Universal Basic Income – not all “basic” things are bad

A couple of weeks ago, Finland announced that they were going to completely reform their benefits system by doing away with all means-tested (and other) benefits and replacing them with a “universal basic income” of €800 per month.

A very good summary of the majority of the benefits and potential drawbacks can be found here – I strongly recommend you go and read it. It falls a little short in some areas: for example, it doesn’t really investigate whether or not the new system will be more or less expensive of the old system, yet still dismisses as false claims that the new system will be too expensive.

However, more importantly, even though the article claims that it would reduce instances of “out-of-work claimants afraid to take up short-term job offers for fear of losing benefit entitlement” this misses off a crucial element (although the main thrust of this point is correct).

In particular, it ignores the fact that some people currently in employment might decide to remove themselves from the workforce – some people currently in work might decide that €800 per month is more than sufficient for them to live on and that they can therefore get by without working. This would result in people that were previously productive (i.e. contributing to GDP) no longer working, such that GDP could fall.

However, the size of this effect could be quite small. Indeed, it could be argued that the people most likely to be disincentivised by the new system are those that are already out of the workforce in the first place. If this is the case, then the policy likely would have a negligible impact on GDP since the reduction in the size of the workforce it would inspire would be limited.

Moreover, even for those that are disincentivised, the overall size of the disincentive depends on the amount of the basic income relative to the amount that someone could expect to obtain from remaining in the workforce, as well as the sort of lifestyle that the basic income can obtain. If the basic income is small relative to the wages obtainable through employment and/or relative to the cost of maintaining the desired lifestyle, then the disincentive effects of the policy are likely to be negligible.

Indeed, these disincentive effects are likely to be outweighed by the positive incentive provided by the removal of means-tested benefits. This removal reduces the marginal tax rate paid by those that would otherwise be on means-tested benefit, thereby increasing their incentive to increase their income.

To see this, suppose (in a hypothetical stylised example) that someone earns €10,000 through working and obtains €9,600 in means-tested benefits that are withdrawn at a rate of €1 per every extra €2 earned – in this scenario, the person gets €19,600 per year through income and benefits combined. Further, suppose that the income tax rate is 0% until someone earns more than €25,000. Under the means-tested benefit scenario this person has the chance to increase their in-work income to €12,500 – this might seem automatically worthwhile because they will get €2,500 per year more. However, the fact that their means-tested benefits are withdrawn gradually means that the total amount they would get is lower than this. Specifically, their means-tested benefits would now only amount to €8,350, such that this person would obtain €20,850 per year. This is an increase in total money of only €1,250 despite the person’s increase in work income of €2,500. In other words, this person faces a marginal tax rate of 50%, which could provide a large disincentive from taking on more work.

The situation with the universal income is much simpler – the person gets €9,600 benefit regardless of their paid income. Hence, any increase of the person’s income (below the income tax threshold) is kept by that person, so that in this scenario the person’s total annual money would increase by the full €2,500 to €22,100. Therefore, under universal income, a potentially very strong disincentive to work is removed, encouraging people to work and thereby increasing GDP.

As such, the issue regarding work incentives and the impact the policy will have on employment via the change in work incentives is far more nuanced than the article suggests. Hence, the article may well understate the benefits to this policy.

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