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Sunday, September 28, 2014

Consequences Of A Basic Income Guarantee

The idea of a Basic Income Guarantee (hereafter known as BIG) has become increasingly a topic of interest. My views have been greatly influenced by Hyman Minsky and Modern Monetary Theory (MMT), where a guaranteed job was preferred to guaranteed income. (Minsky referred to this as an Employer of Last Resort programme; MMT refers to this as a Job Guarantee.) I explain why I view a BIG as being essentially unfeasible within Canada, using logic similar to their analyses.

Not A New Idea

The idea of a guaranteed income has floated around for a long time, and has had a wide variety of supporters. In fact, it was an option advanced by Milton Friedman in the form of a negative income tax. Hyman Minsky analysed the possibility in The Macroeconomics of a Negative Income Tax in 1969 (original presented at a conference, and is available in the book Ending Poverty: Jobs, Not Welfare, which I reviewed here). He noted that

From time to time public policy proposals which once were far out quite suddenly achieve social respectability. This seems to be the case with the "social dividend" when it is dressed up in its currently more fashionable garb as a "negative income tax".
This seems to be true today, except that the "negative income tax" dropped out of fashion, and the new thing is a "guaranteed income". (I have seen arguments that a negative income tax is not the same, since you supposedly would have to wait until year end to receive the money. This is not correct; the government can "mail out" monthly amounts as a "pre-refund" during the year, and then things are squared at year end.)

His analysis within the essay covers a lot of ground. I do not want to attempt to present the more complicated parts of it, as those revolve around a lot of thorny issues of how an income guarantee impacts motivation to work. The modern proponents of an income guarantee have heard similar arguments, and they have what they see as good counter-arguments. Instead, I will follow a fairly simple "static" analysis based on part of his work, and the issues I worry about are fairly apparent.

His summarised his conclusions as:

The negative income tax has been proposed as an effective, straightforward weapon for the eradication of poverty. It is in truth a complex instrument, and its use may lead to unintended and undesirable side effects. In particular, a negative income tax may tend to induce inflation, reduce measured gross national product, and lower the measured rate of growth of the economy.

An Example BIG For Canada

I have seen reports of Canadian activists arguing in favour of a BIG which amounts to $12,000 per Canadian per year. The idea is that every adult resident citizen would receive a monthly $1,000 cheque from the Federal Government (see discussion below) unconditionally. (I have no idea whether people want to scale up based on the number of children; I will assume that is not the case.)

(Note for non-Canadian readers: The exchange rate and price levels are such that you can translate that to be the equivalent to about $12,000 U.S. dollars per year. Although retail prices are higher in Canada due to embedded taxes, things like health care are much cheaper, and so the situations should be roughly comparable. Translations to other regions are more difficult, as the domestic price level in Canada can swing a lot versus other regions if you use market exchange rates.)

I would view that as a reasonable working figure for what they are attempting to achieve: someone without any other income sources will be able to live a fairly modest lifestyle on that amount. (A single person would have a difficult time without doing something like having a room-mate.) By way of comparison, the maximum pension under the Canadian Pension Plan and the Old Age Supplement is around $18,000 per year.

It would be possible to have a much smaller "income guarantee", of say $100 per month ($1,200 per year) - a "little BIG". This would make the income tax system even more progressive, and it is quite feasible. But the feasibility arrives from the fact that such a move accomplishes very little, and so it does not have the big macroeconomic consequences of a "big BIG". Within this article, I am only discussing a full-sized BIG.

To be clear, I have not spent a spectacular amount of time researching various BIG proposals. It may be that they envisage some clever mechanism to get around the problems I raise here. Although possible, it seems unlikely.

Advantages Of A BIG

A BIG has some apparent political advantages over a Job Guarantee. Steve Randy Waldman discusses these in an excellent post at Interfluidity. (He has a later post with more links.) The fact that Milton Friedman approved of a negative income tax is a good clue what the advantage is: it is a way to make the welfare state acceptable to supporters of the free market. There are no bureaucrats from the nanny state telling recipients what to do with the money; they can spend it in whatever way they wish within private markets.

Since it would be have to be integrated with the income tax system - no matter how people think it can be packaged politically - it would be regulated by roughly the same income tax apparatus that already exists. The only key is to validate that citizens receiving cheques are in fact alive. (As I discuss below, if you have little income, you do not need to file a tax return.)

Put it this way - a negative income tax is a serious tax cut. Since when are modern conservative parties against tax cuts?

Sizing The Programme

Using data from Statscan, the number of Canadians 20 years or older is about 28 million (total population of 35 million) in 2014. (The natural cut-off for the programme would be at 18 years, but the data table does not have the cohorts split there.) At $12,000 per person, the annual spending would be about $332 billion, which is about 17.2% of nominal GDP.

By way of comparison, looking at the 2014 Budget from the Federal Ministry of Finance, total Federal programme spending (that is, not including the sizeable transfers) was expected to be 13.0% in the 2014-5 budget year, and total budget revenue was 14.3% of GDP. In other words, this programme is larger than the entire Canadian Federal Government. (Note that the Provinces have much larger economic footprints than American State governments.)

Any observer of Canadian politics should see an immediate problem - there is no way of doubling the size of the Federal government without there being all-out Constitutional warfare. Realistically, the programme would have to be split between the Federal and Provincial levels, and Ontario and Québec are not in a great position to shoulder a larger social welfare burden. Although the Federal Government controls the currency it borrows in, the same is not true of the provinces.

Gold-Plated Pensions?

Another obvious political problem is the issue of universal pensions. The OAS supplement (about $6,000 per year) could be dropped, but the base Canada Pension Plan (or Québec Pension Plan) of (up to) $12,000 per year was "paid for" via contributions during citizens' careers. This financing issue is psychological - government pensions are pay-as-you-go - but it is an important political point. The Canada Pension Plan was not sold as a welfare payment; it was payment in return for working contributions. This made the plan politically unassailable over the decades, but that also means that it would be difficult to phase the payments out.

Would seniors get both the guaranteed income and the Canada Pension Plan? If so, younger generations - who have low expectations about their own future pensions - will start mulling over plans involving ice floes very rapidly.

Interactions With Income Tax

The interaction between the BIG and the income tax system would cause a lot of grief. The Canadian income tax system is such that if you earn less than about $10,000 per year (depending upon the province and other factors; no, I am not giving tax advice) you end up with no income taxes payable. If you do not have any income tax payable, you are released from filing out your tax form. (Even if you are audited, as long as you can prove your taxable income was low enough to not generate taxes payable, you pay no penalty.)

This is extremely useful. It allows people to earn marginal amounts of money, and not have to worry about being dragged into the tax system. For example, it allows people to hire teen-aged baby sitters and pay them without tax withholding. It allows a small informal economy to exist (as long as nobody is getting rich doing it), without creating loopholes in the tax law that richer members of society could drive a semi-truck through.

However, this threshold would interact with the BIG and cause large potential problems. If it was left in place, it would be possible for an adult to receive $22,000 per year without paying any income tax. For a couple, the limit would be $44,000 per year. At the current price level, that amount of after-tax income allows for a comfortable middle class lifestyle. However the couple would only be working part-time in marginal positions. (A person working at the Québec minimum wage of $10.35 an hour would be able to hit the $10,000 annual income threshold working 80 hours per month.)

This points to the obvious problem: how can a largely middle class society produce the goods and services it currently consumes on the basis of working part-time at minimum wage?


How the payment is indexed is a major problem. If the payment is fixed, the guaranteed income will wither away until it is irrelevant. But if it is indexed to the CPI, it would become an "engine of inflation" (Hyman Minsky's description of the welfare state programmes of the 1960s).

For example, if the oil price shoots up, there will be an upward shock to the CPI. This will then feed through to the BIG payments, and nominal demand will rise. This will create the demand spiral that we saw in the 1970s.

(As an aside, if the payments were indexed to an external store of value - such as the U.S. dollar - and indexed it at a high enough frequency, it would be an engine of hyperinflation. Presumably, nobody would be crazy enough to call for such a form of indexation. I just note this for theoretical reasons, as an answer to the question "what could cause a hyperinflation in a developed economy"?)

This is not insurmountable. The Government should just believe its inflation target promise, and have a fixed 2% increment every year. The idea is that it should keep up with inflation in the long term, but it should not apply positive feedback to deviations from target.

Functional Finance Concerns

One part of MMT that is often portrayed incorrectly is the stance on how government pays for its expenditures. The government could just issue money to pay for the BIG, without solvency concerns (assuming that financial operating procedures are modified slightly; the government may need a serious overdraft with the Bank of Canada). But an amount of 17% of GDP to the fiscal deficit would be a rapid driver of inflation, using Functional Finance principles, a fact which is well recognised by MMT economists. (Functional Finance is associated with the economist Abba P. Lerner; I have a primer here.) (During wartime, governments ran much larger deficits, but that required the government to take over the economy.)

At present, the Federal Government could widen its deficit slightly (2-4% of GDP, say) without there being an observable impact on inflation. Since they are attempting to tighten fiscal policy, that's an entirely theoretical question. But it is clear that taxes would have to rise a significant amount in order to keep inflation from taking off if a BIG is implemented. Since the BIG spending should have a high multiplier, the change might even have to be deficit-neutral to avoid an increase in inflation. That is, all of the changes made to implement the BIG (BIG payments, removal of redundant social programmes, increased taxes) would have to leave the projected deficit roughly unchanged, yet the inflation rate would rise by a couple percent. Although society could survive an inflation rate around 4%, a much higher inflation rate would most likely create a very irate middle class.

This is only possible if marginal tax rates hit very high levels - probably around 50% even at low levels of income. Canadian personal income tax rates are already fairly high. Tax evasion is already a problem; the incentives to cheat will explode. Although the lower middle class would be better off in absolute dollar amounts, the very high marginal income tax rates would be very obvious on pay cheque stubs. (I do not have the income distribution data in order to analyse how the tax schedules would have to look; Minsky did an example of such analysis in his article.)

Some could argue that very high tax rates on the ultra-rich will pay for the programme. We have had experience with such tax regimes in the past, and the reality is that the amount of taxes raised were low. The increase in inequality - as measured by the tax system - that happened after the decrease in top marginal rates may not have reflected true economical inequality increasing (as was argued by Piketty).  A more realistic assessment is that if you tax 90% of something, it tends to disappear from the government's sight. Raising top marginal rates would only provide a temporary boon; the income will change into benefits of non-taxable form very rapidly. Realistically, the upper middle class will have to shoulder the burden of increased taxation, and marginal rates will be around 50% for everybody.

Additionally, the need to tax low income earners heavily increases the tax surveillance required. Will it make political sense to audit teenagers to see how much they are making baby-sitting? What about barter transactions, where people exchange food they grew in their back yards in exchange for services?

It would be possible to axe certain other welfare state programs, but that would not appear to offer too much savings. The Employment Insurance programme (Canada re-branded Unemployment Insurance for some reason) would probably have to continue untouched. It exists as a measure to allow the middle and lower classes to avoid financial catastrophe in the event of a temporary loss of employment income. Since the BIG payment is not sensitive to your overall income, it does not help in such an event. The only programmes that could be removed as being redundant are welfare transfers, and the Old Age Supplement. (The fact that it does not increase when your employment income drops means that it is not useful as an automatic stabiliser, as Neil Wilson has often observed.)

Not Future-Proof

In Technology Paves The Way For A Basic Income Than A Job Guarantee, Peter Cooper argued that the destruction of jobs by technology means that societies will have a considerable surplus that needs to be redistributed. In the long term, I am more concerned about the impact of Peak Oil (and Peak Food), as I discussed in the review of Jeff Rubin's End of Growth.  

Although GDP growth will continue despite the limitations of the oil supply, that growth will be weighted towards immaterial positional goods in the service sector. The cost of necessities - which are heavily levered off of the price of oil - will rise, and it will be harder to provide them. 

At present, it is difficult to opt out of the formal monetary economy as the standard of living is much higher than would be the case if you "drop off the grid". Subsistence farming may sound romantic, but it is hard work. 

But if the cost of necessities rise, the difference in the standard of living between someone in the formal economy and paying tax and those who have dropped "off-the-grid" may not be as marked, particularly if the government guarantees an income without the recipient being made to work for it. If dropping off the grid become attractive, more will do it. This will raise the taxes on those who remain, as there will be a smaller number of people to cover the fixed resource costs of government. As a Chartalist, I find it worrisome to be in a situation where there is no obligation to pay tax - what gives the currency value?

Society has already made an all-in bet on continued growth coming from technology and energy supplies that will somehow appear from somewhere. An income guarantee would be a crushing disaster if that hoped-for scenario does not turn out. Given the reality of possible political paralysis in a crisis, there is no reason to assume that the policy could be reversed fast enough to avoid far-reaching damages to the structure of society. 

Conversely, in the case of the Job Guarantee, payments are only provided in exchange for work. This means that there would be a large labour pool available to deal with the consequences of whatever crisis hit the economy. This means the Job Guarantee policy is sustainable regardless of the winds of technology.

In summary, although the idea obviously has its attractions, I doubt that the financial numbers will ever make enough sense for mainstream political parties to endorse the concept.

(c) Brian Romanchuk 2014


  1. What about funding it via a land value tax. The land value is distributed equally to all citizens, or via government owned enterprises if they make a profit so it is not contractionary (including JG_)
    You can have a job guarantee as well.

    1. Property taxes are not particularly well loved. In order to raise $12,000 per adult, the average property tax would go up by that amount times the number of adults per property. In Canada, this would absolutely crush British Columbia, which would be entertaining for us Québécois. (The average land value for a house in Vancouver is around $1,000,000, and probably around $200,000 for a house in Montreal.) Older retirees with big houses would also be wiped out. (There may or may not be Constitutional issues with such a tax.)

      If we somehow smooth out the transition, the system could be made to work. But it would mean that smart rich people would just buy smaller than average houses, and they would end up ahead in the system. Based on "The Millionaire Next Door", that's already the case for the bulk of millionaires. It's only the ultra-rich with massive mansions who would get hit, and it is likely that they would adapt and find a way to avoid the tax.

      Obviously, a BIG could be made to work. But it could greatly distort the tax system, and the rise of the informal economy would have to be closely monitored.


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