A couple of months ago, I wrote a post making some observations on the closely related ideas of a Universal Basic Income or Guaranteed Minimum Income. The most important was
Observation 1: Any UBI scheme can be replicated by a GBI with the same effective marginal tax rates, and vice versa
I meant to follow up with a more detailed exploration of financing issues, but all sorts of other things intervened. However, I’ve now prepared a draft, which is over the fold.
Comments and criticism much appreciated
How could a UBI/GBI be financed along with the other activities government must undertake? I’ll assume that that final government expenditure, excluding transfer payments, amounts to 20 per cent of national income, and that revenue from sources other than income tax amounts to 10 per cent of national income. That’s fairly accurate for Australia.
By thinking about the UBI case, it’s easy to work out the required tax rate. Keeping things simple, I’ll assume a single rate of taxation for all income above the threshold of 20 per cent of the average, For a UBI of 40 per cent and a net financing requirement of 10 per cent, the required revenue is 50 per cent of national income. If 20 per cent of income is untaxed, the required tax rate would 62.5 per cent. However, since those in the lowest quintile have incomes below the threshold, the proportion of untaxed income is a little lower and the required tax rate is approximately 61 per cent.
The UBI can be replicated as a GBI with the same effective marginal tax rate (EMTR). In this case, the net revenue requirement is equal to 27.6 per cent of national income, derived as the cost of the GBI (17.6 per cent), plus the net financing requirement for final government expenditure 10 per cent.
The version discussed in the previous post phases out the GBI at a withdrawal rate of 40 per cent over the income range from 20 to 120 per cent. To get an EMTR of 61 per cent, we need a 21 per cent marginal rate of income tax. For income above the 120 per cent threshold, where no GBI is received, the effective marginal tax rate is equal to the income tax rate.
The outcomes are shown in Table 2. Column 2 shows tax paid by those in equal quintile and the total revenue expressed as a proportion of national income. The revenue from income tax is 27.6 per cent of national income, which is approximately equal to the financing requirement. Column 3 shows the average rate of taxation for each quintile. Column 4 shows disposable income, taking account of taxes other than income tax, which are assumed to be a combination of fixed charges (equal for all households) and proportional taxes. Column 5 gives the shares of disposable income, after taxes and transfers
Market income Tax paid average rate Disposab
le Share of disposable income
Q1 10 0 0 44.5 11.1
Q2 40 4.2 10.5 60.8 15.2
Q3 80 12.6 15.8 74.4 18.6
Q4 120 21 17.5 88 22.0
Q5 250 100.3 40.1 132.2 33.1
Mean 100 27.6 27.6 80.0 20
Observation 4: For 80 per cent of households the required average rate of income tax is below 20 per cent. Even for those at the top of the income distribution, the average rate is only a little above 40 per cent.
The fairness of the redistribution associated with this tax-transfer system is a matter of value judgement, but it does not seem excessive to me.
Of more interest is whether an EMTR of 60 per cent is too high, and will have such adverse effects as to render the system unworkable. This seems unlikely. Under the current tax-transfer system, many households face EMTRs of 60 per cent or above because of the withdrawal of benefits and family payments.
Until the mid-1980s, the top marginal rate of income tax was 60 per cent. This rate applied to incomes in excess of $35000 (equal to about $65 000 today, adjusted for inflation). Estimates of disincentive effects are hard to make, but the economy functioned adequately. Admittedly, there was, and still is, significant avoidance and evasion of tax, but the worst abuses had been closed off by the mid-1980s. That is, we have experience of a successfully operating income tax system in which significant groups paid marginal rates of 60 per cent or more.
Taking all these factors into account, it seems clear that a UBI/GMI could be financed with EMTRs within the range of historical experience and not such as to produce catastrophic adverse incentive effects. There would certainly be some reduction in market work and more time allocated to non-market activities of all kinds (non-market productive activity, childcare housework and leisure). That’s consistent with the whole idea of a program to reorient the benefits of technological progress away from consumption and towards freedom from dependence on employers.