IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
The unconditional basic income became subject of a heated debate recently. Across ideological borders there are supporters and opponents. The possible consequences of its introduction are controversial. Critics are afraid that people would reduce the amount of their paid work and hence threatening the financial sustainability of the unconditional basic income. So far, no country introduced an unconditional basic income on a large scale. Experimental results which could offer any conclusions on the reaction of people towards an unconditional basic income are therefore easy to survey.
The unconditional basic income is a regular payment to all citizens independent from their financial situation. It would be financed through taxes. Current discussions revolve around the sum of 1,000 Euro per month for each German citizen. Considering the population of 81 million people, it can easily be seen that financing this idea would be big challenge.
An unconditional basic income which replaces all social transfers is supported by the fact of less bureaucracy as the need of the receivers does not have to be reviewed. However, in this article we do not assess how likely an introduction without any exemptions from this rule, which would counteract this advantage, is.
Today’s social transfers are heavily bureaucratic and costly and have another serious disadvantage in their current form. If benefit receivers take on more than just one job as part of a “Minijob”, the social benefits are reduced substantially or even go down to zero. For the receivers the reduction of the transferred amount acts like a tax on additional income – net of the reductions their income is not increasing one to one with their additional earnings. The implicit taxes caused by the reduction of transfers are – also due to the national insurance payments – relatively high. Everyone in a single household starting a job instead of receiving ALG II and earning 1,500 Euro gross is therefore facing an implicit tax rate of approximately 80 percent. The monetary incentive of starting a job is very limited under such circumstances.
The unconditional basic income would avoid these high implicit tax rates for low income households. Each Euro of income would be taxed at 50% according to a recommendation of the Hamburg economist Thomas Straubhaar. Whoever takes on a job would still receive the unconditional basic income and still dispose of 50 percent of the earned income.
The negative income tax suggested by Milton Friedman in 1962 shares some characteristics with the idea of an unconditional basic income. It also curtails the issue of low incentives for pursuing paid work. If the income of an individual falls below a certain threshold, no income tax is paid but the person receives payments instead. At a constant marginal tax rate which turns negative for incomes below a certain income threshold, the income after tax is always increased by the same amount of the additional income.
Unlike in the case of an unconditional basic income, within a negative income tax framework the net-payments and credits are tied to the income earned. However, with regards to the impact on the income of working individuals the negative income tax and the unconditional basic income are equal.
We are not diving into the question whether receiving net-transfers in the absence of an indigence is justified, or if the introduction of the unconditional basic income would really be accompanied by the abolishment of all means tested transfers. We are focusing on studies which allow drawing conclusions on the impact of unconditional transfer payments on the working behaviour of recipients.
The “New Jersey Graduated Work Incentive Experiment” was a randomised controlled trial undertaken in the years from 1968 to 1972. Randomly selected families in urban areas with an income below 150 percent of the poverty line received money transfers which were tied to their additional income earned – just like envisaged by the negative income tax framework. Among the participants only a small negative effect on the provision of labour was found, which deferred insignificantly from the control group, which did not receive any transfers. An additional study focusing on rural areas found that male workers reduce their working hours by 1 percent on average compared to the control group while female participants reduced their working hours by around 27 percent. However, it was not possible to exclude the possibility that the differences arose from coincidence. Whereas the labour participation rate of the female participants of the study decreased significantly by 28 percent.
The “Seattle/Denver Income-Maintenance-Experiment” was the biggest negative income tax experiment so far. The participants where separated in three and five years payment periods. People that received the payments for three years reduced their working hours by up to 7.3 percent while for the five-years-group a working hours reduction of up to 13.5 percent was found. The statistically significant result indicate that the reduction of the working hours increases the longer the period during which the negative income tax is applied.
In 2017, Finland started an unconditional basic income experiment with 2,000 unemployed individuals. For two years the participants receive an unconditional monthly payment of 560 Euro. This sum is not sufficient to abolish all other transfer payments. As the experiment has not ended yet, there are no result available so far.
In Germany, there exists a private initiative which draws individuals that will receive a basic monthly income of 1,000 euros for one year. Unfortunately, due to the very short period of time of this experiment no verifiable conclusions on the change in labour provisions can be expected.
Contrary to the experiments in industrialised countries an Indian study on a basic income from 2014 found a positive labour effect. The payment was below the income level which would be sufficient for satisfying basic needs.
Against the background of the experiment and therefore the payments lasting for only two years, the recipients of the unconditional basic income used the additional income mainly for improving their living conditions in the long run and invested in their capital stock. Hence, the livestock was increased and a more efficient budget management was fostered. Some households built their own water supply or cooperated with neighbours to built a shared own. This benefited women in particular which were now relieved from collecting water for the whole family from public wells. Scientists found that women in particular had more time now which they used for obtaining additional income.
Overall, around 21 percent of households which received an unconditional basic income during the examined period increased their income by expanding the scope of their paid work while only 9 percent of the households in the control group did so.
An experiment, undertaken without a control group in Namibia, finds that similar to the Indian experiment the people use the additional income to increase their economic productivity. The authors of the study write: “This result contradicts the claims made by critics that the unconditional basic income would lead to laziness and dependency.”
The study participants in Namibia and India have in common that both groups live in societies in which distribution of work is less pronounced than in industrialised countries. They mostly relied on a subsistence economy. The empirical results imply that households which depend primarily on a subsistence economy use the transfer payments to improve the productivity of their work by investing in their capital stock. This might help explaining the observed effects. When the gains from work increase substantially it gets more attractive to work.
Individuals in highly collaboratively organised societies often have easy access to loans and would use transfer payments presumably not for increasing their capital stock in order to be more productive in their work. Supporters of a unconditional basic income in relatively wealthy societies are also usually not aiming for that. On the contrary, individuals are thought to be freed from the need of having to obtain income in the markets. For these reasons, the experiences with unconditional basic incomes in developing markets are not meaningful for developed markets.
The findings from North America seem to be better suited for estimating the potential labour provision effects of an unconditional basic income. These studies conclude that the labour provision is more likely to decrease with the introduction of an unconditional basic income. The longer the expected period of payments lasts the stronger the observed effect.
That an unconditional basic income of a certain amount reduces the level of labour provided remains out of question. How many people would still work when it would amount to 5,000 Euro per month? In light of the scarce empirical literature on the effects of unconditional transfer payments, however, all statements regarding the impact of a moderate unconditional basic income on the labour provision behaviour should be treated with caution.