The Negative Income Tax and Basic Income are pretty much the same thing

I’ve been talking about the Negative Income Tax lately, and equating it with the idea of a Basic Income. I think most of the policies’ respective advocates would deny that they’re the same policy. In this post I’m going to outline why that’s incorrect and I’m happy to say that they’re basically the same thing.

For the uninitiated, a Negative Income Tax is a form of welfare that replaces most existing welfare schemes with a single payment that supplements the income of the unemployed and low-paid. The payment is withdrawn as your earnings increase, ideally at a gradual enough rate that increasing your earnings (and hence reducing leisure time) is always worthwhile.

An example: a £5,000 basic payment at a 50% marginal withdrawal rate (this means that for every additional pound earned, the worker will receive 50p less in NIT payments). Someone with an income of zero would receive an NIT payment of £5,000, or just under £100/week. If they took a job that paid £5,000/year, they would receive a top-up of £2,500/year; that paid £7,500, a top-up of £1,250/year. Once they reached £10,000/year, they would receive nothing in NIT.

This idea was supported by Milton Friedman, among others, and has a reasonably strong pedigree on the right. Even libertarians who object to income redistribution in principle usually concede that a Negative Income Tax is the least bad form of welfare, because it is administratively simple and perverts incentives less than most welfare schemes. It is particularly appealing to many liberals and libertarians because it is unpaternalistic.

A Basic Income, on the other hand, is usually conceived as a flat payment to everybody irrespective of circumstance. This leads to a very big problem: assuming it replaces most forms of welfare as an NIT does, a basic income high enough for unemployed workers to subsist on would simply not be affordable to pay to everyone. A policy that ideally would be designed to help the poor ends up being a very expensive subsidy to people who do not need extra money.

Advocates of the Basic Income recognize this, and their solution is typically to use the tax system to ‘claw back’ the payment from relatively high earners. So everyone gets the money, but it is withdrawn according to earnings.

In practice, that’s more or less the same as a Negative Income Tax – the only difference is whether the withdrawal takes place at the ‘front’ of the payment (as with the NIT), or the ‘end’ (as with the Basic Income). Strange as it may seem, the policies advocated by Milton Friedman and the Green Party are the same in all but the technical detail.

But even if there is a surprising amount of agreement in terms of the kind of welfare we’d like to see, the detail may be more difficult to agree on. How much should a ‘basic income’ be? When should it begin to be withdrawn, and at what rate?

Questions like this are, I think, likely to be where what breaks up this (unholy?) alliance. But maybe not. Traditional policies like the minimum wage probably do more harm than good, and, rightfully, the question of how to improve the lives of the low paid does not seem to be going away. It will take compromise, but in the Negative Income Tax / Basic Income, we may have an answer.

Five intriguing papers I discovered this week II

As the second in a series, here are summaries of five interesting journal articles I read in the last week. All of these ones are new, although that may not always be the case.

1. “Very Long-Run Discount Rates” by Stefano Giglio, Matteo Maggiori and Johannes Stroebel

Giglio et al. use the difference between the prices of leasehold and freehold properties in the UK and Singapore to compute long-run discount rates. They find that over 100 years, the discount rate is 2.6%—whereas properties with 700-year or longer leases trade at par with freeholds. They point out that this 2.6% discount rate may have implications for climate change policy; the famous and influential Stern Review recommended using a 0% discount rate, which may justify much more extensive anti-CO2 measures now. Some slides explaining their findings are available here.

2. “Is the stock market just a side show? Evidence from a structural reform” by Murillo Campello, Rafael P. Ribas, and Albert Wang

Campello et al. look at a 2005 reform that, in a staggered 16-month basis and after a trial, allowed $400bn worth of Chinese equity, previously untradable, to be bought and sold. Using “wrinkles” in the roll out that provide quasi-experimental tests, they find that firm profitability, productivity, investment and value all improved substantially. “Policies that ease restrictions on [capital] markets may have positive effects” runs the final line of their conclusion—quelle surprise!

3. “Social security programs and retirement around the world: Disability insurance programs and retirement” by Courtney Coile, Kevin S. Milligan and David A. Wise

These three authors add to the burgeoning literature proving that those on the edge of retirement respond to incentives just like anyone else. This shouldn’t really be a surprise, but the heavy flow of publications adding evidence in this direction suggests that maybe there was once a bizarre consensus in the other direction. Coile et al. show that delaying eligibility to pensions, increasing the stringency of disability insurance programs, and other welfare reforms for older people have “very large” effects on how much labour they decide to supply. Not exactly shocking, but certainly important in ageing societies.

4. “What Happens When Employers are Free to Discriminate? Evidence from the English Barclays Premier Fantasy Football League” by Alex Bryson and Arnaud Chevalier

In this nifty and quirky paper the authors try and isolate “taste-based” racial discrimination, by looking if fantasy football players pick footballers differently based on their race, controlling for “productivity” (i.e. their expected points tally). They find no evidence of taste-based discrimination here, suggesting that much of the apparent discrimination found in other studies (e.g. studies of fake CVs where different ethnicities see different acceptance rates even when they have similar qualifications and experience) could be statistical. That is, since employers cannot directly observe productivity (unlike in fantasy football), and since different ethnicities have different productivity distributions, certain ethnicities are on average less valuable to employers. Of course, it might be that people exercise taste-based discrimination as well when they have to interact regularly with the group/race/ethnicity in question—fantasy football is much more at arms length.

5. “The Role of Publicly Provided Electricity in Economic Development: The Experience of the Tennessee Valley Authority, 1929–1955″ by Carl Kitchens (ungated)

The most fun kind of research to read is one that confirms a niggling view you’ve had for a while, but one that nevertheless overturns a happy consensus. The Tennessee Valley Authority is a classic example of “enlightened” central planning, targeting a hard-up area with massive coordinated infrastructural investment and widely believed to have delivered substantial benefits. But if these dams and systems were really such good investments wouldn’t private companies have got around all the barriers to such an investment already? There are some cases where I suppose that sort of basic argument doesn’t hold, but it’s a pretty good first approach to any area, and it turns out the TVA is one of them. Kitchens newly-published paper finds “that the development of the TVA during its first 30 years did not cause manufacturing, retail sales per capita or electrification to grow any faster in areas receiving TVA electricity than in other areas in the Southeast.”

How much does Will Hutton actually know about pensions?

Yes, it's a Monday morning so we've the weekend's Will Hutton column to pick through if we so with. And I have to say that it's a real doozy. We might hope for just a little better than this from someone who wants to tell us all how we should live our own lives, how the country should be run. He wants to talk about the new pension rules:

Meanwhile, insurance companies will lose a great part of the £11bn inflow they have been using to support long-term investment. To date, that has been invested in company and government bonds. But with more energy, imagination and drive, it could have been a rich source of long-term capital for British infrastructure projects – had the instruments been developed in which the insurance companies could have invested. Even as it was, the government has managed to coax the companies into coming up with £5bn a year on infrastructure over the next five years. But now an important source of the funding – annuity inflows – will evaporate.

The annuity inflows were not a large part of the financing of this market. For in one of his acts of financial repression (yes, that is the technical term for it) Gordon Brown insisted that annuioties should be largely funded by gilts. The pension funds which built up over the years, yes, these could be and are invested in some micture of bonds and equities and infrastucture projects and so on. But it's the very switch from those funds into hte annuities that reduces the amount available for such investments. But that pales beside this ludicrous misunderstanding:

But it is not "their money" and we all live in a society whose members' decisions profoundly affect each other. Mr Webb, I assume, would not make this remark about individuals being free, as neighbours, to play offensively loud music, or free not to bin their household rubbish or free to refuse to school their children. Being free to binge your lifetime savings, which taxpayers have helped create, falls into the same category. Every citizen in these island pays higher taxes than they otherwise would to compensate for the lack of tax coming from tax-sheltered pensions. The contributions to build up personal pension funds are allowable against tax and the funds, once acquired, pay no capital gains tax and no income tax on dividends. Up to 40% of the value of any pension fund is thus created through the construction of a watertight tax-free zone. We should care if the resulting money is spent on a Lamborghini: a chunk of the car belongs by right to taxpayers.

Sigh. The tax benefits that pensions savings get is not actually a waiving of tax. It is only tax deferral. It is true that you do not pay tax on the money you put into your pension fund. But it is also true that you do pay tax on any pension that results from that saving. And it's absolutely true that if you cash out your pension to the extent that you can afford a Lamborghini then you'll be paying at least the higher rate on most of that cash. Quite possibly the 45 p rate on some of it too.

That I pay tax upon my money in 2015 rather than in 1985 gives the taxpayers no claim over my car now, does it?

It's not just that assumption he's making there, that if you don't get taxed then taxpayers own part of you and your possessions. It's that he simply doesn't seem to be aware that pensions taxation is all about deferral, not the simple non-taxation of the income at all. And as I say, these are the people we're supposed to get our ideas from about how to run the country?

Osborne’s Surprise

The most exciting part of George Osborne's fifth budget came as a total surprise.  This was the complete overhaul of the pensions system, and it achieved two of the Adam Smith Institute's long-term objectives: simplification combined with tax reduction. 

The previous rules, complicated and cumbersome, arose from the Treasury's lack of trust in people's ability to manage their own affairs competently.  The Treasury tried to micro-manage how pension pots should be drawn upon.  They limited the amount that could be taken in cash, and capped the amount that could be drawn in annual income to a small amount, with a punitive 55% tax on anything in excess. 

The Treasury's concerns were twofold.  They didn't want high earners to use pension pots to circumvent income tax, and they didn't want people drawing so much that they had insufficient left to support them and might become a burden on the state.  People were compelled at one stage to buy an annuity, despite the poor value these have represented.

Osborne's bold budget has introduced the revolutionary idea that people are better at judging their own interests than Treasury officials are.  At a stroke he has given them the choice of how much to draw and when to draw it, and abolished the 55% rate.  Anything they do withdraw will be taxed at their marginal rate.  Significantly, the Chancellor pointed out that those on his side of the House know that lower tax rates can sometimes bring increased revenue, and he expects it will happen in this case.

Saving for retirement has suddenly been made more attractive, and since much of this saving is in equities, it means more investment will be available to create and sustain jobs and to boost growth.  It also means that fewer people will choose to be dependent on the state in their old age.

The Chancellor has expressed his confidence that people will behave responsibly and with due regard for their own interest.  Bravo.  It is an admirable sentiment and one that should be adopted in other Departments.  The ASI will be encouraging them to do so in the months ahead.

I find myself agreeing with Richard Murphy

I think I'm going to need to take a little lie down. I find myself in agreement with Richard Murphy on something. Even that it's only partial agreement is disturbing. He says:

I have read a lot about what fairness is of late. I have come to the conclusion that there is no objective answer to that. Whatever one person thinks is fair is, apparently, acceptable to at least someone, somewhere. That is why it comes to fairness majority opinions matter. On the welfare cap I have no doubt the majority will consider what is being proposed to be profoundly unfair if they realise just who is affected.

As to the definition of fairness, yes, he's correct: for this is the point of Adam Smith's linen shirt. That you cannot afford one does not make you poor. But if you live in a society where not being able to afford a linen shirt marks you as being poor then yes, in that society you are poor. So, what we all, collectively, think of as being fair is indeed what is fair in our society. And that is a malleable thing. We used to, vilely, think that it was just fine to hang people for stealing a loaf of bread to take but just one example from our past.

However, I disagree entirely with the idea that people are going to think that the benefits cap is indeed unfair. It is, after all, set at around median household income and we do, most of us, think of the welfare system as a safety net and not something that should provide a better than average lifestyle.

But we can go further than this. It was most amusing watching the reactions to the initial part of the benefits cap, the limitation on the amount of housing benefit that anyone could claim. The number was announced as being £400 and everyone exploded in outrage. What? You can't rent a rabbit hutch on that amount per month! The next turn of the news cycle brought the clarification that this wasn't a monthly limit, this was a weekly one. At which point the outrage exploded again: what, you mean people have been getting more than £20k a year, tax free, in subsidy for their rents? But, but, that's more than I earn!

We British have alwasy prided outselves on our sense of fair play: possibly in error. And we do indeed have ideas about what is fair within our own society and the definition of what is fair should properly be judged on what we collectively think is so. But recent experience tells me that the idea of a benefits cap is something that most of us will describe as fair. Simply because most of us do think that the welfare system is a safety net, nor either something that should provide a substantial lifestyle nor an exercise in social and economic re-engineering.