Male-Female Wage Differentials in Ireland

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Male-Female Wage Differentials in Ireland

    Dynamic Effects of a Basic Income:

    Phase 2 of a Study for the Working Group on Basic Income


    Tim Callan*

    Gerry Boyle

    Tom McCarthy

    Brian Nolan*

    John Walsh*

    Richard Nestor*

    Dirk van de Gaer

    *The Economic & Social Research Institute

    †NUI, Maynooth

     6 June 2000


This study draws extensively on the 1994 Wave of the Living in Ireland Survey, the

    Irish element of the European Community Household Panel. Brendan Whelan and James Williams of the ESRI‘s Survey Unit were responsible for the survey design, data collection and database creation.


Dynamic Effects of a Basic Income: Phase 2 of a Study for the

    Working Group on Basic Income


Chapter 1: Introduction

    Tim Callan and Brian Nolan

Chapter 2: The Basic Income Concept: Review and

    International Perspectives

    Gerry Boyle, Tom McCarthy and Dirk van de Gaer

Chapter 3: Basic Income and Financial Work Incentives

    Tim Callan, Brian Nolan, John Walsh and Richard Nestor

Chapter 4: Migration and the Informal Economy

    Gerry Boyle and Tom McCarthy

Chapter 5: Basic Income and the Labour Market

    Tim Callan and Brian Nolan

Chapter 6: Competitiveness, Investment and Growth

    Gerry Boyle and Tom McCarthy

Chapter 7: Conclusions

    Tim Callan and Brian Nolan


    Chapter 1


    Tim Callan and Brian Nolan

    1.1 Introduction

     This study, for the Partnership 2000 Working Group on Basic Income, explores the potential dynamic impact of the introduction of a basic income in Ireland. It builds on earlier reports to the Group (Callan et al., 1999; Clarke, 1999) in Phase 1 of the

    research. These examined the cost, revenue and distributional implications of the Basic Income proposal on a static or ―first-round‖ basis i.e., before any individuals or

    firms changed their behaviour in response to the introduction of the scheme. This study, Phase 2 of the research, goes beyond that framework to consider the likely changes in decisions by individuals and firms, the broader economic and social

    1impact of such changed behaviour, and the potential impact of such changes on the

    tax rate required to finance the basic income proposal.

     The introduction of a basic income would radically alter the financial work incentives facing many individuals in the population. Some of these changes for

    example, improvements in the financial incentives to take up employment for some of those currently unemployed are the intended consequence of the scheme. But there

    are also wider changes in financial work incentives associated with the introduction of the scheme, affecting those in employment and others in the potential labour force. Disentangling the effects of these complex changes in the balance of financial incentives across different individuals is at the heart of this study.

     The study begins with a review in Chapter 2 of available international evidence on the dynamic impact of negative income tax schemes, before turning to a detailed consideration of the particular scheme proposed for Ireland. Chapter 3 focuses on the key task of assessing the impact of the proposals on financial work incentives for the potential labour force. This includes not only those currently in employment, but also those who are unemployed and those who classify themselves as fully engaged in

     1 While Chapters 3 to 5 focus principally on the formal labour market and related issues (gender differences in the labour market impact, migration, participation in the informal economy) some wider issues including the impact on education and training and rural living are dealt with in the concluding section of Chapter 7.


    ―home duties‖. Chapter 4 considers the impact of the scheme‘s introduction on financial incentives for emigrants and migrants, and the complex issue of the changes in the incentive to participate in the informal rather than the formal economy.

     Drawing on this evidence, one can then build an assessment of the potential overall labour market impact of the scheme, which is addressed in Chapter 5. Other potential channels of dynamic impact, which could affect competitiveness, investment and growth, are considered in Chapter 6. Finally, Chapter 7 draws together the evidence from earlier chapters and some wider considerations concerning the dynamic impact of the basic income scheme.


    Chapter 2



    Gerry Boyle and Tom McCarthy

    2.1 The Concept of a Basic Income

     The purest form of a basic income would be an unconditional income granted to each individual, irrespective of the labour market or marital status of the individual. All other income would be taxed at a single rate. All tax-free allowances would be abolished. All social security and social welfare payments would be eliminated and replaced by the basic income. The basic income thus provides an integrated approach to social welfare and taxation, with a number of attractive features.

     Following Atkinson (1995), we can mention at least four potential advantages of the basic income. First, the system might help to reduce poverty. If the level of the basic income were sufficiently high, those who at present have to live on lower social welfare benefits or who fall through gaps in the official ―safety net‖ income support scheme would stand to benefit. Workers who at present have earnings below the tax-free allowance might profit from the replacement of the tax-free allowance by the basic income. Second, those individuals who are working in the home and whose partners are working outside of the home would now receive an income of their own. The tax-free allowance of their spouse might go down, but the distribution of income within the family would change significantly. The potential impact on the household‘s expenditure pattern and on the distribution of well-being within the household is a complex issue (see Behrman, 1997; and for Irish evidence, see Rottman, 1994, Cantillon and Nolan, 1998 and forthcoming). Third, the basic income's unconditional nature implies that the income received from the government would not depend upon the labour supply status of the individual. There would no longer be any means tested benefits. As a consequence, the poverty trap would disappear, providing an incentive for those with low earnings potential to enter employment. Fourth, because of the unconditionality of the system, the


    elimination of tax allowances, and the single tax rate, a basic income could save on administrative costs. The exact amount of these savings will be hard to quantify, however.

     Apart from these positive properties, the introduction of a basic income also has some drawbacks. First, a high basic income might discourage labour force participation and thus decrease national income. If the level of the basic income were high, the increase in non-labour income would have a negative income effect on labour supply. In addition, if the tax rate necessary to finance the basic income were very high, then this might depress labour supply too. If, moreover, the basic income is truly unconditional, then unemployed people might be less motivated to search for a job, thereby decreasing labor supply further. To obtain the net effect on labour supply these effects must be balanced against the positive effect due to the elimination of the poverty trap mentioned above. Second, the introduction of a basic income would involve a very extensive redistribution of income both vertically and horizontally, as shown in depth in the phase 1 study. While some of the distributional consequences might be seen as desirable, and compensation mechanisms could avert some unintended consequences, some would argue that there are also undesirable distributional consequences. Third, the basic income might discourage investment and hence hinder economic growth. An important channel through which this might occur is the discouragement effect on occupational pension schemes (see, e.g., Integrating Tax and Welfare, the Report of the Expert Working Group

    on the Integration of the Income Tax and Social Welfare Systems, hereafter abbreviated as TWG, p.202). Finally, a basic income might stimulate the informal economy, if the marginal tax rate on additional income is very high, and might lead to changes in migration patterns through its impact on income guarantees and tax rates.

     The extent to which the basic income scheme can live up to each of its promises and is confronted with each of its shortcomings is crucially dependent on the level of the basic income and the tax rate necessary to finance it. Therefore, one crucial question is how high a tax rate is required to finance a certain level of basic income. Phase 1 of the research for the Working Group was devoted to this issue. The present phase 2 study will build on these results to explore the various channels of dynamic impact of the scheme, both positive and negative. In the present chapter, we begin by considering the evolution of concepts of basic income and negative income tax. We then examine evidence from


    various negative income tax experiments, and consider what lessons might be drawn from this experience in assessing the potential dynamic impact of the proposed basic income scheme for Ireland.

    2.2 Basic Income Schemes and Negative Income Taxation

     ―Basic Income‖ is a relatively new name for a concept that can be dated to the early part of this century Atkinson (1998) says that it is an idea that was advocated by the State Bonus League in 1918. A variety of titles have been attached to the concept such as social dividend and demogrant. In the UK the idea has long been championed in various

    forms by a long line of economists and social activists from Cole to Meade to Rhys-Williams to Parker to Atkinson.

     A ―Negative Income Tax‖ (NIT) is a parallel concept to the basic income in that it can be constructed to produce a similar outcome. However, it has quite a distinct intellectual history, as we shall see. Moreover advocates of basic income schemes argue that the concepts are quite different. Milton Friedman espoused the idea in his 1962 book Capitalism and Freedom while George Stigler advanced the idea in 1946 as an alternative to the minimum wage.

     In this section we examine this comparative intellectual history with a view to establishing whether the concepts of basic income and negative income taxation are analytically identical and thus establish the validity or otherwise of using experiments with one for the evaluation of the other.

     A tax benefit system that gives everyone a fixed income tax free and taxes all other income goes under the name of a basic income. There are many ways in which the other income can be taxed. If all other income is taxed at a uniform rate, then we have a basic income/flat tax system. This is the system that is most frequently studied in the literature. The present proposal belongs to this category. It should be noted, however, that the tax rate need not be uniform. In a previous study, Callan et al. (1994) studied the

    consequences of a dual rate structure, with a ―benefit withdrawal rate‖ on lower incomes allowing a lower marginal tax rate on middle and high incomes. (Such a structure bears some resemblance to the existing tax and welfare systems, where tax-cum-benefit withdrawal rates are highest on low incomes, altering the trade off between the level of income guarantee and the tax rate on middle and high incomes).


     At first sight a negative income tax looks somewhat different. Under a negative income tax, a specified amount of income is tax-free. All additional income is taxed at a certain rate. Those individuals whose income is lower than the level of tax-free income receive a subsidy (or ―refundable tax credit‖) that is proportional to the difference between their income and the level of the tax-free income. Hence those without any other source of income receive the highest subsidy. If the subsidy received by those who have no other income under the negative income tax proposal is equal to the size of the guaranteed income, and both systems have the same tax rate, both systems are identical in accounting terms.

     Differences between the concepts arise mainly due to the degree of conditionality attached to the payment; but there are also associations between the different labels (NIT and BI) and the envisaged level of income guarantee. We now examine this and other concepts.

     Universality is central to many conceptions of the welfare state. It has advantages in that it avoids unintended distortions that may arise from making entitlement categorical. However, it has implications for the cost of welfare programmes. It is for this reason that various forms of conditionality have been attached to welfare payments. An important feature of most basic income schemes is the unconditional nature of the basic income. We noted above that many economists have lent support to basic

    income/negative income tax proposals. However, we also find that many economists will not support fully unconditional schemes. Recently, several economists have argued that imposing work requirements for the receipt of welfare payments will be efficiency enhancing in certain circumstances (Besley and Coate, 1992). This idea has a longer history and would inform the thinking behind the views of some economists. However, there is a broader argument. Tobin, for instance, argues that a puritanical ethic cannot tolerate the idea of a completely unconditional transfer. Atkinson (1995) gives a modern slant to this view suggesting that some form of ―participation price‖ must be paid in order

    to preserve social cohesion.

     When people study basic income or negative income tax proposals, they usually assume that the guaranteed income, or its negative income tax equivalent, replaces all existing social benefits. Both negative income tax and basic income proposals are


    reconcilable with the existence of other social benefits, however. Hybrid taxation and social benefit systems along these lines are the small-scale negative income tax

    2(discussed by Barr 1998, chapter 11) or a partial basic income (see Atkinson, 1995)).

     Quilley (1998) tries to analyse the kind of policy strategy that might lead towards a basic income. The continuing prevalence of the work ethic and the commitment of governments to focus on labour market participation leads him to defend a participation income (like Atkinson, 1995). Further European integration will increase the need for a common European social policy. The simplest way to achieve this, compatible with residual national social policy at the national level, would be a basic or participation income at the European level. Consequently, he pleads for a basic income on the European level. Ecological concerns are becoming more and more important, such that the Euro-grant should be financed by Eco-taxes. This would have the additional advantage that a political majority in favour of the European participation scheme might arise more easily.

     Manning (1998) considers the introduction of a basic income scheme in New Zealand. The most original part of his proposal is the way the basic income will be financed. Instead of increasing personal taxation, he proposes to levy a tax of about 5% on foreign exchange and domestic transactions, and replace private money creation by public money creation by re-introducing reserve ratios in the banking system. The initial inflationary impulse would be reduced by a forced savings scheme for the high incomes: their basic income would be frozen for a period of three to five years put on an account. All of this is very creative, but the effects of such policy measures on economic activity are very hard to predict for an open economy. They could very well be quite severe.

     Finally there is the question of the similarity or not of basic income/negative income tax systems and systems of refundable tax credits in particular the US Earned

    Income Tax Credit (EITC). Ventry (19xx) argues that the EITC cannot be seen as a type of negative income tax citing legislative plans in the US that contained both types of schemes. The NIT provided at best an intellectual precedent for the EITC, he argues. The differences are more pronounced than the similarity that appears to be the automatic

     2 The proposal examined here has some elements of a hybrid system.


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