A Universal Basic Income is a wolf in sheep’s clothing. Even Australia’s opposition party has rejected the policy proposal on the grounds it is free money for millionaires. So why does this idea continue to be so popular?
Robots are a foolish reason to consider a universal basic income (UBI). And yet so many still want to indulge in such nonsense. The link between technological disruption, income security, and UBI, is weak at best. And existing targeted welfare systems already achieve income support from any type of workplace disruption, robotic or otherwise.
The fundamental idea behind a UBI is that all members of society should get an equal share of that society’s income prior to even attempting to earn a market income, and regardless of what their market income is. It is a worthy principle.
In contrast, a targeted welfare system phases in income support when individual or family income falls below particular thresholds, and phases it out again when market incomes rise. This is in effect a national income insurance scheme, and again, a worthy idea.
So why all the buzz about the less progressive UBI welfare system that will have to raise additional taxes from the wealthy, only to give it right back? Wasn’t less administrative cost one of the big selling points of a UBI in the first place?
The main difference between a UBI and targeted welfare system comes from the different effects of each system on the incentive to work, and as a consequence, the efficiency of the labour market; the largest and most important market in the economy.
It might be a surprise, but the UBI wins on this front. If there is to be any genuine economic debate about a future with a UBI, it is will come down to this.
To untangle why the UBI wins in the economic efficiency stakes compared to a targeted welfare system, we need to tap into the economic concept of effective marginal tax rates (EMTR). This concept describes the difference between an additional dollar of market income earned and the change in household income after considering both taxes and any changes to welfare received.
A simple example demonstrates. In Australia, family benefits are a type of welfare paid to parents on low incomes. Because it is targeted and not universal, this welfare payment phases out at 50c per dollar of income earned by parents until it is exhausted and no benefit is received.
However, within the income range where this benefit phases out, parents also become subject to income taxes. At incomes above this point, if a parent earns an extra dollar of market income, they pay taxes of around 20c on each extra dollar, in addition to losing 50c of parenting benefit. Their EMTR is 70%. For each extra dollar of market income, their net household income increases by just 30c.
This massive wedge between what employers pay, and what households receive, generates inefficiencies. Workers might decide not to change jobs for the small amount of extra money they get, nor invest in training that provides them only tiny gains in after-tax income. Economists call these effects a welfare trap, since all the incentives to increase work and income are eroded by the high EMTR.
This massive wedge between what employers pay, and what households receive, generates inefficiencies.
But the less targeted the welfare system, the longer the phase-out income range, and the lower the effect of this on EMTRs. The stylised figure below helps demonstrate. The top panel shows with the orange line the effect of a phase out of welfare at 50c per dollar at household incomes less that $50,000 per year. In addition is the income tax system that begins at an income of $20,000 with a marginal tax rate of 20%, and ratchets up to 40% at around $40,000, which is shown in blue.
Notice that for this household, once they earn $40,000 per year and extra dollar of income costs them 50c in lost welfare and 40c in tax, leaving them just 10c. If this household took a promotion which took their market income from $40,000 to $50,000 per year, their net income would rise by just $1,000, or 10%.
The second panel shows what happens if the welfare system is less targeted, phasing out at 25c per dollar all the way to a household income of $100,000. Here, the EMTR does not rise as much for those households with incomes near $40,000, but it does rise for higher-income earners. Yet the maximum EMTR is now just 65%, which is a much more efficient outcome.
The third panel shows just the marginal tax rates with no phasing out of welfare. This is the outcome from a UBI, as it is, in essence, non-targeted welfare. The catch, however, is that because a UBI must be paid to many more households with high incomes, the taxes on these same households would need to be increased. Or alternatively, taxes would need to be increased on companies, property or economic rents, that are mostly paid by these high-income households. The bottom panel shows the increased tax rates on high incomes that would need to account for this.
At the end of the day, the case for a UBI boils down to a general case for a greater role of the state in expanding the welfare system as a nation income insurance scheme, which is likely due to the growing volatility of market incomes. This volatility might be coming from automation and robots in some sectors, but in others, it comes from the casualisation of the workforce, with zero-hours contracts, and fewer employer obligations in terms of job security.
The case for a UBI boils down to a general case for a greater role of the state in expanding the welfare system as a nation income insurance scheme
The main economic benefit of a UBI over a targeted welfare system is that it results in lower effective marginal tax rates across the board. However, this outcome can also be achieved by expanding existing targeted welfare systems to make them less targeted at low incomes only so that they also reach middle-income households.
How do you spend your days?
Writing mostly. Also teaching the bright minds of tomorrow realistic economics at the University of Queensland. Chasing the kids. Sometimes time for football and rock-climbing.
Why is this important to you?
The political environment in the developed world is rapidly becoming more polarised than it has been for over half a century. I see this as a dangerous situation that makes it harder for people to get good information that is not tainted with views from the extremes.
What drove you to focus on economics. Was there a particular moment you can remember that led you to this field?
Observing the wilful blindness within large companies and organisations who seemed to have a knack for ignoring the obvious sent me crazy! As I began to see this more in our public policy debates I realised how much value can be gained by taking a step back and having an objective and systematic look at the world. Economics allows you to do this. If you can survive the first few years of indoctrination and keep your open mind, there is a lot of useful research going on in the field.
What drives you professionally?
Making a difference. I actually was close to leaving economics to become a medical doctor in 2012 so I could at least know I was helping someone. But I decided instead to stay in economics and focus on corruption and related topics that I knew might not make a direct difference to many people but could make a systematic difference if I could share the knowledge widely.
In your opinion what are the three biggest problems facing the developed and developing world?
For the whole world, the number one problem is the ongoing battle over the economic surplus.
Institutions that have funnelled wealth, income, and power, up the distribution are reaching their social limits. Between nations, decades of trade imbalances will likely reverse as previously rising nations stabilise, and new nations embark on rapid industrialisation. The losers from major changes to the distribution of global wealth will not be happy.
If you hadn’t become an economist what would you have done?
Become a medical doctor.
What led us to this moment in history?
Chance and luck, just like always. Though I do believe there are long term patterns that repeat in the great arc of civilisation.
What are the lessons we failed to learn during and since the 2008 crisis?
That finance is not an output of the economy, but an input to it. We had a chance to go back to basics and remember that the real economy is about producing things that people value.
Can you list some ‘baby steps’ out of the current economic mess?
Boost public spending on tax authorities so they can bring international firms into line. Vote out major parties to allow the diverse voices of the minor parties to rise up and reset the scope of public debates.
If you were a President / Prime Minister what would your first three pieces of policy be?
First, ensure that when political decisions result in windfall gains to private entities that these gains are taxed or sold by the government to recoup their value. Second, create a public bank with a mandate for investment in value-added export industries and renewable energy generation and distribution.
Third, ratchet up taxes on land, wealth, and inheritance.
Tell us something you have been wrong about?
I never thought the Sydney property market would be at a $1 million median price by 2016. I thought Trump would do better than expected in the election, but not win it.
Name the book that changed you.
Ultra Society by Peter Turchin. It made me stop thinking of economic growth as a competitive process, but a cooperative one. As an economist trained to see competition and understand its merits, I have now broadened my view to see how in fact competition and cooperation work together.
What would you do differently if you were to start all over again?
Nothing. Life is a lesson. It’s not something to be optimised. I want to make all the mistakes again… maybe a few more as well.
Give our readers, members and subscribers a piece of advice that has served you well.
From my Dad, about taking on new and challenging projects - “If it was easy, everyone would do it.”
Anything you would like to plug? Now is your chance.
My personal blog is fresheconomicthinking.com. Also, read macrobusiness.com.au, and follow me on Twitter @DrCameronMurray.