An Economic Case for Universal Basic Income

by komal sri-kumar and masood sohaili
Robert Nickelsberg/Getty Images

komal sri-kumar is an economist who heads Sri-Kumar Global Strategies and a senior fellow at the Milken Institute. masood sohaili is a Los Angeles-based partner in the law firm DLA Piper.

Published August 4, 2017


The idea of a universal basic income — a no-strings-attached monthly stipend to every resident — has been widely touted as a substitute for a social safety net that could satisfy liberals and libertarians alike. We think it could do much more, serving as the rock on which to build a fairer and more efficient economy. Indeed, combined with the elimination of some tax preferences that distort markets, it could put the economy on a sustainable long-term growth path even as it reduces the degree of income inequality.

One major benefit of a universal basic income — a benefit emphasized by conservative believers — is its value in reducing distortions in labor incentives that undermine productivity growth. But the promise runs deeper, potentially eliminating biases in both tax policy and monetary policy that favor investment over employment, and in the process concentrate wealth and suppress wages.

The Multi-Trillion Dollar Misunderstanding

In a world long mesmerized by the role of capital-intensive technological change — everything from mass production to digitization — there's a common tendency to ignore the ways in which the owners of capital are favored over the "owners" of labor. Start with the fact that, unlike wage income, investment income is not subject to Social Security, Medicare or most other payroll taxes. Capital income is also taxed at significantly lower rates, and the tax can often be deferred.

One of the policy justifications for the more-favorable tax treatment of capital income is that investment creates jobs. Now, that argument is suspicious on its face: why would tax incentives that make labor relatively more expensive than capital increase the demand for labor? In any event, the happy historic correlation (not necessarily causation) between investment and job growth has broken down.

Adding to workers' woes, labor has become less attractive to employers because labor productivity has stagnated. The numbers are pretty grim. Labor productivity rose at an average annual rate of only 1.1 percent between the fourth quarter of 2007 (when the Great Recession began) and the third quarter of 2016. That compares to the 2.7 percent average annual increase between the first quarter of 2001 and the fourth quarter of 2007.

What's more, the mysterious dynamic that drives technological change seems to be piling on more bad news. A recent study by PricewaterhouseCoopers estimates that 38 percent of U.S. jobs could be lost to automation in the next 15 years — a greater percentage than in any other developed country in that period.

Lower-income workers have been hit especially hard by wage stagnation and the decline in job creation that, in part, result from the favorable tax treatment of investment income and the slowing growth in labor productivity. Moreover, ill begets ill; the Princeton economist Alan Krueger persuasively argues that by virtue of their meager personal savings, geographic immobility and anticompetitive practices on the part of their employers, low-wage workers don't benefit much when the demand for labor does rise.

Sri Kumar Komal Sohaili Masood 2

What Recovery?

It's hard to dispute that most lower-income earners have been left behind in the recovery from the Great Recession and do not have meaningful opportunities awaiting them in the foreseeable future. Even though the standard measure of unemployment (the so-called U-3 rate) has dropped from over 10 percent in early 2009 to 4.4 percent in April 2017, a more comprehensive measure of joblessness (U-6) that includes discouraged workers and those involuntarily on limited hours indicates that unemployment is still a pervasive problem. The U-6 stood at 8.6 percent in April — almost two percentage points higher than at the peak of the Clinton boom.

Another indicator that the benefits of the economic recovery have not been fully shared by the workforce comes from the fact that the labor force participation rate for prime-working-age 25-to-54-year-olds was 1.4 percentage points lower in April 2017 than in December 2007. And among 25-to-54-year-olds lacking a high school diploma, participation was a shockingly low 45 percent. Simply put, the recovery has not been strong enough to suck marginal unskilled workers back into the labor force.

Now, compare the ongoing difficulties of labor — particularly less-skilled labor — to the rebound of financial wealth. The S&P 500 equity index has more than tripled since it bottomed out in March 2009, while wages in manufacturing are up a mere 14 percent. In part, the success of stocks can be attributed to the great forces of technology and globalization that have favored capital. But a big factor was the creation of a super-low interest rate environment by the Federal Reserve that inflated the value of stocks and bonds alike as investors chasing yield bid up prices.

The Fed policy of keeping rates low by amassing a vast portfolio of bonds can be defended as having been necessary to sustain the recovery in the absence of more fiscal stimulus or a big rise in private investment. But it's hard to deny that the major beneficiaries are those in the top 1 percent, or even the top one-tenth of 1 percent, who own the bulk of financial assets.

The lack of emphasis on training and apprenticeship opportunities in the United States set in an environment of mediocre general public education has not been conducive to generating a labor force that matches contemporary skill requirements.
The Giant Hole in the Middle

These days, practically everyone knows that income inequality is growing. Few, we expect, know by how much. The inflation-adjusted after-tax average income of the top 1 percent almost tripled between 1979 and 2013. By comparison, the bottom fifth saw their incomes rise by 46 percent over those decades — with much of that gain attributable to more women entering the labor force rather than wage increases.

One often-neglected aspect of the income-distribution story is the unintended role played by macroeconomic policy – in particular, the reliance on monetary rather than fiscal policy to tame the business cycle. President Barack Obama managed to convince Congress to pass a big fiscal-stimulus bill in the first months of his administration. But it was inadequate to the task, leaving the ongoing job of digging the economy out of the Great Recession to the Federal Reserve. And, as we have noted, the Fed's flirtation with a zero rate of interest succeeded in boosting the value of financial assets (which are largely owned by the wealthy) but not in raising wages and employment among lower-income workers.

As American investors' wealth surged from a financial-crisis low in 2009, the United States earned the dubious honor of having one of the most unequal distributions of income among OECD countries (exceeded by only Chile and Mexico). The deterioration in income distribution is confirmed by figures from the U.S. Census Bureau. After showing no clear trend between 2000 and 2007, the Gini coefficient — a measure of inequality that makes comparisons easier — rose significantly from 2008 onward.

The traditional correlation between investment and labor income has broken down, in large part because of the advantageous tax treatment of capital income and what amounts to an asset bubble created by very low interest rates, combined with the economy's seeming inefficiency in raising labor productivity. The lack of emphasis on training and apprenticeship opportunities in the United States, set in an environment of mediocre general public education, has not been conducive to generating a labor force that matches contemporary skill requirements or to increasing productivity.

Jon Lowenstein/Noor/Redux
Structuring Universal Basic Income

Growing inequality and lagging wages, so long written off as the consequences of immutable economic forces, have, in the Trump era, become the focus of much hand-wringing — though not of effective action. A mix of ideological differences and pure partisan opportunism makes it almost impossible to contemplate the conventional sort of fix possible in an earlier era. That's where a universal basic income fits in. It would pay every adult resident a stipend, regardless of the individual's other sources of income. The quid pro quo (and the source of the savings to pay for the program) would be the elimination of most other forms of government assistance (including Social Security over a phaseout period), other than those related to medical care.

It is important to emphasize that there would be no creation of a separate welfare class nor any stigma attached to receiving a universal basic income. Quite the contrary: unlike, say, food stamps or housing vouchers, everyone would receive it. Consequently, animosity toward poverty programs and shame at receiving handouts would be reduced because those programs wouldn't exist.

As a practical matter, it would make sense to apply universal basic income benefits against the tax obligations of higher-income Americans, while paying others monthly. We would like to see it set in the neighborhood of $10,000 per year per adult. Combining it with some major tax changes — notably the elimination of the preferences for investment income — would ensure that the fiscal impact of the introduction of a universal basic income would remain manageable. Indeed, some residual stimulus could prove serendipitous, allowing the Federal Reserve to tilt toward market-based interest rate levels that allowed for policy flexibility in the next economic downturn.

Reuters/Jason Cohn
Structured properly, a universal basic income would give workers the financial breathing room to take the time for acquiring skills.
Improving Workers' Negotiating Power and Productivity

Structured properly, a universal basic income would give workers the financial breathing room to take the time for acquiring skills. Their decisions about education and training would be based on their own analysis of the benefits versus the costs. Consider, too, that it would also go a long way in offsetting the excessive bargaining power now enjoyed by employers in the market for less-skilled workers. Low-wage employees who would otherwise be living hand-to-mouth and unable to risk even temporary unemployment would be freer to shop around for better jobs – or even to contemplate moving elsewhere in search of better opportunities.

In some cases, this could prove a win-win for employers as well as their employees. We would envision the elimination of the minimum wage as part of the universal basic income package. This would give employers the flexibility to take a chance on marginally productive workers who could prove their worth on the job. More typically, it would increase employers' incentives to offer training to inadequately skilled workers.

For example, an employer could offer a low wage during a training or apprenticeship phase, with a significant bump in compensation if and when the skills were acquired. Employees, for their part, could take chances on such offers, because a universal basic income would always be there as a backstop. Note, too, that this would take the pressure off government to subsidize such training and, in the process, risk even greater market distortions.

In our view, a universal basic income would be most effective as a productivity enhancer if it were accompanied by changes in secondary education that emphasized basic skills in anticipation of on-the-job technical training. This is not dissimilar to the opportunities available for students in Germany who are not bound for college – a system, by the way, that can only work smoothly because young workers can count on income replacement from the government if they founder.

There is a strong consensus that a great number of jobs will become obsolete as a result of the inevitable march of technology in the next few decades. (Think, for example, of truck drivers in an era of autonomous vehicles and delivery drones.) There is much disagreement, though, about whether technology will open up new jobs (as it has in the past) or whether it will simply put downward pressure on wages as too many workers compete for too few jobs.

The advantage (among many) of a universal basic income is that it would prepare the economy and society for either outcome. On the one hand, the basic income would give workers the financial wiggle room to retrain. On the other, it would buffer the impact of labor-saving technological change that led to a continuation of wage stagnation (or worse). The bottom line: it would be an efficient, market-based means of integrating workers into an economy in which the only certainty was rapid change.

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Better than Welfare

Programs designed to ease the burden of poverty range from old-fashioned welfare — food stamps, housing assistance, Medicaid, Supplemental Security Income — to a host of initiatives to spur remunerative work, ranging from job training to college tuition grants to earned-income tax credits. But the inherent nature of means-tested benefits implies that almost all of them create market distortions that undermine efficiency in general and work incentives in particular, because added income triggers benefit losses.

Progressives try to minimize the inefficiencies by structuring benefits carefully so that the "tax" on higher earnings is modest. Conservatives are inclined toward plans that make dependence less palatable — adding work-search requirements, drug-testing, time limits on benefits and the like. The resulting mix does the job minimally well, but at great cost in terms of fiscal waste, increased regulation and size of government, social stigma and simmering popular anger about the free ride others are allegedly getting. A universal basic income would wipe away many of the liabilities of the current social safety net, increasing the efficiency of labor markets and redistributing income without the potential for backlash against freeloaders that has become more than potential in recent years.

Many experts — and most people first hearing about the idea — are concerned that a universal basic income would make people lazy and discourage work. But some well-constructed experiments with no-strings income supplements suggest a subtler outcome. In the 1960s and 1970s (in a less conservative era), both Canada and the United States commissioned studies of the impact. And while researchers concluded that there was about a 13 percent reduction in hours worked by households, there was only a slight reduction in the hours worked by the primary earner. Joel Dodge, a writer for Quartz, summarized the findings: "Universal basic income wouldn't make people lazy," he concluded. "It would change the nature of work." Women who were secondary earners reduced their work hours more, presumably to stay home with young children or to substitute housework for boring unskilled jobs. Dodge also noted that teenagers worked less part-time, but apparently used the extra hours wisely: the experiments led to double-digit increases in the percentage of students completing high school.

At the very worst, the experiments suggest that a universal basic income would lead to a modest reduction in labor-force participation. At best, it would increase participation because the incentive-sapping impact of means-tested welfare benefits would vanish. Consider, too, that a reduction in labor hours is not an inherently bad thing if it allows people to live more creative and fulfilling lives, any more than health care reform was a bad thing because people no longer stayed in jobs they hated simply to keep their health insurance.

A universal basic income would be an efficient, market-based means of integrating workers into an economy in which the only certainty was rapid change.
An Achievable Dream

The good news is that support for a universal basic income extends across the ideological spectrum from libertarians to liberals. The bad news is that the support is thin across this spectrum. We have no illusions that its introduction would prove easy, or would prove to be a panacea.

But we are convinced that this battle for Americans' hearts and minds is worth the fight. For one thing, it would lead to immediate improvement in the lives of a lot of people who've gotten the short end of the stick in an era of ever-greater income insecurity and income inequality. For another, it would help to head off the potential for social and political instability as economic change — automation, in particular — leaves roadkill in its wake, not to mention making the economy more efficient and market-based, allowing U.S. businesses to compete more effectively on the world stage.

We cannot continue on our current path, hoping to prosper as a nation in a global marketplace with a hobbled labor force. Nor can we stop the march toward globalization or deal with socioeconomic discontent by erecting barriers that limit the flow of trade and technology. Bullying companies to make uneconomic decisions around manufacturing and forcing them to keep jobs in the United States could only succeed in the hobbling of the proverbial goose.

In short, a universal basic income offers an efficient, market-based opportunity for workers and businesses to avoid a future otherwise sure to be clouded with social malaise and stunted economic growth. And that, surely, is a cause worth fighting for.

main topic: Public Policy
related topics: Income Distribution, U.S. Economy