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Basic Income and Welfare

Background

A recent Guardian piece by Declan Gaffney asserts that a Universal Basic Income could not replace the UK’s social security (or welfare) system. The piece can be read here:

http://www.theguardian.com/commentisfree/2015/dec/10/finland-universal-basic-income-ubi-social-security

A basic income that replaced the UK’s social security system would need to be so generous that it would disincentivise the jobless from looking for work. Hence a punitive social security system that relies on sanctions is necessary because otherwise the jobless will not look for work. In short, such a Basic Income would make life too comfortable for the lazy and workshy.

Well perhaps this is true. given Declan’s assumption of a universal and unconditional basic income intended to replace the social security system. Such a basic income would need to be very generous and might well have the effect that Declan fears. A valid  inference of Declan’s fine piece is that Basic Income is a nice idea but infeasible; so let’s keep means tested and contingent benefits. and rely on Universal Credit to provide the right balance between carrot and stick.

Should the idea of Basic Income be abandoned?

Given Declan’s point, that UBI could not, or should not, replace the social security system, is Basic Income simply a nice but impracticable idea?

I agree that it would be too expensive for basic income to replace all social security, at least in the UK’s circumstances. UK housing costs, for example, are far too high and would need to fall massively before a Basic Income could be anywhere near sufficient to cover housing costs. Until such time as the high cost of housing in the UK  is addressed, a system of means tested benefits for housing costs will be needed.

Similarly, the social security system also provides contingent benefits, that is benefits which compensate for disability, unemployment, old age, and child rearing. It would not make sense for a uniform basic income to be set at a level  which covers contingent costs  of minorities – it would be far too expensive. In any case, the National Insurance Fund insures against some of these contingencies via contributions.

So Declan says (and others say) that the current social security system accommodates the variegated needs of the population and that a basic income is unnecessary and inadequate. However, I do not believe Declan’s argument is dispositive.  A modest basic income scheme, that is, one which does not seek to replace all social security benefits, is a practical  and worthwhile option.

Proposal for a modest basic income

A hat tip to Mike Gist (@mgist) who suggested that I calculate the net tax liability at different income levels before and after introduction of a basic income. I have done this analysis for the tax year 2015/2016, assuming an annual personal allowance of £10,600, which, to help fund the scheme, would be scrapped. So post tax income after implementation of basic income and after scrappage of the personal allowance is being compared with post tax income before scrappage of personal allowance. Tax credits have been excluded from the analysis.

The analysis shows that no one, whatever their income level would be left worse off if annual basic income were to be set at £4,240. Below is a graph of the results.

  1. The graph shows that for market incomes of below £45k (approx) tax payers would be better off post tax after abolition of annual personal allowance under basic income of £4,240 p.a.
  2. For incomes between £45k approx and £100k, there is no gain or loss. For incomes over £100k there is a gain which stabilises at £4,240 when income reaches £120k approx.
  3. The gain for incomes over £100k arises because personal allowances are currently restricted or non-existent at this level. Scrapping the annual personal allowance as per the scheme thus causes all income levels to be treated equally with respect to personal allowances.

Basic income simulation

Other points

  1. The analysis shows that the cost of even this modest scheme will exceed the current (pre-scheme) income tax take. To establish the cost of the scheme it is necessary to know how many people will gain how much for all income groups.
  2. A basic income set at £4,240 is sufficient to replace Job Seekers’ Allowance for the unemployed, and Working Tax Credits for those in work. Hence the aggregate spend on JSA and WTC can be deducted from the additional cost calculated in point 1.
  3. The basic income would replace working tax credits without the cliff edges and complexity that the existing system contains.
  4. The graph’s U shape is caused by the kinks in the current income tax schedule, and not by the properties of the basic income scheme itself. The withdrawal rate is a constant 20%. There is thus a strong incentive for workers at lower pay rates to increase their market earnings.
  5. The scheme has been formulated with the same parameters as are used in the existing income tax regime. That is the bands and rates (20%, 40%, and 45%) on which income tax is charged are identical as those which are in current use.
  6. Some of the annual gains of £4,240 accruing to 45% tax payers (those earning more than £150k p.a.), could, if a government had a mind to, be taxed away by raising the rate to 50%.
  7. The scheme should be acceptable to the electorate since there are no losers.

Summary and conclusions

An ambitious basic income scheme, that is, one that seeks to replace all social security benefits, is probably incontrovertibly infeasible.

However, because an ambitious scheme may be infeasible this is not necessarily a good ground for rejecting the concept of Basic Income completely. A modest scheme may be both feasible and worthwhile.

A modest scheme, as outlined above, could replace Job Seekers’ Allowance and Working Tax Credits. Withdrawal rates would be at the basic rate of income tax of 20%.

A need for other social security benefits would continue. Incentives to work could be improved by addressing housing costs which are currently so high that without Housing Benefit support it does not pay people to work.

Replacing Job Seekers’ Allowance and Working Tax Credits with an unconditional basic income removes the threat of starvation (which JSA sanctions represent) as an instrument of government policy.  Starving people is wrong and most people would agree that starvation should not be used by governments as a weapon against civilian populations.

Acknowledgements

@mgist for his suggestion that inspired the analysis

@cjfdillow for his comprehensive descriptions of how basic income works.

All errors are mine.

Appendix:

Calculation of post-tax income 

Appendix Basic Income calculations.png

 

 

 

 

Using the tax system to deliver a living wage

In a previous post, I proposed a formula for calculating income tax that would provide for a  negative income tax. I did so because I believe a negative income tax system would be simpler, fairer, more humane, technically more feasible , and cheaper to develop than the current Universal Credit project being rolled out by Her Majesty’s government. A negative income tax would be administered by HMRC and have at its core the following formula for calculating income tax:

T(n) = m∑Y(n) – c∑H(n) – ∑T(n-1)

where

m is the single marginal tax rate;

c is the hourly value of the tax shield

∑Y(n) is the cumulative market income received by the end of period n

∑H(n) is the cumulative hours worked by the end of period n

∑T(n-1) is the cumulative income tax paid by the start of period n.

Comments

The proposed tax system has a single marginal tax rate. The choice of this rate is a political as well as a technical decision (i.e., achieving the desired behavioural effects) An individual’s hourly tax-free pay is given by the grossed-up tax shield (c / m).

In this post, I want to show how a negative income tax system can deliver what many describe as a “living wage”. The figure of £10 / hour has been mooted as a living wage. I shall hence assume this figure for the living wage  in my illustration.

Prologue

In this post, I will incorporate the UK’s national minimum wage (NMW), currently £6.50 per hour, into the model.

I will also use a marginal tax rate of 40%, a tax rate which is both comparable to and competitive with existing UK income tax rates (20%, 40%, and 45%). Hence m has been set to 40% or 0.4 in my illustrations.

I will assume a working week of 35 hours and an individual’s weekly hours will be capped at this level.

I will also show how the model can be used to generate a basic income. I will briefly set out my views on whether a basic income should be conditional or unconditional.

Calculating the tax shield

In this section, I will show how negative income tax can transform the minimum wage of £6.50 / hour into a living wage of £10.00 / hour.  To achieve this, the value of the tax shield (c) must be calculated with reference to the minimum wage and to the living wage of £10.00. The value of the tax shield (c) must be set so that the hourly negative tax payment makes up the difference of £3.50 

Ignoring the summations in the above f ormula (they are not necessary here), we have

T = m x (£6.50) – c = – £3.50

T= 0.4 x £6.50 – c = – £3.50

c = £6.10

The tax formula that transforms the hourly national minimum wage of £6.50 to an hourly living wage of £10 will thus be

T(n) = 0.4 x ∑Y(n) – £6.10 x ∑H(n) – ∑T(n-1)

or on a week 1 basis, the hourly tax charge will be:

T = 0.4 x £6.50 – £6.10

= – £3.50 (negative,  as required)

Illustration

Lenny earns the adult minimum wage. He works 35 hours per week. His pay slip will show:

Market income (35 hours x £6.50/hour)                                       £227.50

Negative income tax  (35 hours x £3.50)                                     £122.50

Take home pay (35 hours x £10 hour)                                         £350.00

 

Lenny now receives £10 per hour.

Incentives

The hourly post-tax income of someone whose market income is £10 would be transformed to £12.10.

T= 0.4 x (£10.00) – £6.10 = – £2.10 (negative)

Hence that individual would take home £10 – (- £2.10) = £12.10 for every hour worked at or below the 35 hour weekly cap on hours. So although the “differentials” between market incomes have narrowed the higher paid worker still receives more per hour than the minimum wage worker.

Tax free allowance

The break-even hourly income with an hourly tax shield of £6.10 and a marginal tax rate of 40% is £15.25. This means a worker with an hourly income of £15.25 will neither pay income tax nor receive a tax payment. This is equivalent to an annual tax free allowance of £27,755 (compared to the current allowance of £10,000 p.a.). Individuals with a a market income of above £15.25 per hour or £27,755 per annum would pay income tax of 40% on the excess.

Basic income

The parameters used in the formula produce an amount 0f £6.10 per hour for those who have no market income. This could be taken to be a basic income payable to anyone whose market income is zero.

T = 0.4 x £0.00 / hour – £6.10 / hour

= – £6.10 per hour (negative)

The issue is whether this fortunate by-product of negative income tax should be conditional or unconditional.

Unconditional basic income

An unconditional basic income would credit every citizen with 35 hours. The basic income would thus be received by every citizen of working age.  The basic income would amount to £213.50 (35 hours x £6.10 per hour).

Hourly income with unconditional basic income and living wage of £10/hour

Hourly income with unconditional basic income and living wage of £10/hour

Conditional basic income

A conditional basic income would credit some groups with 35 hours a week but not others. For example, the disabled, the infirm, and those with caring responsibilities could be credited.  This would automatically trigger a payment at HMRC of £213.50 to individuals falling in these groups. The unemployed would be credited with hours only to the extent of their hourly contributions to society via voluntary work and / or participation in counter hysteresis activities (such as internships, work placements, or work programmes).

Hourly income with a conditional basic income and a living wage of £10/hour

Hourly income with a conditional basic income and a living wage of £10/hour

Conditional or unconditional basic income?

My main concern is that every UK citizen should have access to honest and adequate income. For disadvantaged groups, income accessability, particularly with increased benefit conditionality, can often be an issue.

Provided plentiful opportunities for voluntary work and / or opportunities to engage in counter hysteresis activities are made available to physically and mentally capable individuals without a market income then basic income should be conditional along the lines described above. A reasonably generous income of £213.50 per week would accrue to such individuals if their engagement in these activities was for 35 hours a week. Lesser contributions would be rewarded proportionately.

Summary of the model

Basic income = £6.10 /hour. May be conditional or unconditional. Could replace unemployment benefit.

Minimum wage (statutory)  = £6.50 / hour.

Living wage (assumed) = £10.00 /hour.

Break-even wage = £15.25 /hour.

Marginal tax rate = 40%

Maximum hours of credit = 35

Some final points

The withdrawal rate for someone transiting from unemployment to minimum wage work is about 43% (0.4 x £6.50 / £6.10). This is substantially better than the proposed withdrawal rate of 65% planned for Universal Credit.

However, the withdrawal rate rises as the starting hourly wage rate rises. At a starting rate of £15.25 per hour the withdrawal rate is 100%. It is unlikely that such a high withdrawal rate would be a disincentive to accept work at this wage rate.

It seems likely that a negative income tax designed with the parameters outlined in this post would lead to a lower overall income tax take for the government. Some of this might  be due to a lower marginal tax rate of 40% for top earners compared to their current 45% and because the tax free allowance is more generous than the current £10,000 annual allowance. For this reason, it may be better to use income tax as a means of correcting the inequalities that arise from distortions in the labour market (eg directors effectively setting their own pay) rather than as a means of raising revenue.

Capping the corporation tax deductibility of market incomes to £27,779 per employee (the annual tax free allowance) may also help to mitigate reductions in the income tax take.

The redistribution of income arising from this variant of a negative income tax system is likely to have a stimulative effect on the economy. Poorer workers with a high propensity to consume relative to richer workers should increase demand and hence economic activity.