Future of Work

What are the basic economics of a guaranteed income?

U.S. dollar notes are seen in this picture illustration taken at the Bank of Taiwan in Taipei November 11, 2010. U.S. Treasury Secretary Timothy Geithner insisted on Thursday that Washington would never resort to weakening the dollar to spur growth, seeking to cool tensions as G20 nations struggled to bridge chasms over currencies.

Guaranteed or basic income is a hot topic – this is how it could work, and the impact it might have. Image: REUTERS/Nicky Loh

Nick Bunker
Policy Analyst, Washington Center for Equitable Growth
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In the 1975 book “Equality and Efficiency: The Big Tradeoff,” economist Arthur Okun coined the phrase “leaky bucket” to describe how efforts to redistribute income might reduce economic efficiency. Discussing the merits of his larger argument is a task for another time, but what’s interesting for right now is the contemporary policy example he uses to illustrate the idea.

US wealth inequality and income.
Image: VOX EU

In the wake of the 1972 presidential election, Okun discusses the competing proposals for guaranteed income from the candidates of the two major political parties. To someone reading 40 years later, the idea that a guaranteed income or a basic income was once in the political mainstream seems almost unbelievable. But the idea is slowly making its way back into policy debates.

At FiveThirtyEight, Andrew Flowers runs through the basics of such a plan, as well as the history of the idea, and points to attempts to implement it in the real world. With a basic or guaranteed income, the government would send a check to every citizen or resident to ensure that each individual has a certain level of income. And under a basic income, every person would receive a check of the same amount—whether that person is content with not working and can live on a small budget, or whether that person is a high-earning workaholic.

But there’s also the slightly different idea of a negative income tax, favored by economist Milton Friedman. Under a negative income tax, everyone would be guaranteed the same income, except the check from the government would decrease as the worker earns more. That description might sound familiar if you know about the workings of the Earned Income Tax Credit.

There are some major differences, however, between that credit and a negative income tax. Importantly, the Earned Income Tax Credit requires that a worker actually has a job to receive the credit whereas a negative income tax does not. By increasing the post-tax returns of employment, the Earned Income Tax Credit increases the labor supply and reduces hourly wages. The result, as a paper by University of California, Berkeley economist Jesse Rothstein shows, is that low-wage workers don’t receive the full value of the Earned Income Tax Credit because some of that value is captured by employers through lower wages. For every $1 spent on the program, after-tax incomes only go up by $0.73. But with a negative income tax, every $1 spent actually increases incomes by $1.39.

How does that happen? Because a negative income tax doesn’t require someone to work in order to get it, the reduction in the amount of work people are willing to do (labor supply) ends up boosting wages. So programs like a negative income tax or a universal basic income would likely reduce the amount of labor supply and boost wages.

Will the reduction be because workers already employed work fewer hours (a reduction on the intensive margin) or because workers drop out of the labor force (a reduction on the extensive margin)? There isn’t a sufficient amount of good and recent research on basic income to know how large the effects are or which effect would be larger. There’s also the possibility that making the program not phase out and getting rid of many antipoverty programs with drop-offs in benefits at certain levels would produce some offsetting increases in labor supply. But we just don’t know enough yet.

Thankfully, as Flowers reports, there’s been an uptick in new research starting in the area. So while these questions continue to be open, we may find some closure in the near future.

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