Universal Basic Income: The Basic Trade-offs

I first learned about the UBI forty years ago, in a class taught by the late Bernie Saffran. He said that there are trade-offs in how the government sets two parameters: the level of the UBI and the tax rate on earned income. These in turn affect the UBI’s impact on the budget and on upward mobility.

For example, suppose that the government grants each family of four a basic income of $20,000, and the tax rate on earned income is 20 percent. A tax rate of 20 percent does little to impede upward mobility, but it means that the “breakeven point” is a family earned income of $100,000. Families earning less than $100,000 would be receiving a net transfer from families earning more than that. This would make the UBI very expensive from a budget standpoint, leaving little or no room for other government spending.

On the other hand, suppose that the tax rate is 80 percent. That makes the “breakeven point” an income of $25,000, meaning that the only families receiving a net transfer are those that earn less than $25,000. But the 80 percent tax rate is a major impediment to upward mobility. People who work especially hard will have very little to show for their efforts.

You might think “A tax rate of 80 percent? That’s crazy. There is no way that would be adopted in the U.S.” But it turns out that is close to what we have.

Instead of a single tax rate and a universal basic income, we have a complicated tax system and a set of “conditional transfers,” meaning money that people receive that can only be spent in certain ways (food stamps, for example) and only if they satisfy eligibility rules, including strict income cut-offs.

Examining the overall impact of all of these taxes and transfers, economist John F. Early found that

the middle-income group averages only 20 percent more spendable income than that of the lowest group. Government income redistribution basically flattens out the bottom 60 percent of income to within 20 percent of each other.

Taking into account the way that they lose eligibility for conditional transfers, low-to-middle income families face an average tax rate of close to 80 percent. In fact, there are surely some families in some income ranges who face a tax rate on incremental earnings of more than 100 percent! They would have more to spend if they earned a bit less income. Given the high implicit tax rates that they face, it is a tribute to their work ethic that so many of these families choose to earn income at all. But we offer them hardly any chance for upward mobility.

The economic case for the UBI, as I first learned from Bernie Saffran, is that it enables the government to meaningfully reduce poverty and still allow for upward mobility. Our current hodge-podge of conditional transfers is less effective on both counts, especially the latter.

The three goals

As Bernie taught me, the design of a UBI must trade off three desiderata, or three goals.

1. generosity toward the poorest families
2. room for upward mobility
3. budget affordability

The higher the amount of the UBI, the more generous it is to poor families, but the greater the budget cost. Similarly, the lower the tax rate on earned income, the more room it allows for upward mobility, but the greater the budget cost.

I am in favor of a UBI, but I am concerned about budget affordability. I also believe that conditional transfers can be a useful supplement to the UBI, but that these are best provided by organizations closer to the people receiving the transfers. Local governments and charities can best understand the needs of particular families.

If it were up to me, I would like to see a tax rate of about 25 percent and a UBI for a family of four of $10,000. This would make the “breakeven point” $40,000, meaning that every family earning at least $40,000 would be paying more in taxes than they receive in UBI.

Of course, for the most disadvantaged families, who earn nothing or who have members with special needs, a transfer of $10,000 is not sufficient. That is where I would want community organizations to step in to provide conditional transfers. These local governments and charities can identify the families whose disabilities, child care needs, or other characteristics require larger transfers.

Conclusion

There is no perfect approach for using government transfers to alleviate poverty. Any approach faces inevitable trade-offs. We cannot have everything we might want in terms of providing a generous income and room for upward mobility at an affordable budget cost. What a universal basic income allows us to do is make more explicit and thoughtful trade-offs. Instead, our current programs of conditional transfers are unsatisfying in many dimensions, especially in the way that they retard upward mobility, leaving hard-working middle-income families disturbingly close to the very poorest families in terms of net spendable income.