 – €7000) = €360
Total tax €660.
Effective tax rate = 660/10000 = 0.066 (6.6%).
With such a structure, an employee who earns €6000
monthly would pay €200 tax. Someone who earns €4100
would pay €10 tax, and so on.
The progressive tax rate is applied to income greater
than the maximum fair pay established here on the level
of €7000. It is assumed that each additional thousand of
Euros has its own rate increased by a figure taken from
an interval (0.5% - 1.0%). Assuming the maximum rate
of growth as 1%, the eighth thousand is taxed at 11%, the
ninth thousand is taxed at 12%, and so on. Thus, in the
considered example, the exact size of tax from the
amount exceeding €7000 is computed as follows: 0.11 ×
1000 + 0.12 × 1000 + 0.13 × 1000 = 110 + 120 + 130 =
€360. Policymakers may establish the rate of growth at
less than one.
The tax rate is stepped up to a certain level, and then it
stays constant. If the upper limit is fixed at the level €50
000, pay over €50 000 would be taxed at the rate of 53%.
The last rate concerns individuals with high creative cap-
ital. Movie stars, football stars, inventors, among oth- ers,
earn top income thanks to the personal attributes per-
ceived and accepted by others. They usually act in a
well-developed environment cultivated by state and so-
ciety, which is necessary for their actions. Therefore, it is
fair to pay more tax as the society creates an adequate
environment for their activities, and it is right to recog-
nize that the creative capital of these persons should be
fairly remunerated.
8. Conclusion
The constant perception of capital, labor, and money as
abstract categories leads to entirely new views about
economic matters. An essential part of new theories is
the phenomenon of labor self-financing. It liberates an
economy from a significant part of tax burdens and leads
to a deficit-less economy as well. There is only one re-
quirement. Namely, abolishing cash money and recog-
nizing the indispensable fact that money arises by labor.
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Copyright © 2011 SciRes. ME
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