Universal basic income: Raise taxes or change progressivity?
Updated: Aug 25, 2022
Funding a basic stipend that’s provided to the public on a regular basis can occur either by changing tax policy or by altering the distribution of the tax burden. A study that examined this topic presents the advantages and disadvantages of each approach.
What happens to the economy and to individuals’ well-being when the government funds a universal basic income through taxation? Together with my co-authors – Nir Jaimovich, Itay Saporta-Eksten and Yaviv Yedid-Levi – I researched this very question. We built a model that simulates a modern Western economy, which enabled us to conduct economic “experiments” on a society that chose to promote a universal basic income policy, alongside a focus on production, consumption and work. In the model, as in reality, the program could be funded either by raising taxes for everyone or by changing the distribution of the tax burden (extent of tax progressivity).
In the first stage of the study, the model examined a program in which stipends were funded solely by increasing taxes, with no change in tax progressivity. Let’s examine, for example, a stipend of approximately $500 per person per month at a cost of about 10% of the U.S. GDP. According to our model, a stipend of this amount would have profound consequences: It would lead to a 25% increase in the average tax rate, a decrease of more than 10% in labor force participation and an almost 30% reduction in capital. The significance of these consequences is a decrease of almost 20% in GDP per capita and a decline of about 5% in the average household income in the economy.
These changes occur through three avenues: First, an income tax increase discourages new workers from integrating into the labor market. Second, the existence of an unconditional stipend incentivizes some workers to make do with it and remain out of the labor force. And third, the stipend provides a safety net which leads people to save less.
Here’s another important point: In the economy, when people save less – companies have fewer resources to give each employee. This results in a drop in employee productivity and, therefore, a drop in employee earnings. The drop in the number of employees, together with the decline in productivity per employee, leads to a decrease in GDP and reduces the average standard of living. Consequently, a program that intends to improve workers’ circumstances, ends up harming their well-being (however, individuals who remain outside of the workforce benefit from the change).
In the second stage of the study, we examined the impact of funding such a program by increasing progressivity (i.e., higher tax rates for high-income people and lower tax rates for low-income people). In this case, the macroeconomic damage will be much more limited, and thus it makes it possible to justify a stipend that comes at the expense of just a few percentage points of the GDP. This outcome is due to the fact that an increase in progressivity incentivizes low-wage workers to enter the workforce. Whereas in the previous example, all workers had to fund a universal basic income, now, low-income workers benefit from a reduction in income tax (or from a negative income tax), and thus it becomes more worthwhile for them to enter the workforce.
It’s important to note, however, that the success of such a program comes with two caveats: The first is that a program that provides a few hundred dollars, at most, per person per month can be justified, but not one that would implement a dramatic shift, such as the one that’s currently in public discourse. The second caveat is that if it’s possible to raise a significant amount of money via a progressive tax, I’m not certain that the best way to invest those funds is by distributing them equally to all residents rather than, for example, increasing welfare services, improving education and health systems, or tackling the climate crisis.