On the political economy of a basic income

The idea of a basic income - it's generally referred to as a Guaranteed Annual Income in Canada - has been floated again. My initial reaction was that this is such a good idea that it's hard to figure out why we don't have it already.

For some reason, there doesn't seem to much in the way of a formal modeling exercises that work through the general equilibrium implications of a BI (I will be happy to be corrected on this point), so I decided to set up a blog-sized version. It turns out that although the BI is still a good idea, it's not quite the slam-dunk I thought it was.

The gory details are below the fold.

The model is the simplest one I could imagine: labour is the only factor of production, and since there's no capital, the model is also static. As in any modeling exercise, I'm not pretending that these assumptions are realistic; my goal is to get some basic understanding of the interactions between redistribution policies, labour supply and welfare. The model is calibrated to reproduce a median income of $25,000/year with a gini coefficient of 0.52, which is not far from what we have now. The details of the model and how it was calibrated are written up here.

Two policy experiments were considered:

• Conventional welfare, in which agents have access to a minimum income, but those who choose to accept it are not permitted to work. Those who work are subject to a flat income tax.
• A basic income, in which payments are not conditional on the labour supply decision, and in which only market income is subject to a flat income tax.

In the graphs that follow, the horizontal axis is the rate at which market income is taxed. The range of variation of the tax rates corresponds to values in which it is possible to satisfy the zero-deficit condition.

First up is labour participation rates:

This illustrates one of the strongest arguments in favour of a BI, and against conventional welfare: conventional welfare forces marginal workers out of the labour market. For any tax rate, an economy with a BI will have higher participation rates. Note also that participation rates fall below 0.5 pretty quickly.

Next up is average income per capita:

Because conventional welfare forces workers out of the labour force, total income - and hence average income - is generally lower than the BI case. (I'm not sure what's happening at the very left-hand side of that graph).

Next up is income inequality:

Since a BI benefits everyone in the lower part of the income distribution - and not just those who choose to exit the labour force - a BI reduces income inequality more than does a conventional welfare program. There is a region in which conventional welfare reduces inequality more than does a BI, but as we will see shortly, we don't want to go there.

So far, the advantages of a BI look pretty clear. But the analysis is not so clean as all that. Here is a graph of payments against tax rates:

Since the payments are targeted under conventional welfare, they can be set at higher levels, and the gap is highest for low levels of taxation.

This matters when we look at welfare effects. The metric I'm using here is average utility across the population:

It is here that we see that the advantages of the basic income are not as clear-cut as all that. For low levels of taxation, conventional welfare provides better value: public funds are concentrated at the left-hand tail of the income distribution, and since since those workers are the least productive, total and average income isn't much affected by their absence from the labour market.

It is important to note than in both cases, there is a point at which increasing payments reduces aggregate welfare: the costs of seeing more people leave the labour market exceed the welfare gains of increasing the incomes of those at the left-hand tail of the distribution. Here is a graph of welfare against payments expressed as a percentage of average income:

(This graph takes into account the negative effect of higher payments on average income note earlier.) Curiously enough, the optimal payment in both cases works out to about 50% of average income. This may be a coincidence, or something built into the model; I don't know. But it should serve as a warning to some of the more excitable supporters of a basic income: payments will not necessarily be all that generous.

It is the case the the BI optimum is superior to the optimum we can obtain with conventional welfare, but attaining this optimum is contingent on taxation levels that are higher than what we have now.

This is hardly the last word, of course. A more realistic model would incorporate physical and human capital:

• If human capital is endogenous, then the effect of income taxes on output will be accentuated. The reduced rate of return on investments in human capital will lower output and income.
• A model with physical capital and savings introduces an alternative mechanism for generating tax revenues: consumption taxes. Substituting consumption taxes for income taxes will attenuate the disincentive effects of a BI.

The case for a basic income is still a strong one, but someone will have to work through these issues before it becomes a serious proposal. And BI proponents should also be prepared to make the case for higher levels of taxation.

 

Comments

[Declan]

Interesting. Is that a typo on the gini coefficient (0.52) or are you measuring something different than what I'm used to seeing (~0.3 for Canada).

The necessary reduction in the magnitude of payments due to their universality has always been the sticking point in making the basic income work as far as I recall.

It would be interesting to see a comparison of (average) marginal tax rates by income for the current system (in a particular province, say) vs. what it would look like under a basic income plan with the same cost. I realize that here you are comparing two flat rates, but I'm just saying.

Also would be interesting to see a list of all the various government welfare programs, tax breaks and subsidies etc. and how they are allocated across the income spectrum.

And a pony, of course.

[Declan]

Never mind, I presume you were using market income gini (as would make sense), not after tax.

[reason]

So the case is stronger with some form of progressive taxation? Seems an obvious conclusion to me.

[reason]

But anyway, a lot of the argument relates to the necessity of adjusting for other savings that become possible (student subsidies in particular). And ,yes, some people would choose to drop out of the workforce, but it may be that that is a good thing. The market doesn't capture everything of value.

[reason]

P.S. I am all for this, because it lets the government take a step back and reduces the busybody component of bureaucracy. But I don't think you can completely do away with help in kind, some people are just not that competent.

[Noni Mausa]

Thanks for this.

A few points:

First, basic income, to my mind, would be just the thing for the so-called "sandwich generation", of adults who are responsible both for the care of children and for their elderly relatives. The same goes for persons who care for disabled adult children.

As I understand it, the elderly adults and disabled adult children would bring with them to the household their own BI payments, as would the stay-at-home caregiver. The result of this would be to dramatically increase household income for families who are currently scrambling to make ends meet, if in fact they meet at all.

The amounts need not be large. The Mincome experiment in Dauphin Manitoba (http://www.uniter.ca/view.php?aid=38460) provided only the equivalent of single adult welfare (about $6,000 a year in 2004 dollars, approximately). If a household had one adult staying home, caring for a disabled child and an elderly parent, the stay-at-home adult, the child and the elderly parent would draw into the household about $18,000 a year. And any of them could work on either a full-time or casual basis as desired without jeopardizing the cushion. And this money would not disappear -- some of it might be saved, but the bulk of it would be spent immediately. I believe it's been proved that the "trickle down effect" doesn't work. A basic income program would test the "trickle up effect", and water the roots of the economy.

Considering how conservative values seem to encourage extended families and close family ties, basic income could easily be sold both to the right and to the left.

Second point -- one huge effect that I would expect to see from basic income would be the removal of a great deal of waste of time and energy in pursuing social programs, waste of health care dollars in caring for persons suffering from the effects of anxiety, malnutrition and petty crime. A lot of the money currently spent on social programs and the highly paid administrators of social programs would be diverted into the pockets of Canadians -- Canadians who would immediately spend that money.

Finally, I believe basic income would be a great boon to the job market, in this sense -- persons wishing to leave unsuitable jobs and retrain for other types of work would have some comfort in knowing that there was a basic income available to pay many of the day-to-day costs of living.

[Nick Rowe]

Very nice post! Very clean simple model! I am always disappointed that so much discussion of BI totally ignores the simple basic point you cover here: namely that we are comparing a BI with the existing system of welfare, where you lose welfare if you get a job. The question is not whether BI creates disincentives to work; the question is whether those disicentives are worse for BI than welfare.

Some minor points of clarification/exposition:

1. When you vary the tax rate, I assume you also vary the level of BI/welfare to keep the budget balanced? (You must be doing this, but I don't see you explicitly say this, and it would help the reader understand it more quickly if you did explicitly say this. Or did I miss it?)

2. You assume that a person who gets any labour income at all loses all welfare (I think). Without affecting any of your results (I think, correct me if I am wrong), you could make the weaker and more realistic assumption that under the Welfare regime, any labour income is effectively taxed at a 100% marginal rate (you lose $1 of welfare for every $1 you earn). If you make this inconsequential adjustment to your model, the difference between BI and Welfare in your model is that BI has the same marginal tax rate everywhere, while Welfare has a 100% marginal tax rate for people below some cutoff, and a flat tax thereafter. More generally, the question becomes: "Is it a good idea to have marginal tax rates decreasing in income
at low levels of income?).

3. Are you using a simple Utilitarian SWF (maximise sum of utilities)? (I think you are). More generally, I think (from seeing your graphs) that you could prove that for any generalised utilitarian (is that the right word?) SWF, from Rawlsian at one extreme to simple utilitarian at the other, the optimal BI tax rate will always do better than the optimal Welfare tax rate.

[Stephen Gordon]

Nick: Thanks.

1) Yes, everything is based on a balanced budget condition. I should have been more explicit, especially since making sure that things added up was the part that took the most work...

2) I don't see how the model would distinguish a 100% marginal tax rate from the brute-force conventional welfare story recounted above. If agents value leisure, they wouldn't work unless there was a consumption gain to balance the loss of leisure. If they're facing a 100% marginal rate, then they would have no reason to work.

3) Yes, it's a utilitarian sum/average of utilities.

[Nick Rowe]

Following your points above:

1.OK.

2. I agree. There is no difference in your model between assuming a 100% marginal tax rate and assuming you lose all welfare if you earn $1. Nobody will choose hours which would put them at the 100% marginal tax rate. This is a purely expository point, where you can relax an assumption without affecting the results in any way.

3. My fault. On re-reading your post I saw where you explicitly say you are looking at average utility.

4. Now. Something else. I think your model makes a stronger case for BI than you realise. Here's why:

a.) If you really are a simple utilitarian, then your last two graphs prove that BI is better than Welfare. The top of the BI curve is (in both graphs) higher than the top of the Welfare curve. So if I can choose the tax rate (or the payment) to be anything I want under either regime (i.e. it's not exogenously forced on me) I will always choose BI. Your paragraph: "It is here that we see that the advantages of the basic income are not as clear-cut as all that. For low levels of taxation, conventional welfare provides better value: ...." is only relevant if the tax rate is exogenous. But it is hard to imagine a case where a policymaker can choose BI vs Welfare, but cannot choose the tax rate. (Or is it?)

b.)My intuition tells me that this point above would generalise to ANY (sensible) SWF. Here's why: it can never be part of any optimal tax system to have marginal tax rates of 100% (or higher). You are always over the top of the Laffer curve at 100%. By moving from Welfare to BI, you go from the wrong side of the Laffer curve to the right side of the Laffer curve, which means you can help some people escape the welfare trap, and at the same time get some extra (net) tax revenue to hand out somewhere else.

5. (I'm thinking out loud here, as perhaps is obvious.) Let me make this last point slightly differently: Suppose you choose a Welfare regime, with any (balanced budget) level of welfare and tax rate. My conjecture is that I could find a tax rate and BI that would make every individual better off/no worse off (Pareto Improving). I can't (yet) prove this conjecture, but your last graph seems to suggest it might be true, as does my "Laffer Curve" intuition above.

I am (almost) certain that this conjecture is true if you allow non-flat taxes (it seems to follow immediately from the Laffer curve intuition, because if we start with Welfare, and then reduce the net marginal tax rate for welfare recipients from 100% to 99%, we help some welfare recipients and get more revenue.

I am less certain if my conjecture is true if we restrict oursleves to flat taxes. Here's how we (i.e. you) could prove or disprove my conjecture: set basic income = welfare (in absolute terms, not as a percentage of income) in your model (so that those with zero earning ability are indifferent between the two regimes), then plot the distribution of utility across agents under both regimes. Actually, maybe my conjecture could not be true for all distributions of skills etc...

Sorry. I should probably spend more time thinking before posting, but administrative duties call....

[Stephen Gordon]

You're probably right. The reason I used the expression 'political economy' was that this toy model suggests that the welfare effects of switching to a BI while holding tax rates and tax structures constant are not necessarily positive. The debate would have to widen to include (among other things) a discussion of what proportion of total income should be made available for redistribution.

[em butler]

when you give 25 grand to a non worker, what will you pay a worker??
one assumes it will only be a rare person that will accept a job that ,after expenses, doesnt guarantee him more than he would get unemployed..

[Noni Mausa]

Not $25k -- $6k per capita. Just enough to desperately starve on, if it's your only income. About equal to current welfare rates. (http://www.cbc.ca/canada/story/2006/08/24/welfare-report.html)

What does the government get in return? All the money they currently spend on figuring out how to deny people enough money to starve on. All the machinery of punitive "social services" and legal pursuit of possible welfare cheats. A certain fraction of the money currently spent on hospitalization, medication and prisons. A lot of the money currently spent on institutional care for disabled.

Plus, I would imagine that with $6k per capita coming in, a fair number of couples will opt for one of them to stay home with the kids, thus indirectly increasing the security of neighbourhoods, freeing up quite a number of sponsored child-care spots, and re-energizing the volunteer sector.

In fact the only downside of basic income, a revenue neutral strategy directly benefitting families and communities, is that, judging from the penny-pinching $2,000 Child Tax Credit, is a result being carefully avoided by Canada's New Conservatives.

Noni

"Give a man a fish,

it's easier."

[em butler]

6K or 25K..... makes no never mind...if you are going to get rid of poverty ,why fool around??
Since there will be no more production than the present ,there will be no no extra goodies to distribute... poverty will continue with the added bonus of massive inflation..
and come to think of it,the soviet union did not suffer from inflation...just empty shelves..

[em butler]

>>>What does the government get in return? All the money they currently spend on figuring out how to deny people enough money to starve on. All the machinery of punitive "social services" and legal pursuit of possible welfare cheats. A certain fraction of the money currently spent on hospitalization, medication and prisons. A lot of the money currently spent on institutional care for disabled.??
whodathunkit...paradise with a gov "handout" and no strings attached and no supervision..
How did that work out with your children(if you had any)
the allowances I handed out were just for cheap goodies...
How is it working out for your pre-columbian immigrants??

[Noni Mausa]

One quick example -- when you support 100 welfare recipients, you are actually paying the support of 100 recipients plus six or eight highly paid social services employees, their offices, equipment, some fraction of a prosecution lawyer, etc etc.

Under BI, those other costs would drop to a small fraction of current costs.

And who is on welfare? The National Council of Welfare: "Who would choose to live on such a meagre income? People are on welfare because they have lost their jobs, are widowed, are separated or divorced and are raising their children alone, are fleeing abusive relationships, or have a disability that prevents them from holding a job. Increasing numbers of people on welfare have multiple barriers to employment. They face additional challenges due to any combination of low job skills, lack of access to child care, long-term unemployment or substance abuse problems, to name a few.

So why should people care? Because, in a Canada with an increasing number of non-standard and insecure jobs—most of them low-paid with few or no benefits—and limited access to Employment Insurance, many are a step away from having to turn to welfare themselves. And all Canadians are paying the price through higher health and justice costs, lost human potential, and the diminished productive capacity of those living in poverty." http://tinyurl.com/23lw3a

2005 numbers = 1.7 million Canadians dependant on welfare, of whom 500,000 were children.

Noni

[happyjuggler0]

Stephen Gordon,

How does your model stack up to a flat rate income tax coupled with a graduated negative income tax such as proposed by Milton Friedman?

It seems to me that with a more limited percentage of citizens getting government handouts that one wouldn't need as high a flat tax as under your system. As such I can easily envision less deadweight loss from the income tax thanks to international tax refugees if nothing else. Also it seems to me that the graduated NIT strongly discourages anyone from not working, especially those nearing retirement age.

Most people I have been familiar with here in the US who are nearing retirement age seem to do a lot of calculations to see how much is it worth to keep working, as opposed to living under a fixed income of x, or 1.25x, or 1.5x etc., and as such I can see how a BI would create some serious deadweight loss of people near their peak wage levels, especially when combined with a high flat rate income tax.

I like the idea of a consumption tax much better under your system than a flat rate income tax precisely for deadweight loss reasons.

[happyjuggler0]

italics ended .

[happyjuggler0]

By the way, while I understand completely the notion of a 100% or greater than 100% effective marginal tax rate from going off welfare to working, I think it is incorrect to say that no one would work under such a tax rate. The reason being that that 100% marginal tax rate is short term to medium term, while in the long run it is better to be working and moving up the income ladder, something you can never do while stuck on welfare.

While I realize that many, if not most, people who are on welfare on a quasipermanent basis aren't thinking this way about the long term, I am highly confident that many, if not most, of those who are on welfare for quite short periods of time are indeed thinking this way.

Therefore the real issue is the hardcore types who are perennially on welfare that one needs to direct ones antipoverty thoughts to.

[reason]

em butler...
Clearly doesn't understand that with BI (or Citizens Income or Basic Minimum Icome or Negative Income Tax or whatever you want to call it) there is no poverty trap. You get to keep what you earn on top. em butler obviously likes having beggars around. It must make him feel good or something.

[reason]

By the way with a BI you could also do away with the minimum wage. I've never understood why progressives (most of them) have never taken to this idea. Only the left libertarians (such as the Henry George people) seem to regard it well. I like to call it "National Dividend" then you could even sell to the "Ownership society" people.-)

[E. Poole]

Perhaps a game theoretic approach would be more appropriate than a GE model or some static partial-equilibrium model in trying to grasp the impact of a Basic Income programme?

I see by the comments, that most people associate poverty, wealth and well-being with _monetized wealth_. That is a huge mistake IMO. For the record:

A Basic Human Capital investment already exists: public education.

A Basic Health programme already exists: universal (sic) health care.

[Noni Mausa]

E Poole was right to mention elements of common wealth such as public education and universal health care. A Canadian living on a very low income is effectively far wealthier than someone whose society doesn't have these resources.

Other such resources include public libraries, road clearing, public or easily accessible free toilets, water fountains offering free, clean potable water, to name a few.

Holding these resources publicly is also far cheaper than if individuals had to provide them for themselves. I have lots of books, it is true -- but not hundreds of thousands.

Having said that, SOME monetized personal wealth is necessary. An old friend of mine is disabled and on welfare. He never goes anywhere to see people, though he has a number of friends who would be happy to see him. Why not? Because every such trip would cost him $4.50 in bus tickets -- about 3% of his entire monthly budget beyond rent and utilities. And he cannot walk farther than 2 or 3 blocks because of the disability which put him on welfare in the first place.

The same mobility problem keeps him from accessing many of the common resources -- notably the library -- of our shared society.

[E. Poole]

I suspect that most economists are sympathetic to a basic income program. The disincentives on the margin for poor working people are legendary.

A fewer but still significant number of economists would anticipate political rent-seeking that would turn this kind of program into something it was not originally intended to do.

For example:

Was unemployment insurance/employment insurance (UI) orginally intended to bankroll the overfishing and collapse of fish stocks on both coast?

Was UI originally intended to subsidize the softwood lumber industry and other natural resource extractive industries?

Could anyone have imagined that west coast NDP activists regularly suggest programs that dissipate if not destroy the value of public assets, especially public natural assets?

Now are these plucky NDP politicos being wise sage neo-marxists a la Baran and Sweezy, constructively helping to avoid crises of capitalist over production?

Or are they simply acting as self-interested populist politicians who are kindly helping their constituents, very much mired in first-come, first-serve colonial traditions, suck value out of the Commons?

The other parties are capable of equally sinning but none pretend to value the public space as much as our own plucky, idiosyncratic social democrats.

All this to say, I see a strong potential for a GI/BI type program to be derailed.

[Janne Karlsson]

Good work!I can´t see that it could be a Basic income
"un-ecomic" like that
Winners of the Nobel Prize in Economics that fully support a basic income include Herbert Simon,James Tobin,Friedrich Hayek, James Meade, Robert Solow, and Milton Friedman

In 1968, James Tobin, Paul Samuelson, John Kenneth Galbraith and another 1,200 economists signed a document calling for the US Congress to introduce in that year a system of income guarantees and supplements. In the 1972 presidential campaign, Senator George McGovern called for a 'demogrant' that was very similar to a basic income.
And have read at 300 fully financed proposals of serious economists!Know it´s time to act!BIEN Basic Income Network have of fully financed models,and now have another one! Thanks!But it´s time set pressure on
the politicians and Waken Media up!Thanks Jan Karlsson

[Luke Willen]

A BI/Citizen's income could well be a way out of the current economic downturn. History tells us that something like the current situation could well turn into a 1930s style depression.

At the moment governments, as in the United Kingdom are spending vast amounts of money to bail out the banks but this is not working.

Instead of trying to bail out the banks as such, except to prevent the entire system collapsing which has already been done would it not be more effective to pay that money directly into people's bank accounts?

In UK terms £150 - 200 per week per person might be enough to help people whether or not they are currently employed. This would be paid for by a raft of measures for example the government money now being used to bail out the banks, rationalising the current welfare services as these would no longer be needed at anything like the current levels (both on the City Council housing benefit side and on the Government Welfare payments side), simplifying the tax system such that everyone pays a percentage of total income back to the Government in tax. BI might for example be taxed at 2%, income from employment or other source at, let's say 5%. Additional taxes such as VAT can continue to be levided as now. National Insurabce contributions can also go into the community pot.

Then you can tax companies who choose to export jobs to other countries such as China or India to take advantage of the cheap labour available there (consequently putting US, Canadian, British workers etc out of work) If a business does not want to have to pay such a tax then it can stay at home employing worjers here.

Paying BI should actively encourage people to take part time work as anything they earn (less tax) would supplement their existing payments. Hence they can afford to buy more and therefore stimulate the economy both at the domestic level and world wide. If all the leading economies were to go down this route this would do much to stimulate trade and get the world economy moving again.

As history also shows a failure to resolve the kind of economic issues we face today will lead to trade wars, social disorder, political extremism and, before too long, wars which at first might be relatively small but they will grow and coalesce into bigger conflicts. Such wars will escalate until we have what will effectively be another world war. The costs of that to humanity, civilization and perhaps even the very survival of the human race will be infinately greater than those involved in setting up and implementint a fairer global economic system based, among other things, a BI or Citizen's Income.
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