The idea of universal basic income (UBI) has been around for a while now, but I have never seen anyone showing the distortions it causes with a simple argument. Here I will bring an extreme example to illustrate the absurdity of UBI, and then, I will support it with some math for those interested. With my example, I argue that UBI is extremely inefficient; even if the government taxed a household and then rebated all of that tax to them in the form of a UBI, this household would work less and be worse off than without this intervention.
The verbal argument is as follows. Suppose that there are 1,000,000 identical households in the economy, and each household chooses how many hours to work. Optimally, each of them will work until their marginal utility from consumption equals to their marginal disutility from work. In the absence of a tax on income, the marginal utility from consumption depends on the hourly wage the household receives.
But if the government imposed a tax, T, on labor income, then each additional hour of labor would generate less income for the household at the margin, and thus their marginal utility of consumption would be lower. This, in turn, would reduce the number of hours all households would work, even though the government would give each household a UBI that is exactly equal to the taxes they pay.
Now, let’s take the UBI idea a step further. Suppose that government imposed 100% tax on all income, and redistributed the revenues equally to everyone in the form of a UBI. Since income is fully taxed, no one would have a reason to work, and so there would be no income to tax, and no UBI to distribute to anyone. This is a simple example how a bad policy can destroy a thriving economy.
For those interested in the math, here is a model that formalizes this logic:
Suppose each household has a utility function: log(c)+A l, where c is consumption, A is a scalar, and l is leisure. The budget constraint is c=w (1-T)(1-l)+G. w is the hourly wage, T is the tax rate, and UBI is G=Tw(1-l). Since there are 1,000,000 households in this economy, each of them takes G as a given, which means that they cannot affect G by changing their own actions.
Maximizing the utility function subject to the budget constraint gives the following optimal solution: c*=[w(1-T)]/A. So, consumption without the tax is higher than consumption with it c*(T=0)>c*(T>0), and thus utility is also lower.
*The views expressed herein do not reflect the views of CMHC.
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