Why the effects of a guaranteed income on income and employment in Texas and Illinois shouldn't surprise us

The idea of a universal basic income (sometimes called an income guarantee) has gathered a lot of interest over recent years, particularly as fears of job losses to artificial intelligence have risen. The underlying idea is simple. Government makes a regular payment to all citizens (so it's universal) large enough to cover their basic needs (so it's a basic income). However, other than a number of pilot projects, no country has yet fully implemented a universal basic income (UBI), and many have apparently changed their minds after a pilot (see here and here). There are a couple of reasons for that. First, obviously, is the cost. A basic income of just $100 per week for all New Zealanders would cost about $26 billion per year. That would increase the government budget by about 14 percent [*]. And $100 is not a basic income, because no one is going to be able to live on such a paltry amount. Second, there are worries about the incentive effects of a universal basic income. When workers can receive money from the government for doing nothing (because it's universal), will they work less, offsetting some (if not all) of the additional income from the UBI?

That brings me to this NBER working paper by Eva Vivalt (University of Toronto) and co-authors. The paper was originally published back in 2024, and received quite a bit of coverage then (for examples from the media, see here and here), but has been revised since (and I read the September 2025 revision). Vivalt et al. evaluate the impact of two large guaranteed income programmes in north central Texas (including Dallas) and northern Illinois (including Chicago), both of which were implemented by local non-profit organisations (with the programmes funded by OpenResearch, founded by OpenAI CEO Sam Altman). These are not quite UBIs of course, because they weren't available to everyone. Nevertheless, they do help us to understand the incentive effects that could apply to a UBI. Like many would hope a UBI would be (ignoring the immense fiscal cost), the programmes were quite generous (for those in the treatment group, at least) and:

...distributed $1,000 per month for three years to 1,000 low-income individuals randomized into the treatment group. 2,000 participants were randomly assigned to receive $50 per month as the control group.

Vivalt et al. look at the impacts on employment and other related outcomes. There is a huge amount of detail in the paper, so I'm just going to look at some of the highlights. In terms of the overall effect, they find that:

...total individual income excluding the transfers fell by about $1,800 per year relative to the control group, with these effects growing over the course of the study.

So, people receiving the UBI received less income (excluding the UBI - their income increased once you consider the UBI plus their other income). In terms of employment:

The program caused a 3.9 percentage point reduction in the extensive margin of labor supply and a 1-2 hours/week reduction in labor hours for participants. The estimates of the effects of cash on income and labor hours represent an approximately 5-6% decline relative to the control group mean.

People responded to receiving a UBI by working less, just as many of those who had concerns about the incentive effects of a UBI feared. However, the negative incentives also extended to others in the household:

Interestingly, partners and other adults in the household seem to change their labor supply by about as much as participants. For every one dollar received, total household income excluding the transfers fell by around 29 cents, and total individual income fell by around 16 cents.

So, although households received $1000 extra per month from the UBI, their income only increased by $710 on average, because the person receiving the UBI, and other adults in the household, worked less on average. What were they doing with their extra time? Vivalt et al. use American Time Use Survey data, and find that:

Treated participants primarily use the time gained through working less to increase leisure, also increasing time spent on driving or other transportation and finances, though the effects are modest in magnitude. We can reject even small changes in several other specific categories of time use that could be important for gauging the policy effects of an unearned cash transfer, such as time spent on childcare, exercising, searching for a job, or time spent on self improvement.

So, people spend more time on leisure. Do they upgrade to better jobs, which is what some people claim would happen (because the UBI would give people the freedom to spend more time searching for a better job match)? Or do they invest in more education, or start their own business? It appears not, as:

...we find no substantive changes in any dimension of quality of employment and can rule out even small improvements, rejecting improvements in the index of more than 0.022 standard deviations and increases in wages of more than 60 cents. We find that those in the treatment group have more interest in entrepreneurial activities and are willing to take more financial risks, but the coefficient on whether a participant started a business is close to 0 and not statistically significant. Using data from the National Student Clearinghouse on post-secondary education, we see no significant impacts overall but some suggestive evidence that younger individuals may pursue more education as a result of the transfers...

Some people have concluded that the results show that a guaranteed income or UBI is a bad policy. However, the guaranteed income did increase incomes (including transfers) overall and therefore makes people on average better off financially. Leisure time is an important component of our wellbeing, so we shouldn't necessarily consider more leisure time a bad outcome for a policy. In fact, Vivalt et al. also find that on average the guaranteed income increases subjective wellbeing on average (but only in the first year, after which subjective wellbeing returns to baseline). 

The results should have surprised anyone. They are consistent with a simple model of the labour-leisure tradeoff that I cover in my ECONS101 class. The model (of the worker's decision) is outlined in the diagram below. The worker's decision is constrained by the amount of discretionary time available to them. Let's call this their time endowment, E. If they spent every hour of discretionary time on leisure, they would have E hours of leisure, but zero income. That is one end point of the worker's budget constraint, on the x-axis. The x-axis measures leisure time from left to right, but that means that it also measures work time (from right to left, because each one hour less leisure means one hour more of work). The difference between E and the number of leisure hours is the number of work hours. Next, if the worker spent every hour working, they would have zero leisure, but would have an income equal to W0*E (the wage, W0, multiplied by the whole time endowment, E). That is the other end point of the worker's budget constraint, on the y-axis. The worker's budget constraint joins up those two points, and has a slope that is equal to the wage (more correctly, it is equal to -W0, and it is negative because the budget constraint is downward sloping). The slope of the budget constraint represents the opportunity cost of leisure. Every hour the worker spends on leisure, they give up the wage of W0. Now, we represent the worker's preferences over leisure and consumption by indifference curves. The worker is trying to maximise their utility, which means that they are trying to get to the highest possible indifference curve that they can, while remaining within their budget constraint. The highest indifference curve they can reach on our diagram is I0. The worker's optimum is the bundle of leisure and consumption where their highest indifference curve meets the budget constraint. This is the bundle A, which contains leisure of L0 (and work hours equal to [E-L0]), and consumption of C0.

Now, consider what happens when the worker receives a UBI. This is shown in the diagram below. At each level of leisure (and work), their income (and therefore consumption) is higher. That shifts the budget constraint up vertically by the amount of the UBI. If the worker spends no time at all working, they now have consumption of U, instead of zero, and if they spend all of their time working (and have no leisure) their consumption would be W0*E+U. The worker can now reach a higher indifference curve (I1). Their new optimal bundle of leisure and consumption is B, which contains leisure of L1 (and work hours equal to [E-L1]), and consumption of C1. Notice that the worker now consumes more leisure and more consumption as well. Because leisure has increased, that means that the number of work hours has decreased. The increase in leisure, decrease in work hours, and increase in income overall (when the UBI is included), are consistent with what Vivalt et al. found.

So, based on a simple model of the labour-leisure tradeoff, the results of this guaranteed income programme are not surprising. We should have expected a reduction in work, and a reduction in labour income, and that's what Vivalt et al. found. The question policymakers are left with is whether a large income transfer like this is worth it for government, if each $1000 transferred increases incomes by just $710 on average.

[HT: Marginal Revolution, back in 2024]

*****

[*] Of course, if other welfare payments were scrapped in favour of a universal basic income, then the net cost would be lower. Nevertheless, the point that the cost is very high still stands.

The impact of British austerity on mortality and life expectancy

In 2010, the British government adopted a contractionary fiscal policy (austerity) to try and reduce government debt, which had built up during the Global Financial Crisis. Education and social security (social welfare) bore the brunt of the reductions in government spending, but other areas of spending, such as health, were not immune to the cuts (although health spending did not reduce, the increase in spending from year to year reduced substantially). However, austerity is not a free lunch. What were some of the consequences of the reduction in spending?

That is the question that this discussion paper by Yonatan Berman and Tora Hovland (both King’s College London) takes up, focusing on the impacts on mortality and life expectancy. Berman and Hovland note that the reductions in welfare and health spending did not affect all parts of the country equally. They use the differential impacts between different local authorities (or regions, in some analyses) to evaluate the impact of the austerity measures, in a difference-in-differences research design. That essentially involves comparing areas that were more impacted by austerity to those that were less impacted, between the time before and the time after austerity was introduced in 2010. Berman and Hovland measure exposure to austerity by the reduction in welfare (or health) spending per capita at the local authority level (or region). Their data covers the period from 2002 to 2019 in annual time steps. In addition to a pooled difference-in-differences analysis (which estimates one overall impact of austerity), they also conduct an event study, which estimates the impact of austerity over time. The event study analysis is the more interesting, so that's what I will focus on. The key results for reductions in welfare spending are summarised in Figure 5 in the paper:

The y-axis on the figure shows the coefficient (how much life expectancy changes for a  £100 per capita per year reduction in spending, relative to the pre-austerity baseline). The red vertical line shows the point in time where austerity began (in mid-2010). Notice that there is a clear reduction in life expectancy for both males and females, starting from about 2013, and increasing over time. Berman and Hovland note that:

...after the onset of austerity measures, we observe a clear reduction in life expectancy, with a more pronounced effect among females. The results indicate that every £100 per capita per year of lost benefits led to a decrease in life expectancy of approximately 0.5–2.5 months.

The results are qualitatively similar for health spending, as shown in Figure 6 of the paper:

Again, the negative impact on life expectancy is noticeable from 2013, and increases over time. Also, notice that the effect from health spending is much larger in magnitude for each £100 per capita per year reduction in spending. This is not surprising, given that health spending has a more direct impact on health, mortality, and longevity. However, the overall impact of austerity also depends on the amount of spending that was cut, which was much larger for welfare than for health. 

Now, it would have been good for Berman and Hovland to explore a little further why the impact of austerity on life expectancy was delayed by two or three years. The delay might raise concerns about whether there were other things that changed between 2010 and 2013 that affected mortality and life expectancy differentially by exposure to austerity. Having said that, we might expect cuts to spending to take some time to filter through into worse health outcomes, and that is also consistent with the increasing magnitude of the impact over time shown in Figures 5 and 6.

Combining the two effects (of welfare spending and health spending), and conducting some back-of-the-envelope calculations, Berman and Hovland find that:

Between 2010 and 2019, austerity measures caused a three-year setback in life expectancy progress, equivalent to about 190,000 excess deaths, or 3 percent of all deaths.

The costs of austerity were quite substantial! However, were there offsetting benefits? Berman and Hovland conduct a Marginal Value of Public Funds (MVPF) analysis, which essentially weighs up the costs and benefits of austerity (in this context, it is basically a cost-benefit analysis for austerity). In this analysis, they find that (when combining both welfare and health effects), the total costs (in terms of the value of life years lost) was £89.6 billion, while the savings on government spending were £38.75 billion. So, every pound of government spending saved had a cost to society of £2.31. On a cost-benefit basis, austerity was not a good deal for society. Moreover, the distributional impacts were important, because:

...poorer local authorities saw smaller increases in life expectancy between 2010 and 2019, or even decreases, compared to richer local authorities (defined by average pay in 2010). These results indicate that austerity measures were not only regressive in their impact on post-tax and transfer income, but they also led to more unequal health outcomes.

If governments are looking to implement policy, ideally those policies shouldn't make society worse off. That should go without saying. Based on this paper, British austerity appears to have made British people significantly worse off, trading lower government spending for higher mortality and lower life expectancy. Berman and Hovland stop short of saying that this was bad policy, instead concluding that:

Paradoxically, this fiscal strategy appears to have contributed to an increase in mortality, potentially offsetting its financial gains. However, it is possible that without austerity, the economic recession in the early 2010s might have been more severe.

It may be the case that the recession would have been worse without austerity, but that is not a certainty. However, given the choice up front, would people living in Britain have preferred a longer recession with fewer deaths, or a shorter recession with more deaths? If austerity really did reduce the length of the recession, the implied tradeoff here is quite stark, and Berman and Hovland's analysis suggests that a longer recession may have been the preferable option.

[HT: Les Oxley]

Governments need to be careful to avoid tax traps with high effective marginal tax rates

In yesterday's post, I referred to New Zealand's tax and transfer system, and its impact on inequality. One aspect I didn't refer to was the incentive effects of the system. These incentive effects are bound up in the effective marginal tax rate (EMTR), which is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements. A high EMTR creates a disincentive to earn more.

This is beautifully illustrated by this Financial Times article from March this year (paywalled):

How could a £1 pay rise leave you tens of thousands of pounds worse off? The answer is the childcare cliff edge in the UK tax system, which will get considerably steeper for higher-earning families from September.

The government’s expansion of free childcare provision in England this autumn means that working families with children aged under three will be able to claim 30 hours of government-funded childcare a week on top of the tax-free childcare scheme. Valuable benefits, but the bulk of this entitlement is lost if one parent’s adjusted net income is more than £100,000 per year.

In other words, earning more than £100,000 per year leads to a high EMTR. This is shown in the following figure from the article:

Notice how income after childcare expenses decreases markedly at £100,000 per year, and doesn't get back to the same level until income rises to nearly £150,000 per year. This creates a lot of negative incentives. The article gives several examples, one of which is:

Rob* works in tech. Since his daughter was born five years ago, he has turned down two promotions that would have taken his pay over £100,000 as he could not negotiate a high enough pay rise to compensate for the loss of childcare hours. Eventually, he quit his job and became a contractor. “This is riskier, but my earnings have jumped to the point where it is worth it,” he says. “My wife and I have decided to have no more children to maintain the quality of life we have with the one.”

The high EMTR causes people to avoid being promoted or take pay rises, to work less, change jobs, make riskier decisions, and avoid having more children. And all of that from a single example of one taxpayer.

The dumb thing is that this is not a new problem. The article notes that this threshold has been in place since 2017! That's more than long enough for the government to notice the negative incentive effects. The reason it has come to media attention now is that the threshold hasn't been changed in some time, and more and more families are being affected.

Governments need to be very cautious in setting up the tax and transfer system. While the system does generally reduce inequality, as yesterday's post showed for New Zealand, it can nevertheless create unintended consequences. Governments typically want people to work more and receive less assistance from the government. However, high EMTRs can create traps that keep people working less. The UK's childcare tax trap is unfortunately not unique in this.

Read more:

• Welfare programmes, effective marginal tax rates, and the US marriage penalty

The impact of taxes and transfers on inequality in New Zealand

This week, my ECONS102 class covered inequality, and social security. Which is timely, because I have been meaning to blog about this Treasury Analytical Note from 2024, by Tod Wright and Hien Nguyen, for some time. Wright and Nguyen look at the distributional impact of taxes, transfers, and government spending (on healthcare and education).

Importantly, they distinguish between three conceptions of household income: (1) market income, which includes taxable income (including wages, income from self-employment and from investments) and non-taxable income (such as gifts and inheritances) [*]; (2) disposable income, which adjusts market income by subtracting direct taxes (such as income tax) and adding in transfers from government (such as income support payments); and (3) final income, which adjusts disposable income by subtracting indirect taxes (such as GST and excise taxes), and adding estimates of the government spending on health and education services that the household receives in kind. Looking at the difference in the income distribution (and measures on inequality) between market income, disposable income, and final income, gives a sense of how redistributive the tax and transfer system is.

I'm not going to get deep into the weeds on the methods. However, it is worth noting that the analysis is for the 2018/19 tax year, and makes use of Treasury's TAWA (Tax and Welfare Analysis) model, supplemented by data on indirect taxes paid by households from the Household Expenditure Survey (HES) The TAWA model is constructed from administrative data from Stats NZ's Integrated Data Infrastructure. For health and education spending:

We estimate education spending received by children and students based on their reported enrolment in educational institutions in HES. Health spending amounts are distributed over all individuals in HES in proportions determined by the Ministry of Health’s (MoH) Person-Based Funding Formula (PBFF) model... which assigns expected healthcare costs to a person based on their demographic characteristics.

The resulting income distributions are summarised in Figure 2 in the note, which shows the average income (under each of the three conceptions of income) for each income decile:

Notice that, for households in the bottom deciles, market income is low, disposable income is higher, and final income is highest. This reflects that they receive net transfers from the government (they receive more in transfers than they pay in direct taxes), so that disposable income is higher than market income. They also receive more in in-kind government spending (on health and education) than they pay in indirect taxes, so that final income is higher than disposable income. For high-income households, the pattern for market vs. disposable income is reversed (they pay more in direct taxes than they receive in transfers). However, only for the very top decile (the highest income households) does the payment of indirect taxes exceed the benefits received from in-kind transfers, so that final income is less than disposable income.

Overall, the distributions in Figure 2 show that taxes and transfers reduce inequality - there is less inequality in disposable income than market income, and less inequality in final income than disposable income. The effects of the different components of the tax and transfer system in reducing inequality is demonstrated in Figure 9 in the paper:

The coloured parts of the columns show the components that add to income (transfers, or income support, in orange; and in-kind benefits, in blue) and subtract from income (direct taxes, in grey; and indirect taxes, in yellow). The black point estimates in the centre of each column show the combined effect on income within that income decile. Income support declines by income decile, as you would expect, while in-kind benefits are fairly consistent. Direct and indirect taxes both grow with income. Overall, the bottom five quintiles (making up half of all households) receive more in transfers and in-kind benefits than they pay in taxes, while the top four quintiles (and especially the top quintile) pay more in taxes than they receive in transfers and in-kind benefits.

Finally, Wright and Nugyen show the effect on inequality, measured by the Gini Index, where:

...including income support benefits in the calculation results in the lowering of the Gini coefficient from its value of 45.6 ± 1.5 for market incomes to 35.8 ± 1.6 for gross incomes. The inclusion of direct taxes to form disposable incomes further reduces the Gini coefficient to 33.1 ± 1.5. The equalising effects of these contributions are partially offset by the inclusion of indirect taxes, which lead to a post-tax income Gini coefficient of 34.9 ± 1.6 – ie, whereas direct taxes reduce income inequality as quantified by the Gini coefficient, indirect taxes increase it. However, the inclusion of in-kind benefits in the final household income calculation has a significant redistributive impact, resulting in a drop in the Gini coefficient to 28.1 ± 1.4.

As you would expect given the data from the figures, the tax and transfer system substantially reduces measured inequality. That is exactly what it is expected to do, in a country with progressive income tax, a social safety net, and universal access to healthcare and education. There is far more detail in the analytical note, so if you are interested in how taxes and transfers affect the income distribution (or how they affect the distribution for retired and non-retired households separately), I encourage you to dig into it further.

[HT: Inside Government, and Offsetting Behaviour, both last year]

*****

[*] One major caveat for this analysis is that the non-taxable income excludes capital gains. It also includes imputed rent on owner-occupied dwellings, which should be included to better capture the distributional effects of home ownership.

More on social security and work disincentives

Duncan Garner had an interesting article in the National Business Review yesterday (gated), on work disincentives associated with social welfare (or social security). And interesting timing, given that I had just written about this a few days ago (see here). Garner wrote:

Until recently, Eric was on the DBP with three kids and was paid $850 a week by Work and Income. They lived in a state house and paid $125 a week because it’s income-related rent. 

Life wasn’t easy but they could get by and Eric could drop off and pick up his kids before and after school and he was in control. Sure, the struggle was real but the state was there for him. 

But he hated the example it set his kids and wanted to show them he went to work each day and paid his way...

So Eric picked up a 40-hour truck driving job and was slowly removed from the welfare system. 

He was paid just over $30 an hour for the truckie job, which is well above the minimum wage and the new job took him all over Auckland. But then his state house rent went up by close on $200 because his income had gone up too. 

Then came the killer blow. How was he to pay for the kids after-school care? In reality he’d never paid a cent for care before because it was always his job, as a solo dad on the DPB. 

But now it could add another $200 to his weekly outgoings and, once you add the extra housing costs, it soon showed he was worse off working, by about $200 week.  

He was better off signing back on to the DPB. He hasn’t done that and wants to make paid employment work.

This again illustrates the problem of high effective marginal tax rates. The effective marginal tax rate (EMTR) is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements. In this case, Eric earns more as a truck driver, but then gives up more in lost welfare and entitlements (including the new obligation to pay after-school care) than what he would gain in higher income. On a purely monetary basis, he is worse off.

Interestingly, Eric notes that there are substantial non-monetary benefits from working, and those offset the net monetary loss. Not everyone would feel that way, and that's why high effective marginal tax rates provide such a disincentive for working. I don't necessarily agree with all of the broader points that Garner makes in his article, but on this we do agree:

We need to redesign welfare so these perverse outcomes don’t take hold.

Read more:

• Welfare programmes, effective marginal tax rates, and the US marriage penalty
• Work disincentives, and the income and substitution effects in social security 

Work disincentives, and the income and substitution effects in social security

In yesterday's post, I discussed effective marginal tax rates and the marriage penalty in the US social security system. The social security system can create incentives (and disincentives) for activities unrelated to working and income (in that case, marriage). However, most of the time when we talk about incentive effects in social security, we are talking about decreased work incentives.

I was reminded (by a note I left myself) that Abhijit Banerjee and Esther Duflo discussed these effects in their book Good Economics for Hard Times (which I reviewed here). In particular, Banerjee and Duflo note that there are both income effects and substitution effects associated with the social security system. Specifically:

...for people near the point between being takers from and payers into the system, there is potentially a strong disincentive to work. In other words, in addition to the income effect (I do not need to work if I have enough money to survive on already) that most policy makers worry about, such schemes can have a substitution effect (working is less valuable since what I make in extra income is taken out as reduced welfare payments).

The latter point relates to the effective marginal tax rate (the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements). To see how these disincentives work, consider the diagram below. The income curve shows the distribution of income without any transfers. The poverty line (representing the minimum level of income necessary in order to lead a comfortable life) is M*. Now consider a perfectly targeted transfer, that would raise the income of any person whose initial income is below M*, exactly up to M*. People with initial income of M* or higher receive no transfer at all.

With this perfectly targeted transfer, poverty would be eliminated. However, what we are interested in is the incentive effects. Consider a person with income of M0. They initially have zero income (probably they are not working at all), and their income is raised to M*. They do very well from the transfer. Now consider a person with income of M1. Their transfer is less, and their income is raised to M*. However, they were working (perhaps part-time) and earning M1. Comparing themselves to the person with income of M0, the person with income of M1 might realise they don't need to work so hard and can still end up with an income of M* after the transfer. This provides a disincentive to work. This is the income effect described by Banerjee and Duflo. The person with an income of M1 couldn't be incentivised to work a bit more either. Every dollar of income above M1 is eliminated by a reduction in the perfectly targeted transfer (the effective marginal tax rate is equal to 100 percent). This is the substitution effect that Banerjee and Duflo described. Now consider a person with income of M2. They are earning more than M*, but they might also look favourably at the person with income of M0, and decide to leave work. The disincentive effects don't just apply to those below the poverty line, who are initially eligible for the transfer.

Finally, Banerjee and Duflo probably understated how wide the disincentive effects are. They note that they apply "for people near the point between being takers from and payers into the system" (which is people near the income of M*). However, I think they probably apply to everyone with income below M*, as well as some people with income higher than M*.

I noted in yesterday's post that the custodians of the social security system need to understand the unintended consequences that the social security system creates. They also need to understand how the system affects work incentives.

Read more:

• Welfare programmes, effective marginal tax rates, and the US marriage penalty

Welfare programmes, effective marginal tax rates, and the US marriage penalty

This week, my ECONS102 class covered the economics of social security. In countries like New Zealand and the US, the tax and transfer system (of which social security is one part) leads to a complicated relationship between income before taxes and transfers, and income after taxes and transfers are accounted for. The effective marginal tax rate (EMTR) is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements. Because of the variety of government programmes, benefits, and entitlements, it is not trivial to try to work out the effective marginal tax rate, and it varies widely based on circumstances. However, we should recognise that any time the EMTR exceeds 100 percent (or even when it is much lower than that), there will be significant incentive effects.

One example comes from this post by Ed Dolan on the Institute for Family Studies blog from earlier this year. Dolan notes the existence of a significant marriage penalty in the US:

What would happen if the two adults represented in Figure 1 moved in together to form a single cohabiting household with two adults and two children? What would happen if the cohabiting adults then married? 

Figure 2 shows the answer. It assumes that the two adults live in the home previously occupied by the parent with children, pool their incomes, and share all expenses. This time, the vertical lines are based on an FPL [Federal Poverty Line] of $27,750 for a four-person household. For convenience, the figure assumes that each of the two adults has approximately the same earnings...

The relation of net household resources to employment income differs dramatically for the two household configurations. Beginning from zero, the married couple at first does better. Total household resources are higher over most of the range up to the FPL. The married couple’s work incentives are also stronger. Over the range from zero to 100% of the FPL, net household resources rise by $1.28 cents for each dollar earned compared with $1.13 for the cohabiting couple. These advantages come partly from the fact that the EMTR and CTC phase in faster for the married couple, and partly because SNAP and health benefits do not phase out as quickly.

Beyond the FPL, however, the situation is reversed. Between earnings of $28,000 and $56,000, the red curve flattens dramatically as the married couple’s EMTR rises to a confiscatory 88%, compared to just 30% for the cohabiting couple. That is because SNAP, the EITC, and health benefits phase out simultaneously over this income range for the married couple. For the cohabiting couple, the phase-outs are spread over a much wider income range and overlap less. Due to the higher EMTR, net household resources for the married couple drop below those for the cohabiting pair soon after reaching the FPL. 

After earnings rise past twice the FPL, the difference in EMTRs essentially disappears, but the household resource gap never closes. Even when earnings reach $80,000 per year, the married couple is still worse off by more than $10,000.

The Figure 2 that Dolan refers to is shown below. The vertical axis shows net household resources (after taxes and transfers are accounted for), and the horizontal axis shows employment income. The dotted 45-degree line represents points where net household resources are equal to employment income (any transfers received from the government exactly offset taxes). When the solid lines are above the 45-degree line, the household receives more in transfers than they pay in taxes, and when the solid lines are below the 45-degree line, the household pays more in taxes than they receive in transfers. The EMTR is demonstrated by the slope of the lines (a higher EMTR is represented by a flatter slope). The marriage penalty is demonstrated by the fact that the red solid line is below the blue solid line beyond employment income of about US$30,000. This is mostly caused by the high EMTR for married couples from employment income of US$30,000 to US$55,000 (after that the slopes of the two lines are roughly the same).

It is clear from the figure that there is a substantial marriage penalty in the US, arising from how the broader system of taxes and transfers works. Dolan concludes that:

In short, although the welfare system gives a small marriage bonus to couples who are in deep poverty, it imposes a large marriage penalty on households that are just past the official poverty line but still striving to reach full self-sufficiency.

Fortunately, in New Zealand I don't think there is such a marriage penalty. Married and cohabitating parents are treated similarly, in terms of their entitlements. However, there has in the past been a penalty associated with cohabitating. For example, this 2019 report by Olivia Healey and Jennifer Curtin (both University of Auckland) notes that:

The weekly Supported Living Payment for those who are single with children is $379.19; compared to $237.09 each for those who are married, in a civil union or in a de facto relationship. Therefore, those who are partnered may be better off financially if they separated given two singles would receive a combined amount of $758.38 compared to $474.18 as a couple. The financial penalty on couples is a difference of $282.20 a week.

All countries with more than the simplest of all social security systems are likely to have a myriad of similar problems, which seem to raise issues of fairness and equity. The custodians of the social security system need to better identify the circumstances in which they will occur, consider what unintended consequences may arise, and then address those in a sensible way (which may include changing the rules to avoid these situations arising in the first place). Unless the goal really is to penalise married couples.

The economics of the government's plan for 'social unemployment insurance'

One of the big (and surprising) announcements in the Budget earlier this year was that the government was developing a 'social unemployment insurance' scheme. This would presumably sit alongside the current unemployment benefit system, but would work in a similar way to accident compensation, paying each person who is made unemployed (and meeting certain conditions) 80 percent of their prior wage up to a certain cap.

This would represent a significant shift in the style of social security system that New Zealand operates. In my ECONS102 class, we distinguish three types (or models) of social security system:

1. A social assistance model - where there is an emphasis on self-reliance and responsibility, and the government provides support (often means tested) where a person would otherwise face hardship;
2. A social insurance model - where social assistance is available and based on previous contributions to a fund (which might be an individual account, or a general account for all insured people); and
3. A social citizenship model - where all citizens have a right to assistance for any contingencies they face (and the assistance is often not means tested).

In reality, most social security systems have features in common with all three types, but New Zealand's system up until now has mostly been a social assistance model, with the exception of accident compensation, which is clearly a social insurance scheme. This proposed introduction of social unemployment insurance would move unemployment assistance into the social insurance model (it would be interesting to see what the government would do with sickness and invalids benefits, or whether they would remain under the old system, along with sole parents and student allowances).

Anyway, there was a great article in The Conversation today by Simon Chapple and Michael Fletcher (both Victoria University of Waikato) that outlines some of the economic issues with a social insurance scheme:

However, there are two problems with the private insurance market, meaning they under-provide relative to people’s real need.

The first problem is called “adverse selection”, meaning people choosing to buy insurance have better information about the risks facing them than insurance businesses do, and no good reason to disclose that information.

To protect themselves from this, insurance companies set premiums higher. In turn, due to the costs, this leads to people being under-insured. Ultimately, society’s best interests aren’t met.

There’s also the problem of “moral hazard” – if a person has insurance they may take on more risk, without the insurer knowing exactly which customers are adopting riskier behaviour.

Again, insurance companies set higher premiums and people are generally under-insured. And again, this isn’t in society’s best interests...

These market failures mean there is potential for well-designed government interventions to meet the social interest. In particular, making everyone join a social insurance scheme would fix the adverse selection problem.

But a compulsory social insurance system also expands the scope for moral hazard. People might change their behaviour to increase their eligibility for an insurance payout. They might take on jobs with higher redundancy risks, or be less motivated to look for work, because the consequences are now less severe.

The problems of information asymmetry (including adverse selection and moral hazard) is among my favourite topics to teach in my ECONS102 class. Chapple and Fletcher are right that the unemployment social insurance scheme would not have an adverse selection problem (provided it is compulsory, in the same way that accident compensation currently is), and the key problems would be moral hazard.

To expand on the moral hazard problems a little bit, workers would be less fearful of losing their jobs, because they would receive a higher unemployment payment than previously. So, at the margin, workers would not work as hard, and productivity might decrease. Similarly, absenteeism might increase, which also reduces productivity. 

On the other hand, wages might increase. To see why, consider a search model of the labour market. This model recognises that each matching of a worker and a job creates a surplus that is shared between the worker and the employer, based on their relative bargaining power. A higher unemployment payment increases the worker's bargaining power, since they can afford to hold out for a better deal. Employers will have to offer slightly higher wages than before, in order to attract workers to leave the unemployment payment and accept the job offer. So, wages will increase, and employers will find that vacancies take a little longer to fill.

Workers may also benefit from better job matches. Since they can afford to stay on the higher unemployment insurance payment for longer, they can afford to wait and find a job they really want, rather than accept the first half-decent offer they receive. The number of unemployed will likely increase, and the average length of unemployment spells will also increase.

Clearly, there is a lot for the government to balance here. Chapple and Fletcher also note that:

If it turns out there are gaps in the current system, advocates of social insurance must also consider:

• such a scheme may simply be substituting for one or several of the existing solutions, which would then reduce if the scheme were introduced

• reforming and improving what already exists may be preferable in terms of cost, effectiveness and equity than introducing an entirely new system

• there may be implications for both equity and erosion of the core welfare system of creating a separate, higher tier of assistance for some.

At this stage, all we have had from the government is an announcement, and a promise of "public consultation later in 2021". Presumably that consultation has been delayed until next year, due to the pandemic. It will be interesting to see what comes out of this.

No, economic growth won't save us from the increasing fiscal costs of population ageing

Last week I wrote a post about ageing and creating tax incentives for older people to work longer. The impetus for the tax incentives is the projected increase in the older population, and reductions in support ratios (the number of working people for each older person). However, the issue may not be as bad as assumed by most people (including me).

This new article by Ian McDonald (University of Melbourne), published in the journal Australian Economic Review (sorry I don't see an ungated version online) tells a different story. McDonald first outlines the problem:

The likely prospect of an ageing population, that is, an increase in the share of old people in the population, will put upward pressure on the level of government expenditure in the future. High government expenditures per old person multiplied by the increase in the proportion of old people in the population will drive an increase in government expenditure. This is a major fiscal challenge which we are starting to experience.

He then goes on to summarise projections of government spending, based on assumptions about population growth, and an assumption of unchanged government policy (which is a standard assumption - we can't easily forecast what future government policy may be). He finds that various projections (by McDonald himself, and others):

...suggest that an increase in government spending due to the ageing population somewhere in the range of 4.9–7.8 percentage points of GDP over the 40‐year period seems to be a reasonable projection assuming unchanged government policy.

So, essentially the government would need to either increase spending by 4.9-7.8 percentage points of GDP. McDonald seems to suggest this is not a big deal, but given that government spending in Australia is around 40 percent of GDP, that would entail a 12-20% increase in government spending. That means taxes would need to be 12-20% higher than currently, or government services (or service quality) would need to be cut to compensate for the extra spending.

McDonald's argument that the costs are not prohibitive rests on this:

The prospect of an increasing proportion of old people raises the spectre that our continuing support will be impossible. However, this fear ignores the fact that because of the continuing growth of labour productivity, we who will finance this support will be better off than we are today and will indeed be well able to support older people.

Specifically, he finds that the increase in government spending required for the ageing population is dwarfed by the increase in GDP itself. I don't find this argument entirely persuasive, because if taxpayers were happy to give up some proportion of their income growth in higher taxes, the government could do that right now. In fact, governments tend to be moving in the opposite direction, decreasing taxes even though income per capita is increasing. That suggests that there is already an unwillingness, either by taxpayers or by government, to increase taxes to offset increased costs due to ageing.

I don't think you can just wave your hands, cite 'economic growth', and 'poof!' - all problems relating to the increasing costs of an ageing population disappear. And that appears to be what McDonald is doing. Which is disappointing - I usually like the 'For the Student' section of the Australian Economic Review, but this is one article that falls short of the mark.

Tax incentives can encourage older people to delay retirement and work longer

Developed countries are facing a problem. Increasing life expectancy, coupled with low fertility, is leading to a rapidly ageing population. Countries that have publicly funded old age pensions are likely going to face challenges to their continuing affordability, because there will be fewer working age taxpayers for each pension recipient (what economists refer to as a lower 'support ratio'). The options available to policy makers include increasing the age of eligibility for pensions (as several countries have done in recent years), decreasing the real value of pensions (such as by not adjusting them for inflation), or shifting from universal pensions to means-tested pensions (where older people with high income or wealth would not be eligible to receive the pension).

All of these changes are politically tricky to implement, because as the population ages, older people (and those soon to become eligible for the pension) become an even larger share of the voting population. Also, reducing the real value of pensions (or delaying eligibility for them) may lead to increases in poverty among older people. Another alternative that may reduce these poverty concerns, is to encourage older people to delay retirement, working until they are older and, depending on the pension rules, potentially delaying their receipt of pension benefits (even when the age of eligibility has not changed). One way to encourage people to work more is to allow them to keep more of their labour earnings, such as by lowering the tax rate on labour income.

A reasonable question, then, is how much difference can a tax change make to the labour market behaviour of older people? This 2017 article by Lisa Laun (Institute for Evaluation of Labour Market and Education Policy, Sweden), published in the Journal of Public Economics (open access) provides some indication. Laun uses linked Swedish data from the "Income and Tax Register (IoT), the Longitudinal Database on Education, Income and Employment (LOUISE) and the Employment Register", which allows her to track nearly 190,000 people who turned 65 years old within three months either side of the year end, between 2001 and 2010. Importantly, there were two changes in the tax regime that occurred at the start of 2007, as Laun explains:

The first labor tax credit studied in this paper is an earned income tax credit that reduced the personal income tax on labor income only. It was introduced on 1 January 2007 for workers of all ages, with the purpose of increasing the returns from working relative to collecting public transfers. Motivated by the particular importance of encouraging older workers to remain in the labor force, the tax credit is substantially larger for workers aged 65 or above at the beginning of the tax year...

The second labor tax credit studied in this paper is a payroll tax credit for workers aged 65 or above at the beginning of the tax year. Like the earned income tax credit, it was introduced on 1 January 2007... The payroll tax rate for workers above age 65... was reduced from 26.37% in 2006 to 10.21% in 2007. Since then, it only includes pension contributions. The payroll tax credit thus reduced the payroll tax rate for older workers by 16.16 percentage points.

Laun evaluates the effect of the combination of these two tax rate changes on the labour market participation of older people. Specifically, she looks at the impact on the 'extensive margin' -whether older people work or not (as opposed to the 'intensive margin' - how many hours they work, if they are working). She essentially compares workers who are aged similarly, but on either side of the January date on which their tax rate changes. She finds that there is:

...a participation elasticity with respect to the net-of-participation-tax rate of about 0.22 for individuals who were working four years earlier.

In other words, a one percentage point decrease in the tax rate increases labour force participation by 0.22 percentage points. Given that the employment rate just before age 65 appears to be about 63 percent, and the tax rates dropped by around 20 percentage points, the effect of the Swedish tax change amounts to about 4.4 percentage points of additional labour force participation, or an increase of about 7 percent. The results are robust to various other specifications, and are similar to results from other countries in other contexts not related to retirement. Laun also shows that the retirement hazard (essentially similar to the probability of retirement) decreases by a statistically significant amount as a result of the tax change.

However, pension receipt does not change - people are just as likely to receive the pension after the tax change as before. Interestingly, in Sweden pension receipt is voluntary (but universal and not tied to  whether or not an older person is working or to their earnings, similar to the case in New Zealand), and delaying the pension allows a higher amount to be claimed later (a feature of pension systems that many countries have, but New Zealand does not). So, if working longer led to a delay in eligibility for pensions, you can bet that the effect of the tax change would be much smaller (and potentially zero).

The take-away from this paper is that incentives do matter. It is possible to incentivise older people to work longer, even when they remain eligible for the old age pension. However, this sort of change isn't going to make pensions any more affordable unless the value of pensions in real terms is reduced as well. If people are working more, then the pension could potentially be less generous without substantially increasing poverty among older people. However, that doesn't make any changes in this space any easier to introduce politically.

Wading through sludge

In Saturday's book review post for Sendhil Mullainathan and Eldar Shafir's book Scarcity, I noted that the book fell a little bit short in terms of the linkages with behavioural economics. That was further highlighted to me when reading this new article by Cass Sunstein (co-author with Richard Thaler of the book Nudge), published in the journal Behavioural Public Policy. Sunstein highlights the role of 'sludge', which he defines as:

...‘a viscous mixture’, in the form of excessive or unjustified frictions that make it difficult for consumers, employees, employers, students, patients, clients, small businesses and many others to get what they want or to do as they wish...

When a student seeking financial aid has to fill out an elaborate application form with dozens of difficult questions, that is sludge. When a firm requires a consumer to call to cancel a subscription, and keeps them waiting on hold for a long time before they can deal with a customer service representative, that is sludge. When a potential immigrant has to jump through multiple hurdles, filling out endless paperwork and providing copious amounts of information, a lot of that is sludge. Dealing with sludge is frustrating, disheartening, and demotivating. It can easily lead the student to give up on applying for financial aid, the consumer to give up on cancelling their subscription, or the potential immigrant giving up on their dreams of immigration.

Sometimes the creation of sludge is inadvertent, but often it is intentional. You can imagine that the example of the difficulties in cancelling a subscription may well involve an intentional action on the part of the firm. At the very least, they won't be looking to make it easier to cancel a subscription.

Reducing sludge should be an important goal. As Sunstein notes:

Simplification and burden reduction do not merely reduce frustration; they can change people’s lives... An underlying reason for this is that our cognitive resources are limited...

It is at this point that the link to scarcity is apparent. Sunstein, to his credit, does reference Mullainathan and Shafir on this point. When people are dealing with limited cognitive resources - when they are facing extreme scarcity - burdening them with sludge is simply going to exacerbate their problems. Think about all the times where we burden the poor with excessive paperwork or require costly or time-consuming in-person appointments with case managers at Work and Income or StudyLink - applying for welfare benefits, food grants, student loans, etc. Is all of this necessary, or is the government simply putting obstacles in the way and preventing the people who need assistance from obtaining the assistance that they need? Sunstein argues for what he terms 'sludge audits'. It's an idea worth thinking about.

Sunstein's article makes some important points, and should be required reading for public policy students and for those working in the government sector.

[HT: Marginal Revolution, last year]

More progressive taxation may increase economic welfare in New Zealand

This week in my ECONS102 class, we've been covering poverty and inequality, as well as redistribution and the economics of social security. It's a lot to cover, but one of the key points is that economics can't directly answer the question of how much redistribution (from rich to poor) is the right amount of redistribution, because that depends on the normative preferences of society (or the normative preferences of the government of the day, if you prefer).

So, I was interested to read this article in The Conversation last month, by Nicolaus Herault (University of Melbourne), John Creedy, and Norman Gemmell (both Victoria University of Wellington). The article discusses how tax rates can be used to increase total welfare in New Zealand:

If we asked people in New Zealand what they think the best income tax reform would be, we would expect a range of responses. People will no doubt have different views about which of the four income tax rates and corresponding income thresholds should be lowered or increased.

In our new study, we examine how tax rates should be changed to improve social welfare in New Zealand.

At 33%, the current highest marginal income tax rate in New Zealand is relatively low compared to other major advanced economies. For instance, it’s 45% in both the UK and Australia.

We find that, under a range of assumptions, lifting the highest income tax rate and using the proceeds to lower one of the two lowest tax rates achieves the greatest improvement to welfare.

The underlying research is available here, published in the journal International Tax and Public Finance (sorry, I don't see an ungated version online). Herault et al. used microsimulation, which involves taking a population at some point in time, making some changes (in this case, changes to the tax system), and simulating how the population would respond (in this case, in terms of their welfare). Microsimulation is a very cool method for investigating how the population will respond, especially if you can account for the fact that not everyone will respond in the same way (one of my PhD students is using microsimulation to look at small-area ethnic population projections for Auckland city).

Herault measure 'social welfare' as a combination of household income and leisure time (I prefer to avoid using the term 'social welfare', since it can easily be confused with social security by the uninitiated, and prefer 'economic welfare' instead). In the sort of model that Herault et al. run, if tax rates go up, people will earn less disposable income, but will work less and therefore have more leisure time. And the reverse occurs if tax rates go down. So, it is ambiguous whether their measure of welfare goes up or down when taxes change. They find that:

...the tax reform that would increase social welfare the most consists of a reduction in one of the two lowest tax rates, funded by an increase in the highest tax rate. Such a reform would lead to more rate progression in the tax system, come at no revenue loss to the government, and increase social welfare. This conclusion applies whether one gives a high or low priority to reduction in inequality.

Many people would argue that we need a tax system that is more progressive, in order to reduce income inequality. If these results are to be believed, then it seems that having a more progressive income tax system would increase economic welfare as well.

Ontario follows Finland's lead in dropping its universal basic income pilot

Back in May, I wrote a post about Finland cancelling its universal basic income experiment. However, I totally missed the news earlier this month that Ontario was also cancelling its basic income pilot (a point that was raised in one of the presentations in the basic income session at the European Regional Science Association congress, where I am this week). As reported in Business Insider:

Anger and outrage, shock and betrayal: Those were some of the raw emotions after one of the world's largest basic-income experiments was suddenly canceled.

Earlier this week, Doug Ford, the conservative new premier of Ontario, Canada, pulled the rug out from under the experiment, which provided 4,000 people living at or near the poverty line with a stipend.

Ford's government hasn't publicly said much about its reasoning for canceling the program, other than claiming it disincentivizes recipients from finding work...

It lasted only one year, despite Ford's campaign promise to keep the pilot project funded...

"When you're encouraging people to accept money without strings attached, it really doesn't send the message that I think our ministry and our government wants to send," Lisa Macleod, Ontario's minister of children, community, and social services, told reporters this week. "We want to get people back on track and be productive members of society where that's possible." 

This is very similar to the argument behind the cancelling of Finland's basic income experiment, as I noted back in May. Why does a basic income create a disincentive for low-income work? Consider the model of the worker's decision in the diagram below. The worker has limited time (E) that they can allocate to work (and earn income, for consumption, measured on the y-axis) and leisure (measured on the x-axis). The straight line constraint represents the trade-off between consumption and leisure, and has a slope equal to the wage (actually, -w, because it is downward sloping). The highest possible indifference curve the worker can get to is I0, and the optimal bundle of consumption and leisure is E0 (which includes C0 consumption, and L0 leisure (and E-L0 work)).

What happens when you introduce a universal basic income? Since the worker doesn't need to spend time working in order to claim the universal basic income, this simply shifts the constraint upwards by the amount of the basic income (U). The worker can now reach a higher indifference curve (I1), and their optimal bundle of consumption and leisure is now E1, which includes both more consumption (C1) and more leisure (L1). More leisure means less time spent working (because (E-L1) is smaller than (E-L0)). The introduction of the universal basic income decreases work incentives. This might manifest at the extensive margin (some people who were previously working for a low wage decide to stop working entirely), or at the intensive margin (some people choose to work a little bit less).

Would a basic income increase work incentives? It seems unlikely, unless leisure has suddenly become an inferior good (a good that people prefer to consume less of when their income increases).

Could a basic income remove barriers to work? Perhaps if there are credit constraints to obtaining work, as the Business Insider article notes:

"It is kind of hard to find a job when you are struggling for food and you don't have money to keep your phone active and it goes down out of service," she said. "You can't afford to buy job clothing. You can't even do laundry to wash job-interview clothing."

On a basic income, Baltzer could eat healthier, buy clothes, go to the gym, do laundry, and afford phone and internet service to communicate with potential employers, she said.

However, credit constraints are unlikely to be binding for all non-workers, and it is entirely consistent for a basic income to both remove barriers to work for some people and reduce work incentives for other people. The proponents and critics of basic income are simply talking past each other.

A universal basic income remains a promising idea that is very difficult to implement politically. Ultimately, it is only realistic if taxpayers (and politicians) can make peace with the work disincentives that it will generate.

Finland is ending its universal basic income experiment

I've been meaning to write about universal basic incomes for a while, particularly since it is something that we discuss in my ECONS102 class each year (and something I cover in regular courses for officials from the Vietnamese Social Security Administration). There are several current experiments in universal basic income (including GiveDirectly's experiment in Kenya, some pilot programmes in India, and several others). However, one of the headline experiments in Finland may be coming to a close, as the New York Times reported last month:

For more than a year, Finland has been testing the proposition that the best way to lift economic fortunes may be the simplest: Hand out money without rules or restrictions on how people use it.

The experiment with so-called universal basic income has captured global attention as a potentially promising way to restore economic security at a time of worry about inequality and automation.

Now, the experiment is ending. The Finnish government has opted not to continue financing it past this year, a reflection of public discomfort with the idea of dispensing government largess free of requirements that its recipients seek work.

The biggest argument that people make against a universal basic income (UBI) is cost. For instance, paying every adult in New Zealand a weekly income of $200 (note: that's not exactly a generous basic income at all!) would cost around $36 billion per year, which is about 7% of GDP and would more than double government transfers (currently total social security and welfare payments are about $30 billion).

However, an under-appreciated argument against a UBI is how taxpayers (who would foot the bill for the UBI) would feel about it. And it appears that disquiet among taxpayers (and importantly, voters) is at the heart of the reconsideration of the Finland experiment:

Many people in Finland — and in other lands — chafe at the idea of handing out cash without requiring that people work.

“There is a problem with young people lacking secondary education, and reports of those guys not seeking work,” said Heikki Hiilamo, a professor of social policy at the University of Helsinki. “There is a fear that with basic income they would just stay at home and play computer games.”

The Finnish data on the experiment is supposed to come out next year. It will be interesting to see what they find, even though the experiment itself is over. Importantly, are the work disincentive effects as large as people are worried about? Or do the recipients get jobs even though they're being given free money? It's especially important that these experiments are rigorously evaluated, given that many are arguing that a UBI might be a solution to the loss of our jobs to robots. We need to have a good idea of their effects in order to make an informed decision about whether a wider roll-out is appropriate.

Unemployment benefits and work disincentives

A couple of weeks ago the NZ Herald had a couple of (short) opinion pieces on the choice for beneficiaries between working and remaining on the benefit - one by Karen Pattie, and one by Lindsay Mitchell. Karen writes:

There is a large percentage of my clients who approach our service and ask us to look at the viability of returning to work -- single parents who are committed to getting off benefit and excited about the prospect of returning to work.

When we break down the in-work tax credit, the childcare subsidy, accommodation supplement and temporary additional support, it is not uncommon that the working single parent ends up with under $50 a week more in their hand.

We then look at transport, parking, appropriate clothing etc. for work. Work and Income will assist with a percentage of this cost, however, not the total cost, which then gets taken off the $50.

Then, school holiday programmes need to be paid for along with childcare, which is subsidised, and the $50 in hand is reduced further.

Given this, most of our clients still opt to return to paid work because we can see the benefits of work experience which may lead to better work opportunities. 

Lindsay writes:

A Blenheim single mother of three finds she is only $34 better off working. She says, "When you weigh it up, is it worth going to work? The Government is trying to get everyone off the benefit but there is no incentive to work."

Of course, the 'choice' between working and remaining on the benefit is only relevant when there are jobs available. However, I'm not going to talk about that aspect. Instead, I want to discuss incentives (or rather, the work disincentives that benefits create).

One of the topics we cover in ECON110 is the economics of social security. Part of that topic involves considering the incentive effects of having a social safety net. If there is no safety net (for the unemployed, for example), then there are high incentives to take any employment that is available. The alternative is trying to live on zero income, relying on assistance from friends and family or non-government organisations, begging, etc. When there is a social safety net (for the unemployed), then the incentives for work are reduced, because the income difference between working and not working is lesser.

A rational (or quasi-rational) beneficiary who is offered the opportunity to work will weigh up the costs and benefits of working rather than remaining on the benefit. The costs of working (compared with being unemployed) are mostly the foregone leisure time (less time with the kids, gardening, or playing XBox). The benefits include higher income. If the difference between working and not working is only $34 (as per the example above), then it wouldn't be surprising for that to be insufficient incentive to encourage people to work.

A couple of additional points are important. First, there are non-monetary benefits to working that must also be factored in. Working provides a sense of purpose and identity. It can increase life satisfaction. So, it might not be surprising that some beneficiaries would return to work even if the monetary benefits were lower than the costs. Second, there may be long-run impacts. For example, the initial job taken may lead to improved future job prospects. As Lindsay notes:

Moving into work may provide little financial gain initially. But the individual's sense of well-being and future prospects are improved.

How do we reduce the disincentive for beneficiaries to return to work? We first need to recognise that the disincentives arise in two ways: (1) the relative generosity of the unemployment benefit; and (2) the rate at which the benefit is reduced as the beneficiary earns other income.

So, the disincentive to work can be reduced if the unemployment benefit was less generous. Clearly there is a trade-off here - you probably want the benefit to be high enough to provide for a minimum standard of living; however, making it too generous (compared with, say, the minimum wage) reduces the incentives to work.

The disincentive to work can also be reduced by allowing the beneficiary to continue to receive a (reduced) benefit if they go back to work. So, rather than taking away the entire benefit if a person returns to work, you simply reduce their benefit by an amount that depends on how much other income they earn. This way, you ensure that beneficiaries who take on part-time work can still attain a minimum standard of living, and you ensure that beneficiaries who work are financially better off than those who don't.

The abatement rate (the rate at which benefits reduce due to other income) matters because unsurprisingly it also affects incentives by contributing to the effective marginal tax rate (the proportion of the next dollar earned that is lost to taxation, decreases in rebates, and decreases in government transfers, e.g. benefits). If the marginal tax rate for low earners is 20%, and the benefit abatement rate is 50 cents for every additional dollar the beneficiary earns, then the effective marginal tax rate is at least 70% - quite a high disincentive to work. And then you have to factor in that the beneficiary might also have to pay student loans or child support from that additional dollar, and they might face a reduction in accommodation supplement and family tax credits, etc. So, there's not likely to be much left over. However, if the abatement rate is too low, then a large proportion of low (and medium) income earners will be eligible for income support, and you start to affect the incentives for people who would otherwise be working full-time, etc. So, again there is a tradeoff.

Social security is fraught with incentive issues and tradeoffs. Striking the right balance is always going to be a challenge.

The black market in WINZ payment cards

One of the common examples I use in illustrating the role of incentives for my ECON110 class is the black market in WWII Great Britain. In short, many products (e.g. meat) were rationed. Essentially each household registered with their local shops, and the shops were provided with only the amount of meat for their registered customers. However, some households would prefer less meat and more sugar, so a complex system of black market trades started to occur, whereby households could obtain the goods they actually wanted, rather than those the authorities deemed they should have (you can read more here).

Black markets tend to arise whenever the government limits what citizens are allowed to spend their money on. For instance, in the U.S. food stamp programme (a.k.a. Supplemental Nutrition Assistance Program, or SNAP) many recipients sell their SNAP vouchers for cash, often with the complicity of shopkeepers (see here and here for example).

And now we have a local example, with payment cards from Work and Income New Zealand (WINZ) showing up for sale on Facebook. The New Zealand Herald reports:

Work and Income payment cards are showing up for sale on Facebook trading groups.

In a screenshot provided to the Herald, one person offers a $100 payment card for sale for $40 on the "Buy and Sell Hamilton" Facebook group.

And this is in spite of WINZ attempts to make it difficult for this sort of abuse:

When a card is issued, the recipient must sign it and payments are verified by matching the signature on the receipt to the back of the card.

Grants for food and hardship must be used within three days. 

Of course, setting rules on what payment cards can be used for makes them less valuable to the recipients than cash. It also increases the costs to the government because of the need to enforce the rules. And there needs to be some form of sanctions for recipients who break the rules. Having sanctions increases the cost of abuse for the payment card recipients, by making abuse more difficult (increasing the change of being caught). Presumably there are also penalties for the person who buys and tries to use a payment card in the name of someone else (under fraud laws I expect).

The payment card will only be able to be sold for less than face value, partly because the recipient (seller) probably wants cash fast (so is willing to give up some of the face value of the payment card for cash in hand now), and partly to compensate the buyer for the risk they face (of penalties for fraudulently using a payment card in the name of someone else).

The more urgent the sale (within less than three days), or the more costly the penalties for the buyer, the greater the difference will be between the face value of the payment card and the price it will be sold for. And so, we end up with the situation where a $100 WINZ payment card is being sold for $40.