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

Dynamic Effects of a Basic Income:
Phase 2 of a Study for the
Working Group on Basic Income
FINAL REPORT
Tim Callan*
Gerry Boyle†
Tom McCarthy†
Brian Nolan*
John Walsh*
Richard Nestor*
Dirk van de Gaer†
*The Economic & Social Research Institute
†NUI, Maynooth
6 June 2000
Acknowledgements
This study draws extensively on the 1994 Wave of the Living in Ireland Survey, the
Irish element of the European Community Household Panel. Brendan Whelan and
James Williams of the ESRI’s Survey Unit were responsible for the survey design,
data collection and database creation.
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Dynamic Effects of a Basic Income: Phase 2 of a Study for the
Working Group on Basic Income
Contents
Chapter 1: Introduction
Tim Callan and Brian Nolan
Chapter 2: The Basic Income
International Perspectives
Concept:
Review
Gerry Boyle, Tom McCarthy and Dirk van de Gaer
Chapter 3: Basic Income and Financial Work Incentives
Tim Callan, Brian Nolan, John Walsh and Richard Nestor
Chapter 4: Migration and the Informal Economy
Gerry Boyle and Tom McCarthy
Chapter 5: Basic Income and the Labour Market
Tim Callan and Brian Nolan
Chapter 6: Competitiveness, Investment and Growth
Gerry Boyle and Tom McCarthy
Chapter 7: Conclusions
Tim Callan and Brian Nolan
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and
Chapter 1
INTRODUCTION
Tim Callan and Brian Nolan
1.1 Introduction
This study, for the Partnership 2000 Working Group on Basic Income, explores
the potential dynamic impact of the introduction of a basic income in Ireland. It builds
on earlier reports to the Group (Callan et al., 1999; Clarke, 1999) in Phase 1 of the
research. These examined the cost, revenue and distributional implications of the
Basic Income proposal on a static or “first-round” basis i.e., before any individuals or
firms changed their behaviour in response to the introduction of the scheme. This
study, Phase 2 of the research, goes beyond that framework to consider the likely
changes in decisions by individuals and firms, the broader economic and social impact
of such changed behaviour1, and the potential impact of such changes on the tax rate
required to finance the basic income proposal.
The introduction of a basic income would radically alter the financial work
incentives facing many individuals in the population. Some of these changes – for
example, improvements in the financial incentives to take up employment for some of
those currently unemployed – are the intended consequence of the scheme. But there
are also wider changes in financial work incentives associated with the introduction of
the scheme, affecting those in employment and others in the potential labour force.
Disentangling the effects of these complex changes in the balance of financial
incentives across different individuals is at the heart of this study.
The study begins with a review in Chapter 2 of available international evidence
on the dynamic impact of negative income tax schemes, before turning to a detailed
consideration of the particular scheme proposed for Ireland. Chapter 3 focuses on the
key task of assessing the impact of the proposals on financial work incentives for the
potential labour force. This includes not only those currently in employment, but also
those who are unemployed and those who classify themselves as fully engaged in
1
While Chapters 3 to 5 focus principally on the formal labour market and related issues (gender
differences in the labour market impact, migration, participation in the informal economy) some wider
issues including the impact on education and training and rural living are dealt with in the concluding
section of Chapter 7.
3
“home duties”. Chapter 4 considers the impact of the scheme’s introduction on
financial incentives for emigrants and migrants, and the complex issue of the changes
in the incentive to participate in the informal rather than the formal economy.
Drawing on this evidence, one can then build an assessment of the potential
overall labour market impact of the scheme, which is addressed in Chapter 5. Other
potential channels of dynamic impact, which could affect competitiveness, investment
and growth, are considered in Chapter 6. Finally, Chapter 7 draws together the
evidence from earlier chapters and
some wider considerations concerning the
dynamic impact of the basic income scheme.
4
Chapter 2
THE BASIC INCOME CONCEPT:
REVIEW AND INTERNATIONAL PERSPECTIVES
Gerry Boyle and Tom McCarthy
2.1 The Concept of a Basic Income
The purest form of a basic income would be an unconditional income granted to
each individual, irrespective of the labour market or marital status of the individual. All
other income would be taxed at a single rate. All tax-free allowances would be abolished.
All social security and social welfare payments would be eliminated and replaced by the
basic income. The basic income thus provides an integrated approach to social welfare
and taxation, with a number of attractive features.
Following Atkinson (1995), we can mention at least four potential advantages of
the basic income. First, the system might help to reduce poverty. If the level of the basic
income were sufficiently high, those who at present have to live on lower social welfare
benefits — or who fall through gaps in the official “safety net” income support scheme
— would stand to benefit. Workers who at present have earnings below the tax-free
allowance might profit from the replacement of the tax-free allowance by the basic
income. Second, those individuals who are working in the home and whose partners are
working outside of the home would now receive an income of their own. The tax-free
allowance of their spouse might go down, but the distribution of income within the
family would change significantly. The potential impact on the household’s expenditure
pattern and on the distribution of well-being within the household is a complex issue (see
Behrman, 1997; and for Irish evidence, see Rottman, 1994, Cantillon and Nolan, 1998
and forthcoming). Third, the basic income's unconditional nature implies that the income
received from the government would not depend upon the labour supply status of the
individual. There would no longer be any means tested benefits. As a consequence, the
poverty trap would disappear, providing an incentive for those with low earnings
potential to enter employment. Fourth, because of the unconditionality of the system, the
elimination of tax allowances, and the single tax rate, a basic income could save on
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administrative costs. The exact amount of these savings will be hard to quantify,
however.
Apart from these positive properties, the introduction of a basic income also has
some drawbacks. First, a high basic income might discourage labour force participation
and thus decrease national income. If the level of the basic income were high, the
increase in non-labour income would have a negative income effect on labour supply. In
addition, if the tax rate necessary to finance the basic income were very high, then this
might depress labour supply too. If, moreover, the basic income is truly unconditional,
then unemployed people might be less motivated to search for a job, thereby decreasing
labor supply further. To obtain the net effect on labour supply these effects must be
balanced against the positive effect due to the elimination of the poverty trap mentioned
above. Second, the introduction of a basic income would involve a very extensive
redistribution of income both vertically and horizontally, as shown in depth in the phase 1
study. While some of the distributional consequences might be seen as desirable, and
compensation mechanisms could avert some unintended consequences, some would
argue that there are also undesirable distributional consequences. Third, the basic income
might discourage investment and hence hinder economic growth. An important channel
through which this might occur is the discouragement effect on occupational pension
schemes (see, e.g., Integrating Tax and Welfare, the Report of the Expert Working Group
on the Integration of the Income Tax and Social Welfare Systems, hereafter abbreviated
as TWG, p.202). Finally, a basic income might stimulate the informal economy, if the
marginal tax rate on additional income is very high, and might lead to changes in
migration patterns through its impact on income guarantees and tax rates.
The extent to which the basic income scheme can live up to each of its promises
and is confronted with each of its shortcomings is crucially dependent on the level of the
basic income and the tax rate necessary to finance it. Therefore, one crucial question is
how high a tax rate is required to finance a certain level of basic income. Phase 1 of the
research for the Working Group was devoted to this issue. The present phase 2 study will
build on these results to explore the various channels of dynamic impact of the scheme,
both positive and negative. In the present chapter, we begin by considering the evolution
of concepts of basic income and negative income tax. We then examine evidence from
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various negative income tax experiments, and consider what lessons might be drawn
from this experience in assessing the potential dynamic impact of the proposed basic
income scheme for Ireland.
2.2 Basic Income Schemes and Negative Income Taxation
“Basic Income” is a relatively new name for a concept that can be dated to the early
part of this century – Atkinson (1998) says that it is an idea that was advocated by the
State Bonus League in 1918. A variety of titles have been attached to the concept such as
social dividend and demogrant. In the UK the idea has long been championed in various
forms by a long line of economists and social activists from Cole to Meade to RhysWilliams to Parker to Atkinson.
A “Negative Income Tax” (NIT) is a parallel concept to the basic income in that it
can be constructed to produce a similar outcome. However, it has quite a distinct
intellectual history, as we shall see. Moreover advocates of basic income schemes argue
that the concepts are quite different. Milton Friedman espoused the idea in his 1962 book
Capitalism and Freedom while George Stigler advanced the idea in 1946 as an alternative
to the minimum wage.
In this section we examine this comparative intellectual history with a view to
establishing whether the concepts of basic income and negative income taxation are
analytically identical and thus establish the validity or otherwise of using experiments
with one for the evaluation of the other.
A tax benefit system that gives everyone a fixed income tax free and taxes all other
income goes under the name of a basic income. There are many ways in which the other
income can be taxed. If all other income is taxed at a uniform rate, then we have a basic
income/flat tax system. This is the system that is most frequently studied in the literature.
The present proposal belongs to this category. It should be noted, however, that the tax
rate need not be uniform. In a previous study, Callan et al. (1994) studied the
consequences of a dual rate structure, with a “benefit withdrawal rate” on lower incomes
allowing a lower marginal tax rate on middle and high incomes. (Such a structure bears
some resemblance to the existing tax and welfare systems, where tax-cum-benefit
withdrawal rates are highest on low incomes, altering the trade off between the level of
income guarantee and the tax rate on middle and high incomes).
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At first sight a negative income tax looks somewhat different. Under a negative
income tax, a specified amount of income is tax-free. All additional income is taxed at a
certain rate. Those individuals whose income is lower than the level of tax-free income
receive a subsidy (or “refundable tax credit”) that is proportional to the difference
between their income and the level of the tax-free income. Hence those without any other
source of income receive the highest subsidy. If the subsidy received by those who have
no other income under the negative income tax proposal is equal to the size of the
guaranteed income, and both systems have the same tax rate, both systems are identical in
accounting terms.
Differences between the concepts arise mainly due to the degree of conditionality
attached to the payment; but there are also associations between the different labels (NIT
and BI) and the envisaged level of income guarantee. We now examine this and other
concepts.
Universality is central to many conceptions of the welfare state. It has advantages
in that it avoids unintended distortions that may arise from making entitlement
categorical. However, it has implications for the cost of welfare programmes. It is for this
reason that various forms of conditionality have been attached to welfare payments. An
important feature of most basic income schemes is the unconditional nature of the basic
income. We noted above that many economists have lent support to basic
income/negative income tax proposals. However, we also find that many economists will
not support fully unconditional schemes. Recently, several economists have argued that
imposing work requirements for the receipt of welfare payments will be efficiency
enhancing in certain circumstances (Besley and Coate, 1992). This idea has a longer
history and would inform the thinking behind the views of some economists. However,
there is a broader argument. Tobin, for instance, argues that a puritanical ethic cannot
tolerate the idea of a completely unconditional transfer. Atkinson (1995) gives a modern
slant to this view suggesting that some form of “participation price” must be paid in order
to preserve social cohesion.
When people study basic income or negative income tax proposals, they usually
assume that the guaranteed income, or its negative income tax equivalent, replaces all
existing social benefits. Both negative income tax and basic income proposals are
8
reconcilable with the existence of other social benefits, however. Hybrid taxation and
social benefit systems along these lines are the small-scale negative income tax
(discussed by Barr 1998, chapter 11) or a partial basic income (see Atkinson, 1995)).2
Quilley (1998) tries to analyse the kind of policy strategy that might lead towards a
basic income. The continuing prevalence of the work ethic and the commitment of
governments to focus on labour market participation leads him to defend a participation
income (like Atkinson, 1995). Further European integration will increase the need for a
common European social policy. The simplest way to achieve this, compatible with
residual national social policy at the national level, would be a basic or participation
income at the European level. Consequently, he pleads for a basic income on the
European level. Ecological concerns are becoming more and more important, such that
the Euro-grant should be financed by Eco-taxes. This would have the additional
advantage that a political majority in favour of the European participation scheme might
arise more easily.
Manning (1998) considers the introduction of a basic income scheme in New
Zealand. The most original part of his proposal is the way the basic income will be
financed. Instead of increasing personal taxation, he proposes to levy a tax of about 5%
on foreign exchange and domestic transactions, and replace private money creation by
public money creation by re-introducing reserve ratios in the banking system. The initial
inflationary impulse would be reduced by a forced savings scheme for the high incomes:
their basic income would be frozen for a period of three to five years put on an account.
All of this is very creative, but the effects of such policy measures on economic activity
are very hard to predict for an open economy. They could very well be quite severe.
Finally there is the question of the similarity or not of basic income/negative
income tax systems and systems of refundable tax credits – in particular the US Earned
Income Tax Credit (EITC). Ventry (19xx) argues that the EITC cannot be seen as a type
of negative income tax citing legislative plans in the US that contained both types of
schemes. The NIT provided at best an intellectual precedent for the EITC, he argues. The
differences are more pronounced than the similarity that appears to be the automatic
2
The proposal examined here has some elements of a hybrid system.
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triggering of credit from the state. The EITC is targeted at the working poor and is
designed to complement and not replace the existing tax-benefit system.
2.3 Measuring the Impact of Basic Income
Basic income schemes have many advocates as we have seen. Here we go beyond
conceptual analysis and examine the record from experiments with such schemes. The
analysis of Phase 1 (Callan et al 1999), calculated the cost of a proposed basic income
scheme for Ireland3 assuming no change in decisions by workers, potential workers and
firms. We will refer to this as the “static” evaluation of the basic income scheme.
However, the benefits and drawbacks of a basic income scheme arise partly from changes
in what people do. That is, people may decide to change the terms on which they offer
themselves for work - indeed the income guarantee may even induce risk averse
individuals to become self-employed. People may change their savings behaviour and
non-residents may decide to relocate to Ireland as a consequence of the change in
tax/benefit regime. On a broader level firms may re-evaluate location and investment
decisions. A “dynamic” evaluation of the basic income proposal must take account of
these changes.
A key feature of the dynamic response to the basic income proposal would be its
impact on the labour market. Experience with negative income tax experiments may be of
some help in this regard, as they give some indication of potential labour market
responses to the sorts of changed incentives to which the basic income scheme would
give rise. Of course, the particular experiments in the US had features which differ
sharply from the proposed basic income for Ireland; and the pre-existing systems against
which the US schemes were compared differ from the appropriate scenario for
“conventional” tax-welfare policy in Ireland. Nevertheless, some useful insights can be
gained from a review of this experience, to which we now turn.
2.3.1 NIT Experiments
Given the accounting equivalence between the structure of a negative income tax
and that of a basic income system, the negative income tax experiments performed in
Canada and the US during the 1970s provide a valuable source of information to study
3
The exact details are outlined in the reports of the Phase 1 evaluation.
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the consequences of the introduction of a basic income. In these experiments, a group of
people - the experiment group - were subject to a negative income tax that replaced the
existing tax/benefit system. Another group - the control group - continued under the
existing tax/benefit system. The idea was to observe the relative response of the
experiment group in order to determine whether an income guarantee caused people to
work less.
Table 2.1 provides a summary description of the different negative income tax
experiments carried out in the US between 1968 and 1982. Four distinct experiments
were conducted and are known by their locations: New Jersey/ Pennsylvania, Rural (Iowa
and North Carolina), Gary, and Seattle-Denver. Each differed in terms of the
characteristics of the sample and the type of income guarantee scheme.
The samples were not representative of the US population. Table 2.1 describes the
sample values of three other population characteristics. The New Jersey experiment,
which was the first, contained only husband and wife pairs. Single female families were
represented in the Rural experiment. However, it was only in the two later experiments
that the sample was drawn with the intention of representing such households. The race
composition of the samples also differed ranging from an almost even split between
white (W), black (B) and Hispanic (H) in the first experiment to an entirely black sample
in Gary.
In three of the four experiments, the sample was limited to households with low
incomes. The heading “income cut-off” describes the upper bound – measured as a
percent of the poverty line income - of the income level range included in a particular
sample. Thus 150 means that only households with incomes up to 1.5 times the poverty
line are included. The only experiment where higher incomes were present was the Gary
experiment, but even there high incomes were underrepresented (Burtless and Hausman,
1978, p.1121).
In general the experiments were conducted over a three-year period. A fraction of
the Seattle-Denver sample continued in the experiment for longer. The income guarantee
aspect differed within and across plans ranging from 50% to 132% of the poverty line.
Break-even refers to the income level at which the negative income tax payment is zero.
The tax rate also differed across families. An innovative aspect of the Denver experiment
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was that some people's marginal tax rates declined as their income increased. In the table
the (70-0.0025Y) tax rate describes a scheme where marginal tax rates declined by 2.5
percentage points for every $1000 increase in income.
As a further complication it must be recognised that the control group in each of the
experiments were also subject to different tax-benefit systems. The foregoing points
would suggest that the experiments in themselves are not suitable for predicting the effect
of the introduction of a negative income tax on the US population. Their main value is as
a source of experimental evidence on labour supply elasticities that can be compared with
non-experimental evidence on these magnitudes.
A Canadian experiment – the Manitoba Basic Annual Income Experiment
(Mincome) – commenced in 1975. In broad terms the Canadian experiment was similar
to those in the US. Considerable attention was paid to family composition aspect of
sample design. We cannot compare specific aspects of the payment system since there is
no official Canadian poverty line for this time. The nominal value of the guaranteed
income payment varied from Cdn$3800 to Cdn$5800 per family while the tax rate
extended from 35% to 75%.
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Table 2.1: Comparison of Characteristics of US Negative Income Tax Experiments
Characteristics of the sample
Experiment
Sample
Family
Race
Income CutSize
Composition
(%)
off (as % of
(%)
poverty line)
New Jersey
(1968-72)
1,357
Husband-wife
(100)
Duration
(%)
White (32)
Black (37)
Hispanic (31)
White (65)
Black (35)
150
3 years
150
3 years
Rural
(1969-73)
809
Husband-wife (85)
Lone mother (15)
Gary
(1971-74)
1,780
Husband-wife (41)
Lone mother (59)
Black (100)
None
3 years
Seattle-Denver
(1971-82)
4,800
Husband-wife (61)
Lone mother (39)
White (39)
Black (43)
Hispanic (18)
325
3 yrs (71)
5 yrs (25)
20 yrs (4)
Source: Burtless (1986)
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Characteristics of the plans
Range of
Range of Tax
Range of Breakeven
guarantee
Rates (%)
(as % of
poverty line)
50-125
30
100
to
to
70
250
50-100
30
100
to
to
70
250
77-101
40
128
60
to
253
92-135
50, 70
140
70-0.0025 Y
to
80-0.0025 Y
300
2.3.2 Estimates of Behavioural Responses
Research using the negative income tax experimental data concentrated on
determining whether people worked less when placed on one of these schemes. As a
broad generalisation it can be said that people did indeed work less. 4 However, the
magnitude of this behavioural response was relatively small.
Concern with the labour supply consequences of income maintenance
programmes preceded the negative income tax experiments. During the 1960s and
early 1970s a large number of studies reported labour supply elasticities using very
basic econometric techniques. Later the attempt to address shortcomings in these
studies led to the development of more sophisticated techniques. In particular methods
were developed for dealing with sample selection bias, arising in particular from
problems with labour force participation decisions, and non-linear budget constraints.
This work relied mainly on non-experimental data, i.e. information collected from
what people do under the tax-benefit system in operation. The negative income tax
experiments offered experimental data that allowed the relative behaviour of the
participants in the experiment and the control group to be monitored.
One way in which the results from these studies can be used to shed some light
on the consequences of the introduction of a basic income, would be to look at the
difference in labour supply between the experiment and the control group. There are
several problems with this approach, however (Burtless, 1986). These arise mainly
from the problems with sample design and, in particular, from the nature of the actual
programmes. That is, there is considerable variation in budget constraints as between
the programmes.
The huge variety of budget constraints is turned into an advantage, once the
simple approach is replaced by a more structural approach. Econometric estimation
becomes more efficient if there is a wider variability in dependent and independent
variables. Let us first explain how such a structural approach to labour supply works.
Consider an individual labour supply model, where all complications arising
from family structure are eliminated. It is assumed that each individual takes his own
labour supply decision, irrespective of what the other members in the household do.
Despite this drastic simplification, it is not easy to say whether labour supply will
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increase or decrease when the present tax/benefit system is replaced by a basic income
or more generally even by marginal changes in the income maintenance system.
The replacement of the present tax/benefit system by a basic income has two
effects: income effects and substitution effects. Let us first look at those that are at
present without a job. The lump sum grant people receive will lead to an income
effect. If the level of the lump sum grant is higher than the income these people get at
present and leisure is a normal good, then this positive income effect will increase
their consumption of leisure, and they would like to reduce their labour supply further.
That is, their desired amount of work would be reduced. But if their marginal
effective tax rate (including the impact of benefit withdrawal) goes down then, with
leisure a normal good, their labour supply will become positive. Second, consider
those that are at present in work, and whose wages are sufficiently high such that they
do not receive any benefits. Assume throughout that leisure is a normal good. This
group contains two types of people. There are those with high incomes. Their level of
income is greater than what they will receive under a basic income scheme. The shift
towards a basic income leads to a decrease in their income, which stimulates their
labour supply. The increase in their tax rate makes leisure less costly, and depresses
their labour supply. The net effect of the introduction of a basic income on this
group’s labour supply is therefore not obvious a priori. On the other hand, there is a
group of people who are at present in work with low incomes. The introduction of a
basic income increases their income, which discourages their labour supply via the
income effect. If their marginal effective tax rate (including the impact of benefit
withdrawal) rises their labour supply is sure to fall. If their marginal effective tax rate
falls, the net labour supply effect is uncertain.
To determine the impact of the introduction of a basic income on labour supply,
we need some estimate of the magnitudes of income and substitution effects. Classical
labour supply estimates could be used to calculate these effects. There are several
shortcomings of using these estimates. First, estimates contain only ‘local’
information, information about labour supply responses in the neighbourhood of the
data on labour supply. It is not clear to what extent such information can be
extrapolated to analyse the consequences of a structural change like the introduction
4
While the NIT experiments were not applied to representative samples of the population, the
subsamples to which the experiment applied tended to oversample groups for whom the labour supply
effects might reasonably be expected to be more positive (or less negative) than average.
15
of a basic income (Feldstein, 1976). Second even if the estimated parameters would
remain stable outside the sample region, the limited variability of the variables would
limit the precision of the estimates.
Table 2.2: Estimates of Labour Supply Elasticities from Negative Income Tax Experiments
Compensated Elasticity of
Total Income Elasticity of
annual hours worked w.r.t. the
annual hours worked
net wage rate
Men
0.0902
-0.1139
Women
0.1783
-0.1115
Female Heads
0.1346
-0.1709
The experimental data from the negative income tax experiments from provides
a means of calculating income and substitution effects while addressing the foregoing
points. The substitution effect is that change in labour supply which arises when the
(net of tax) wage rate is changed but we “compensate” for changes in purchasing
power. The income effect focuses on the change in purchasing power abstracting from
the wage rate change. The results are expressed in terms of elasticities. That is, the
numbers are expressed as percentage changes in labour supply relative to a percentage
change in the wage or income. In this way the numbers are unit free. Burtless (1986)
takes a weighted average of the estimates obtained for the four different negative
income tax experiments in the US. We report these estimates in Table 2.2.
Two conclusions can be drawn from these results. First, in comparison to
elasticities obtained from non-experimental evidence, the size of the elasticities is
lower. Labour supply is less responsive to changes in net wages than suggested by the
non-experimental research, particularly the first-generation non-experimental studies
assume. Some would argue that this relates in part to the explicitly temporary nature
of the NIT schemes: a higher response might be expected if the change were expected
to be permanent. Second, the results confirm that the labour supply of men is much
less sensitive to changes in the wage than the labour supply of married women, while
female heads’ is somewhere in between. Household structure thus matters in the
determination of the effect of changes in the net wage on the labour supply in the
economy. Analyses of the Canadian experiment yielded similar results (Ham and
Simpson, 1991).
There are two additional problems when we want to draw inferences about the
replacement of the existing Irish system by a basic income. First, the tax/benefit in the
US in the seventies was very different from the Irish system today, and varied
16
between different states. Second, the negative income tax systems tried out in the
different experiments are varied, both in terms of the size of the guaranteed income
and the flat tax rate. If we limit ourselves to a NIT scheme that is comparable to the
present basic income system in Ireland, sample sizes become very small and the
results are subject to large statistical errors. Put differently: the budget constraints that
households faced in the negative income tax experiments varied widely and are very
different from the budget constraints facing Irish households. A simple comparison of
labour supply responses is therefore not warranted.
2.3.3 Simulation Studies
The estimated elasticities can then be used to estimate the impact of the
introduction of a basic income on the different members of the household. This
procedure works easily for individuals that have a positive labour supply in the
present situation. Refinements need to be made, as we have already noted. In order to
get some idea about the effect of the introduction of a basic income on the labour
supply of those not in work (Fortin et al, 1993 and de Jager et al, 1994). One can
construct a simulation model to compute the effect of the introduction of a basic
income on the labour supply of a representative set of households. This has been done
for the Netherlands by de Jager et al., and for Canada by Fortin et al.
Fortin et al. (1993) provide a model of the labour response of the members of
the household. To this end, they have a detailed model of household behaviour, and
use actual data to get a representative sample of households in Quebec. The reference
case is a stylised version of Quebec tax/benefit system and has a guaranteed level of
income, a 100% tax rate on all other incomes below this level and a constant tax rate
on income above the guaranteed level of income.5 They simulate the consequences of
the replacement of the reference case by a basic income tax scheme or a workfare
program. One of the main results for our context is that, if the new system is a basic
income scheme with a flat tax rate of 45%, then the mean number of hours worked per
year decreases by 84 i.e., about two weeks of full time work per year.
The model by de Jager et al. takes the analysis even further. Not only do they
model household behaviour, but also the analysis is embedded in a general
equilibrium model. This enables them to calculate the general equilibrium effects on
17
wages, exports, unemployment and so on. Such a model definitely allows the most
detailed, and policy relevant picture of policy experiments. The policy experiment
interacts with the economic environment in which it is set. This increases the realism
of the results. While the exact results are, of course, dependent on features of the
Dutch economy, there are some features of more general interest.
de Jager et al. simulate the consequences of replacing the Dutch tax-benefit
system by a basic income equal to 50% of the net minimum wage with a flat tax rate
set such that the government budget balances.6 Some aspects of the existing system
are maintained in an adjusted form, to prevent certain categories, like the aged, from
losing out. The scheme examined by de Jager et al. for the Netherlands, unlike the one
considered here for Ireland, involves substantial losses of net income for those
remaining unemployed or otherwise dependent on a benefit income7. This leads to “an
enormous fall in the replacement rate of unemployed workers”. Despite this, the
overall impact on labour supply and output is negative. Labour supply decreases
overall by about 6%, largely because of a fall in married women’s participation.
Private employment falls by about 3%, with unemployment also falling by 3.5%, but
production decreases by 6 per cent, because of a shift in the composition of
employment from higher to lower skilled groups..8
5
This structure captures the key contrast between the conventional system, with a high rate of benefit
withdrawal, but a lower marginal tax rate on other incomes, and a basic income system with a flat tax
rate on all income.
6
This flat tax rate derived in their calculations is between 51.5 and 53 per cent.
7
Losses are particularly large for single persons dependent on benefits, where the fall in income is not
offset by a negative income tax payment of a partner.
8
Some of these numbers are very sensitive to the assumptions made about the extend to which
employers and unions re-insure the reduction in the disability allowances. The numbers given above
refer to the case where 75% of the income loss is re-insured, tending to moderate the income losses of
those dependent on disability benefits.
18
Bishop (1979) analyses several antipoverty strategies in a more complete
general equilibrium framework. Prices and wages are endogenous in his model. Both
the occupational choice decision and the average number of hours worked are
endogenously determined, making the supply of labour endogenous. A negative
income tax reduces labour supply that raises the level of wages of the lower skilled.
Savings decline, which depresses GNP further. The authors conclude that low wage
workers are better off with a policy focused on training and education.
19
Chapter 3
BASIC INCOME AND THE FINANCIAL INCENTIVE TO WORK
Tim Callan, Brian Nolan, John Walsh and Richard Nestor
3.1 Introduction
The dynamic impact of a move to a basic income system depends critically on
how it affects outcomes in the labour market. If, on balance, a move to a basic income
system were to lead to higher employment and lower unemployment, then the tax rate
required to finance the scheme would be lower than that calculated on a static basis.
If, on the other hand, the net impact on employment were negative, the tax rate
required to finance the scheme would be higher than that calculated on a static basis.
In order to assess which is the more likely outcome – a “virtuous cycle” of
positive effects on employment and a lower tax rate or a “vicious cycle” of lower
employment and higher tax rates – it is necessary to examine the impact of the
introduction of a basic income on the financial work incentives facing the potential
labour force. This is the task undertaken in this chapter. The analysis in the Phase 1
Report made the technical assumption that labour market behaviour and pre-tax
incomes were unaffected by the shift to a basic income system, in order to arrive at a
“first round” estimate of the tax rate required to finance the scheme. We now build on
that analysis by examining the financial work incentives associated with two variants
of the basic income scheme9, costed on a static basis, and comparing them with the
financial work incentives found under the conventional system. This information is
used in Chapter 5, together with the analysis of migration and the informal economy
in Chapter 4, to inform our assessment of the overall impact on labour supply and the
labour market.
9
The basic income scheme is analysed with and without supplementary payment mechanisms under
the Social Solidarity Fund. The supplementary payment mechanisms included in the analysis were
proposed by the Working Group mainly as a way of compensating incipient losses for those on low
incomes
21
In Section 2, we outline a framework for the analysis of financial work
incentive, and detail the particular measures used in this study. Section 3 reports the
main results concerning the impact of a move to basic income on the balance between
income when in paid work and income when not in paid work, for different groups
and individuals.
3.2 Measuring the Impact on Financial Work Incentives
One of the main advantages claimed for a basic income system is that it would
do away with problems of “unemployment traps” and “poverty traps” for those in low
income employment. It can be argued that this would encourage greater flexibility
among those currently unemployed or in low wage employment to take up
employment or increase their disposable income through higher earnings. This is
because the net reward from employment (or increased working hours) may be greater
under a basic income system than under the conventional system, for such individuals.
On the other hand, the net reward associated with employment may be
decreased for some of those currently in employment, leading them to withdraw from
the labour force or wish to reduce their working hours. If we are to be able to assess
the overall balance of these potentially conflicting forces, we need to be able to
summarise the changes in net rewards to employment for the different groups and
individuals in the potential labour force.
There is an extensive, and rapidly growing international literature which
examines such labour supply issues. One clear theme emerging from this (see, for
example, the recent review by Blundell and MaCurdy, 1998) is that in evaluating tax
and welfare changes particular attention must be paid to decisions about participation
in work. The total labour supply response to a policy change includes changes in
participation and changes in hours of work. For many changes to tax/transfer policy it
is changes in participation which tend to be of the greatest empirical importance.
For this reason, we focus first on the balance between incomes when in paid
work and income when not in paid work, and how this balance is altered by the move
to the basic income scheme proposed. The concrete measure used is a “replacement
rate”, which summarises the balance between in-work and out-of-work income by
taking out-of-work income as a proportion of in-work income:
RR 
Out of work family disposable income
In work family disposableincome
22
Thus, an individual might find that family net income when he or she is
unemployed is £120 per week, but that on taking up a particular job that family net
income would rise to £200 per week. The replacement rate in this situation would be
60%.
For those who are in work, estimated of out of work family disposable income
includes any unemployment assistance payment which might be payable (after meanstesting). For those who are unemployed or not at work, estimated in-work income is
based on the gross full-time pay which, on the basis of their age and education, they
could expect to command in the labour market, and on the consequent adjustments to
the family’s tax and benefit position. The implied gross wage for the unemployed is
below the average of those in employment, reflecting the fact that the unemployed
population tends to have lower educational qualifications. While the focus is on the
incentive facing each individual in a couple, we assume that it is the joint disposable
income of the couple which is of interest to each partner.
One of the advantages of a basic income system is that it avoids difficulties
associated with low take-up of in-work benefits. This advantage is captured in the
analysis below, as a low rate of take-up of Family Income Supplement (1 in 3) is
assumed throughout the analysis for the conventional system. There are, of course,
other ways of achieving this end. For example, child benefit increases, up to the levels
of the basic income payments for children, would be a compromise between a full
blown basic income and the conventional system.
While replacement rates have most commonly been used as summaries of the
financial work incentive for those who are unemployed, the balance between income
when in paid employment and income when not in paid employment is also relevant
to the labour supply decisions others in the population. Replacement rates can also be
applied to those who are in work, and to others in the potential labour force.
3.3 The Impact of Basic Income on Replacement Rates
In considering the impact of a basic income on financial work incentives, we
distinguish between three main groups. First, we consider those who are employees –
the bulk of the labour force. Then we consider those who are unemployed. Finally we
consider individuals – almost all of whom are women – naming “home duties” as
their principal economic status. These groups cover the vast bulk of the potential
labour force. In each table we also note the total numbers in the group, since the
23
overall labour market impact will depend not only on the change in incentives for the
group and the strength of their response to incentive changes, but also on the size of
the group in question.
We examine the impact of a basic income on replacement rates from a number
of different perspectives. One common approach is to select a “cut-off” level, and
focus on the impact on the incidence of replacement rates above that level. The
rationale for such a focus is that it is “high” replacement rates may be more likely to
have an impact on decisions regarding job search and job offers. There is, however,
no clear-cut rationale for a particular choice of replacement rate cut-off in terms of the
impact on labour supply. For this reason, we show tabulations of the impact on the
complete distribution of replacement rates, while focusing in the text on the impact on
replacement rates above a 70% cut off. In interpreting these figures, it should be borne
in mind that the estimated replacement rates are based on the cash elements of the tax
and benefit systems and do not take account of non-cash benefits such as medical
cards. While the change in the replacement rates brought about by a basic income
system will not be affected by this, the level of the replacement rates would be higher
if such non-cash benefits were taken into account.
Table 3.1 shows the distribution of replacement rates for employees under the
conventional system, and under the two alternative basic income scenarios – without
and with the compensation mechanisms - described in the Phase 1 study. We also
examine the sensitivity of the main replacement results to a lower tax rate. This is
done by considering the “basic income with compensation” policy with a tax rate of
50 per cent. While this analysis represents a departure from the internally consistent
scenario used in the distributional analysis and in the other replacement rate analyses,
it may be helpful in assessing the sensitivity of the replacement rate results with
respect to the inherent uncertainties attaching to the estimated tax rate.
In all cases there is an upward shift in the distribution, with fewer individuals at
very low replacement rates (under 30 per cent) and more in the middle ranges (30 to
70 per cent). Looking at the top of the replacement rate distribution, under the
conventional system just over 15 per cent of employees face a replacement rate of
over 70 per cent. Under the basic income scenario this rises to 18-19 per cent (19 per
cent with compensation). The incidence of replacement rates over 100 per cent – 1%
of employees under the conventional system - is however eliminated by the basic
income system. In absolute numbers, the effect is to increase the number of
24
employees facing replacement rates above 70 per cent by between 30,000 and 40,000.
Most of this rise is accounted for by the 70 to 80 per cent category..
Table 3.1: Estimated Replacement rate for Employees, 2001, Under Conventional System
with Mixed Tax Cut Package and Basic Income System.
Replacement Rate
Category
Conventional
System, Mixed Tax
Cut Package
Basic Income
System
Basic Income
System with
Compensation
Mechanism
Sensitivity Analysis
(C) with Lower Tax
Rate
Tax Rate
n.a.
51.2
52.4
50.0
< 10
> 10, < 20
> 20, < 30
> 30, < 40
> 40, < 50
> 50, < 60
> 60, < 70
> 70, < 80
> 80, < 90
> 90, <100
> 100
Total
3.1
5.5
19.5
17.4
15.5
13.2
10.7
6.9
4.7
2.2
1.3
100
0.1
2.1
14.3
19.4
18.1
14.6
13.4
8.8
5.9
3.2
0
100
0.1
1.4
13.3
19.3
18.4
15.4
13.3
9.3
6.2
3.3
0
100
0.1
2.2
14.3
19.8
17.8
14.7
13.3
8.8
6
3.2
0
100
Total
1,107,000
Table 3.2 presents similar information for those who are unemployed and in
receipt of unemployment assistance or benefit. Here the introduction of a basic
income system again eliminates the incidence of replacement rates over 100 per cent,
applying to about 2% of the unemployed under the conventional system. It also
reduces the incidence of replacement rates over 70 per cent from about 16 per cent to
6 or 7 per cent. Thus, the change to a basic income system tends to reduce the
incidence of both high and very high replacement rates for the unemployed, while
raising replacement rates at lower levels. The reduction in the number of unemployed
people facing replacement rates above 70 per cent is estimated at about 12,000 to
13,000 cases.10This arises in part because of the low take up associated with in-work
benefits such as FIS,11 whereas the basic benefit system is one way of ensuring
delivery of benefit to all those entitled to it. As well as the improvement in financial
incentives as measured above (which takes into account the direct impact of the
10
This result is not sensitive to a 3 percentage point exogenous fall in the tax rate required to finance a
basic income.
25
complete take-up) there may be an indirect effect because of the uncertainties attached
to transitions to work which require a FIS claim, uncertainties which do not arise
under the basic benefit system.
Table 3.2: Estimated Replacement rate for Unemployed on UA or UB, 2001, Under
Conventional System with Mixed Tax Cut Package and Basic Income System.
Replacement Rate
Category
Conventional
System, Mixed Tax
Cut Package
Basic Income
System
Basic Income
System with
Compensation
Mechanism
Sensitivity Analysis
(C) with Lower Tax
Rate
Tax Rate
n.a.
51.2
52.4
50.0
< 10
> 10, < 20
> 20, < 30
> 30, < 40
> 40, < 50
> 50, < 60
> 60, < 70
> 70, < 80
> 80, < 90
> 90, <100
> 100
Total
1.5
5.8
16.1
22.1
16.4
13
9
6.5
5.3
2.5
1.6
100
0
3.2
12.2
24.1
27.9
17.4
9.2
4.6
1.2
0.3
0
100
0
2
11.6
23.1
27.1
19.2
10.2
5.4
1.2
0.3
0
100
0
2.8
11.2
24.8
26.9
18.7
9.8
4.6
1.1
0.3
0
100
Total
130,000
Finally, in table 3.3, we turn to those (almost exclusively women) who classify
themselves as “engaged in home duties”. Under the conventional system, about 36 per
cent of this group face replacement rates of more than 70 per cent. Under either of the
basic income systems, this proportion rises to close to 50 per cent. This result is robust
with respect to a change in the basic income tax rate of 3 percentage points. (Only a
small number face replacement rates over 100% under the conventional system, but
these are again eliminated). This represents a major shift in the balance between
incomes in paid work and incomes when not in paid work. The number of individuals
in home duties and facing replacement rates of over 70 per cent rises by about 60,000
(with a rise of about 27,000 in the numbers facing replacement rates of over 80 per
cent).
11
Recall that a take-up of 1 in 3 is assumed for FIS under the conventional system.
26
Table 3.3: Estimated Replacement rate for Home Duties, 2001, Under Conventional System
with Mixed Tax Cut Package and Basic Income System.
Replacement Rate
Category
Conventional
System, Mixed Tax
Cut Package
Basic Income
System
Basic Income
System with
Compensation
Mechanism
Sensitivity Analysis
(C) with Lower Tax
Rate
Tax Rate
n.a.
%
51.2
%
52.4
%
50.0
%
< 10
> 10, < 20
> 20, < 30
> 30, < 40
> 40, < 50
> 50, < 60
> 60, < 70
> 70, < 80
> 80, < 90
> 90, <100
> 100
Total
0.3
0.7
3.4
10.2
15.3
14.7
19.4
18
14.2
3.3
0.4
100
0
0.5
1.7
4.3
9.1
15.1
20.6
27
18.5
3.1
0
100
0
0.5
1.1
3
8.4
15.4
21.1
25.9
21.2
3.2
0
100
0
0.5
1.7
3.3
8.8
15.5
21.3
25.9
20
3
0
100
Total
463,700
Another perspective on the changes in replacement rates that would be brought
about by a move to the basic income scheme is given in Table 3.4, which focuses on
the percentage of individuals in the various groups seeing their replacement rate rise
or fall by different amounts. We see that replacement rates rise for most employees,
with increases of over 5 percentage points for about half of employees, and a rise of
over 10 percentage points for over a quarter. For those who are unemployed, an
increase in replacement rates is also more likely than a decrease; but very large falls
are more common than very large rises in the replacement rate. For those who are
engaged in home duties the pattern of change is similar to that for employees, with
increases of over 10 percentage points being even more common. This broad pattern
is not very sensitive to an exogenous change in the tax rate required to finance a basic
income (as shown by the figures for the sensitivity analysis, shown in the table in
italics).
27
Table 3.4: Changes in Replacement Rates under Proposed Basic Income by Labour Force
Status (Basic Income with Compensation, 52.9% tax rate and, in italics,
sensitivity analysis to 50% tax rate)
Fall in percentage points
Little
Rise in percentage
Total
change
points
More
5 - 10
1-5
Within 1
1 - 5 5 - 10
More
than 10
percentage
than
point
10
6.8
3.1
6.3
12.0
26.6
19.9
25.3
100
Employees
6.1
3.1
4.0
9.0
27.0
23.3
27.5
100
Unemployed on
UA or UB
17.1
16.6
8.5
6.4
12.5
9.8
7.7
8.3
31.3
32.2
13.3
16.7
9.5
10.0
100
100
Home Duties
4.2
3.6
5.9
5.3
5.3
4.6
9.8
8.7
22.7
23.3
19.0
18.5
33.1
36.0
100
100
Total
6.9
6.3
4.3
3.9
6.5
4.6
11.0
8.8
25.9
26.4
19.1
21.5
26.2
28.5
100
100
As well as current labour force status, we are also interested in the distribution
of replacement rate effects by other characteristics of the individual concerned. In the
context of responsiveness to these incentives to take up paid employment, we will see
in Chapter 5 that married women tend to be rather more responsive than single
women or men, and that low-education men may be more sensitive than men with
higher levels of educational attainment. For that reason we now look at how the
replacement rates of these different groups are affected by the introduction of the
basic income scheme. Table 3.5 shows that while about 20-30% of the individuals in
each of these four groups see their replacement rates fall or little changed, a
substantial majority in each case see those rates rise. Between one in five and one in
three, depending on the group, see an increase of 10 percentage points or more in their
replacement rate.
28
Table 3.5:
Changes in Replacement Rates under Proposed Basic Income for Different Groups
Fall in percentage points
Married Women
Non-married
women
Men with 2nd.
Level education
Men without 2nd.
Level education
Total
More than
10
5 to 10
1 to 5
3.5
9.6
4.1
3.7
3.2
6.0
Little
change
Within 1
percentage
point
10.0
6.7
5.6
3.3
5.1
10.1
5.2
6.2
3.9
Rise in percentage points
Total
1 to 5
5 to 10
More than
10
25.7
30.1
20.3
16.2
33.2
27.7
7.1
26.8
25.3
26.7
8.2
7.3
24.9
23.2
21.1
100.0
4.9
8.2
27.0
21.1
28.7
100.0
100.0
100.0
When we cross-classify within these groups by current labour force status (not
in table), this shows that once again current employees and those in home duties are
most likely to see their replacement rates rise substantially. This does also occur for
some of the currently unemployed, but far more of them see their replacement rates
fall. In particular, most unemployed married women would see a substantial fall in
their replacement rate. Of the four groups, the effects for married women vary most
with current labour force status. One-third of married women who are currently
employees or in home duties see their replacement rate rise by 10 percentage points or
more, whereas 42% of the married women who are currently unemployed and in
receipt of UA or UB see their replacement rate fall by that much. We return to the
importance of this particular categorisation in Chapter 5.
It is also worth focusing on not simply those who see a substantial increase in
their replacement rate – of 10 percentage points or more – but the sub-set for whom
this brings the replacement rate up to over 70%. These are the group whom one would
expect to be most likely to respond in terms of participation decisions. Most of the
individuals for whom this occurs are, once again, married women who are either
currently employees or in full-time home duties. When these are examined in detail, it
is clear that by far the most important factor serving to increase their replacement
rates in the shift to the basic income scheme is the higher income these people would
then receive when out of work (rather than reductions in in-work income). For many,
their entitlement to a full personal basic income payment means their income when
not in paid work would be a good deal higher than under the current social welfare
system.
29
3.4 The Impact of Basic Income on Marginal Tax Rates
As well as affecting the incentive to be in employment, the basic income
proposal also involves quite substantial changes in marginal tax rates for many
individuals. Even if the changes in the balance between in-work and out-of-work
incomes do not cause individuals to change their participation decisions, these
changes in marginal tax rates might affect the individual’s desired hours of work. For
example, a full-time worker whose net income was unchanged by the reform, but
faced a higher marginal tax rate, might be less willing to work overtime and/or more
inclined to opt for part-time work. Or a low-income worker, receiving FIS, might find
that under a basic income system, the incentive to take on extra hours of work had
improved.
Table 3.6 shows the distribution of marginal tax rates under the conventional
system, as projected for the year 2001, under the “mixed tax cuts” package. The
marginal tax rate is defined here to include income tax, employee PRSI contributions,
levies and the withdrawal rate for Family Income Supplement for those benefiting
from the scheme. (Only those who are classified as “at work” i.e., in paid employment
or self employment, are included in this analysis: for those who are not at work the
replacement rate measures reported earlier are of more relevance than the marginal
tax rate on an additional pound of earnings.)
Table 3.6:
Estimates of Marginal Tax Rates for Individuals “At Work”, Under
Conventional with Mixed Tax Cut Package, 2001
Marginal tax rate
% of individuals
% of individuals
(conventional system) (basic income)
6.5
0
8.3
41.9
0.7
24.8
17.1
100.0
0.7
100
100
1,418,299
<10
10<20
20<25
25<30
30<45
45<50
50<55
60<80
Total (%)
Total (Number of individuals)
It is useful at this point to recall that the standard tax rate in the scenario is 22
per cent, and the top tax rate is 45 per cent. For most employees PRSI and levies
bring these tax rates up to 29 per cent and 52 per cent. The distributions are heavily
clustered around these values, with some variation depending on the PRSI class
30
(private sector, public sector or self-employed) and liability for levies. Roughly
speaking, we find that something over 40 per cent of those in paid work are liable at
the top rate of tax – somewhat higher than the proportion of all taxpayers, as those in
employment include more high earners than, for example, those with pension
incomes. Somewhat more than 50 per cent are liable at the standard rate of tax, with a
further 7 per cent liable only for PRSI.
The estimated tax rate for a basic income system, with or without compensation,
lies between 51.4 and 52.9 per cent. The precise impact of such a change on top rate
taxpayers is somewhat sensitive to the exact figure for the basic income tax rate, but
the broad picture is much clearer. The main impact of the change is on the 57 per cent
of taxpayers with tax rates of below 30 per cent under the conventional system. Their
marginal tax rates would rise to about 50 per cent under the basic income system. For
those on the top tax rate, there could be a small rise or even a small fall in the
marginal tax rate, depending on the precise tax rate. The move to a basic income
system would reduce the tax-cum-benefit withdrawal rate facing the small proportion
of cases affected by FIS withdrawal under the conventional system.
31
Chapter 4
The Impact of Basic Income on Migration and the Informal
Economy
Gerry Boyle and Tom McCarthy
4.1 Introduction.
In analyzing the dynamic impacts of a Basic Income it is important to look
beyond the impact of incentive effects on current members of the labour force. This
involves determining whether a basic income scheme will affect labour force
participation and the size of population in the country. In this chapter we will explore
aspects of these questions. We assess the likely impact on migration and the aspect of
the participation decision that relates to activity in the informal relative to the formal
economy.
The scale of impact is what is of main concern. This is particularly true in
regard to migration. In the past migration flows have shown dramatic shifts. For
instance net out-migration was 41,900 persons (3.2% of the labour force) in 1988
while net in-migration was 22,800 persons in 1998 (1.4% of the labour force).
The informal economy is not a precise concept. On the one hand it refers to the
unofficial economy that may arise as a consequence of the welfare state, i.e. off the
books work at lower cost to the employer accompanied by untruthful benefit claims
delivering a higher income to the worker than would be achieved in the formal
economy, either as a worker or a truthful benefit recipient, and the tax system, i.e. tax
evasion. The so-called social economy is another aspect of the informal economy. A
broad definition is offered by Clarke and Healy (1997), including “home activities
(sometimes called household production) such as child rearing and care for the
elderly, and volunteerism”. The term “social economy” has taken on a much more
specific meaning under the Partnership Agreements. (Report of the Working Group
on the Social Economy, under Partnership 2000), which is also considered here.
We can identify a number of hypotheses concerning the dynamic impact of
basic income in relation to migration and the informal economy.

A basic income induces inward (welfare-driven) migration and outward (taxdriven) migration.
32

A basic income reduces the size of the unofficial economy since no benefit
advantage will accrue to off the books working.

A basic income increases the size of the social economy, broadly defined.
4.2 Migration.
4.2.1 What drives Migration?
The economic analysis of migration relates migration to differences between
income at home and expected income abroad. Harris and Todaro (1970) formulated
the essential characteristics of the analysis. The analysis can be conducted at various
levels of complexity. Income, for instance, can be defined in terms of discounted
lifetime streams while expectations on labour market status can be related to
unemployment rates and growth prospects. Psychic income, arising from preferences
for location specific intangible characteristics, can also contribute to the location of
population (see Borjas, 1994 for a survey).
The relationship between fiscal action and migration has been developed in the
literature on fiscal federalism within sovereign states. Fiscal federalism is the process
whereby different layers of government within a country share taxing and spending
powers. Intergovernmental transfers of some form usually accompany such a process.
The rationale for these transfers arises from the supposed inefficiency of the migration
equilibrium in their absence. If lower levels of government differ in their capacity to
raise source-based taxes, “net fiscal benefits” (i.e. the benefits from local public
services less the cost of contributing to these goods) will vary so that private incomes
can differ in equilibrium. Now this means that a higher “net fiscal benefit” prevents a
worker from migrating to a region where he can be more productive. This outcome
means that national product would be higher in the absence of the fiscally induced
migration. In this way an efficiency case can be made for intergovernmental transfers
that equalize net fiscal benefits. An extended discussion of this literature can be found
in McCarthy and McCarthy (1989) while recent perspectives are developed by Smart
(1998).
We are not concerned with efficiency questions in this section – that is an issue
that arises in respect of the third hypothesis. However, the literature discussed above
provides a framework in which we can explore the first hypothesis. We imagine that
migration flows can be explained in terms of changes in two variables – the Todaro
33
differential and net fiscal benefit. The latter of these has been defined above. The
former is the difference between home income and expected income abroad. Expected
foreign income is the product of foreign incomes and the prospect of getting a job.
The impact of basic income on migration can be explained with reference to its
changes to the Todaro differential and relative net fiscal benefit. In this chapter we
will focus on the impact arising from changes to net fiscal benefit. It would be
necessary to have results on general labour market outcomes in order to explore a
migration connection through changes in the Todaro differential. In particular we
would need to know whether the introduction of a basic income would change the
potential immigrants’ perception of the prospect of obtaining a job in Ireland.12
We will assume that the level of public goods provision will not change as a
consequence of the basic income. It is changes in the tax contribution that change net
fiscal benefit. The incremental impact of the basic income depends on its tax
contribution changes relative to some baseline. In Phase 1 of this study it was
demonstrated (see Table 5.A.1) that the distributional impact of a basic income
scheme was not very sensitive to alternative tax-cutting strategies that could be used
as the baseline. It was shown that the percentage increase in income was 10% or
greater for the lowest three deciles while income reductions occurred for the top four
deciles. We will take these changes as indicative of the impact on net fiscal benefit.
4.2.2 What are the characteristics of the Migrants?
Migration patterns for the last decade are summarized in Table 4.1. The most
striking feature is the change in the pattern of net migration. Net emigration was just
under 44000 people in 1989 while net immigration reached 22800 in 1998. The
reduction in emigration was slightly more significant – a peak to trough fall of 70% than the increase in immigration where the peak to trough change was 60%. We use
the net migration rate, i.e. the numbers of net migrants as a percentage of the labour
force, as a summary measure of changes in the labour market significance of the
pattern of migration. This figure has gone from a low of –3.36 (net emigration) to a
high of 1.41 (net immigration). We recognize, of course, that in a hypothetical
12
Results from the net fiscal benefit analysis, and the overall conclusions on labour market impact
suggest that it is unlikely that the impact of the Todaro differential would be large.
34
extreme case – all migrants in retirement age – that the net migration rate would have
no direct labour market significance.
We are ultimately interested in the overall change in the migration pattern that
might result from the introduction of a basic income. As we will see this impact is
sensitive to the composition of migrants. We know that a basic income will make
some better off and others worse off relative to some baseline. This is the basis of the
first hypothesis described in the introduction. The prospect of gain may induce less
emigration or more immigration while the prospect of loss may induce more
emigration. We know that the former are in the lower end of the income distribution
while the latter are those in the top four deciles. The question then arises as to whether
migrants as a group are broadly reflective of the population.
Questions introduced for the first time in the 1986 Census and questions
regarding nationality and previous residence in the Labour Force Survey (and
continued in the Quarterly National Household Survey) allow us to characterize the
stock and flow of immigrants. The classification of emigrants is more difficult,
however.
Punch and Finneran (1999) have used these data sources to give an overview of
the characteristics of migrants. Among the findings are that the inflow of migrants is
bunched in the 20 to 34 age group. 50% of male and over 50% of female immigrants
are in this age group. While the stock of migrants indicates higher average educational
attainment there is some evidence of higher unemployment among the inflow of
migrants. This is indicative of a common view that there are two distinct types of
immigrants – “those with skills and qualifications who are readily employable and the
unskilled who may experience difficulties in getting a job” (Punch and Finneran,
1999: 234).
Information on the type of person who emigrates can be gleaned from an
examination of families from whom a member has emigrated. This, of course, ignores
those entire families who emigrate. However, given that the age profile of emigrants
is younger – 53% were aged 15-24 in 1999 – it is likely that any bias introduced by
the form of data collection, is relatively small. The main finding is that emigrants are
more likely to come from affluent households and owner-occupied households. It is
therefore likely that a disproportionate share of emigrants might be classified as
potential tax-driven migrants.
35
Table 4.1 Migration Patterns 1988-1999
Emigrants
Immigrants
Net Migrants
Labour Force
Thousands
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
61.1
70.6
56.3
35.3
33.4
35.1
34.8
33.1
31.2
29
21.2
29
19.2
26.7
33.3
33.3
40.7
34.7
30.1
31.2
39.2
44
44
47.5
-41.9
-43.9
-23
-2
7.3
-0.4
-4.7
-1.9
8
15
22.8
18.5
Net Migration
Rate
1327.7
1307.8
1332.1
1354.4
1371.8
1403.2
1431.6
1459.2
1507.5
1539
1621.1
1688.1
-3.16
-3.36
-1.73
-0.15
0.53
-0.03
-0.33
-0.13
0.53
0.97
1.41
1.10
4.2.3 Changes in the number of migrants
The economic motive for migration is a perception of being better off in another
country. As explained in section 4.2.1 we imagine that migration flows can be
explained in terms of changes in the Todaro differential and in net fiscal benefits. For
our analysis the introduction of a basic income has no impact on the Todaro
differential but changes net fiscal benefit and thus induces the migration flow. The
change in net fiscal benefit is represented by a percentage change in income. We
assume that social security systems are unaltered in the countries of origin and
destination of Irish migrants so that the income change due to the basic income
induces a change in net fiscal benefit. The impact of this change in net fiscal benefit is
related to the migration flow via the migration elasticity which is defined as the
change in the migration rate in response to a one percentage point change in the
income differential, i.e. the change in net fiscal benefit.
In order to operationalise this model we need data on the migration elasticity
and the income change induced by the introduction of a basic income. Boyle (1992)
has estimated a migration elasticity of 0.01. We use this as a baseline and scale up by
36
orders of magnitude in order to assess the sensitivity of the migration response to this
elasticity. The scaled-up values we use are 0.05, 0.1 and 0.2.
It is a mechanical exercise to posit a variety of income changes and work though
the impact on migration using our model. What is of concern here is the impact of
delivering benefits – or more generally, allocating a given budget - via a basic income
rather than some other means. This is known as the differential analysis of the impact
of a basic income. In order to perform such an analysis we need distributional
information on the distributional impact – again in differential terms – of a basic
income. This information is contained in the Appendix to Chapter 5 of the Phase 1
report. Table 5.A.1 contains details of the percentage change in income by decile that
would result from a basic income relative to three tax cutting strategies, increased
allowances, mixed tax cuts and standard rate cut and wider band. The results are
broadly similar for each of the alternative strategies. We will therefore use the
distributional impact of the basic income measure against tax cuts used to fund
increased allowances.
Our objective is to use the framework outlined above along with this data to
measure the change that might occur to migration flows. Our base will be the 1998
migration flows, as classified by country of origin or destination. What we do not
know, however is the distributional characteristic of migrants relative to the general
population. As a consequence we simulate three scenarios. The first, POP, assumes
that migrants exactly reflect the income distribution of the Irish population as
captured in the Living in Ireland Survey. The second, POOR, assumes that all
migrants are in the bottom decile while the third, RICHPOOR, assumes that all
emigrants are in the 9th decile and all immigrants are in the poorest.
Table 4.2: Net Migration Rate and Basic Income
Actual 1998: 1.41
Distributional
Assumption
NDE
POP
POOR
RICHPOOR
Migration Elasticity
0.01
0.05
0.1
0.2
1.41
1.41
1.43
1.42
1.41
1.42
1.54
1.49
1.41
1.44
1.67
1.58
1.41
1.47
1.93
1.75
37
The results are contained in Tables 4.2 and 4.3. NDE refers to a case where we
posit an income increase of half a percentage point and ignore distributional effects.
We see from Table 4.2 that this results in no change in the migration rate, relative to
its 1998 base of 1.41, regardless of the size of the migration elasticity.
For the baseline migration elasticity the differential impact of a basic income is
very small. The largest change in net migrant numbers occurs for the POOR
distributional assumption where the basic income would cause net migrant numbers to
increase by 424.13
The results are very sensitive to the migration elasticity once we include the
differential impact. A migration elasticity of 0.2 combine with the POOR
distributional assumption would result in a 37% increase in migration. However, these
simulations are intended to be illustrative of the kind of migration sensitivity required
in order to produce a large change in the migration rate. The migration elasticity
would need to be five times greater than our baseline in order to approach a ten per
cent increase in net migration numbers. A 2200 change in the number of net migrants,
however, is less that the recorded changes in net migration between 1997-98 and
1998-99.
Our estimate of the migration elasticity is at best indicative. Nevertheless our
analysis indicates that the introduction of a basic income would, in all reasonable
scenarios, have a very small impact on the flow of migrants.
Table 4.3 Percentage Increase in Net Migration Numbers
Actual 1998: 22800
Distributional Assumption
Migration Elasticity
0.01
0.05
0.1
0.2
0.01
0.07
0.14
0.29
POP
0.24
1.20
2.39
4.79
POOR
1.86
9.32
18.64
37.29
RICHPOOR
1.22
6.09
12.18
24.36
13
In precise terms the model says that had all things been the same in 1998 the basic income would
have resulted in net migration being 23224 rather than 22800.
38
4.2.4 Further Considerations
To this point we have not addressed the question of entitlements, i.e. whether
immigrants are entitled to the same social security rights as existing residents.
Freedom of movement between member states is one of the basic rights established by
the treaties of the European Union. However, social security systems differ across
countries. As a consequence there is a need for Community rules to protect such rights
within the union. Two basic principles are employed to guide this process (European
Commission, DGV, 1999): a citizen is subject to the rules of one country at a time a
citizen is usually insured in the country where he/she exercises his/her professional
activity. Practice in regard to unemployment benefit and family allowance is likely the
most relevant in relation to entitlement to payment under a basic income.
If basic income is classified in the same way as unemployment benefit then it is
unlikely to promote any long term “welfare migration” from other EU countries.
Under the current system entitlement to unemployment benefit in another EU country
exists for the purpose of seeking work in the host country. The entitlement lasts for a
maximum of three months.
Entitlement is somewhat more complex if the basic income is classified in the
same way as family allowance benefits. The rules operate as follows: “if your family
does not live in the country under whose legislation you are insured, your family may
be entitled to family benefits in several countries, i.e. the country you work in and the
country your family lives in. In such a case your family will get the higher amount of
benefit available” (EC DGV 1999). This would open up the possibility of migrants
seeking to work or reside in Ireland while benefits would be payable in respect of a
family still residing in the migrant’s home country. Under these circumstances, the
migration response to the introduction of a basic income might be somewhat greater.
However, we do not regard this as a “central case” for our analysis. Instead, we
consider that a basic benefit dependent on residence, with rights to residence restricted
to EU nationals and others as determined by existing rules forms a more suitable
central case for the analysis.
The expansion of the EU will bring in countries where income per capita will
be significantly below that of Ireland. The attraction of Ireland has grown with recent
economic growth and the country has in recent times experienced the pressures of
large-scale immigration, including a surge in the number of asylum seekers. The
forces underlying these trends can be expected to have a significant and growing
39
impact under both the conventional tax-benefit system and under a basic income
system. Differences in the migration impact of the alternatives systems are therefore
liable to be magnified in future years.
The simplicity of the basic income system, it is argued, is a significant strength
of basic income. However, it is also likely to contribute to increased immigration, all
other things equal. McCarthy (1993) argued that risk averse individuals are more
likely to make labour market transitions if the income support system guaranteed – in
an uncomplicated manner - an income level regardless of labour market status. The
basic income guarantees a floor income. Now if this is significantly high relative to
average income in a poorer EU country this argument would suggest that the very
structure of the basic income – its simplicity and certainty – would contribute to
increased migration. This suggests that the basic income could be more significant for
migration in the longer term.
Our analysis to date has concentrated mainly on the aggregate net impact on
migration flows, arising from changes in net incomes. It can also be argued that the
composition of such flows is an important consideration, and that the removal of the
conditionality of payments could have implications which are not captured by the
foregoing analysis.
The pattern of distributional impact suggests that Ireland would become a
more financially attractive destination for many of those in the lower reaches of the
income distribution, but less attractive base for those in the upper reaches. Thus, one
would expect the skill composition of outflows and inflows to be affected, even if the
impact on net flows was close to zero. The direction of the likely effect is that those
able to command high wages would predominate among emigrants, while those with
lower skills would bulk larger among immigrants, altering the skill composition of the
Irish labour force.
The sensitivity analysis for higher migration elasticities can, to some extent,
take account of the impact of the removal of conditionality on the net migration
impact. But again, the impact on the composition of flows may be of interest. The
removal of conditionality increases the value of the basic benefit payment particularly
for those who wish to opt out of seeking work in the formal economy. Thus, some
element of inflow from those in this category could be expected.
Taken together the arguments in this section suggest that the introduction of a
basic income is likely to have a limited effect on the net migration balance in the short
40
term, but to have a more significant impact on the composition of gross inflows and
outflows. Differences in the migratory aspects of the conventional system and the
basic income system are likely to be magnified by the entry of poorer countries into
the EU.
4.3 The Informal Economy
In this section we will examine the impact of basic income on that section of
economic activity that has often been referred to – by the clearly inappropriate term –
as the “black economy”. We will use the term, unofficial economy. This is one aspect
of the informal economy – we will discuss the social/voluntary economy below.
The unofficial economy encompasses that aspect of economic activity which
would normally be included in calculating the national accounts but is hidden because
the participants are infringing against the rules governing the payment of taxes and/or
the receipt of benefits. For convenience such activity can be referred to as off the
books working.
The participants in the unofficial economy are likely to differ with respect to
their position in the income distribution with their modus operandi related to this
position. Those in the lower end of the income distribution are likely to combine paid
work and an out of work benefit. The amount of tax evaded, if any, is likely very
small. On the other hand those at the upper end of the income distribution will more
likely engage in off the books working through tax evasion.
By the very nature of the unofficial economy it is not possible to measure its
size with any degree of precision. A variety of methods have been used – one popular
method tracks the use of large denomination notes.14 International estimates of the
size of the unofficial economy as a percentage of GDP have fluctuated between
numbers less than 10% to figures over 20%. In a recent paper Thomas (1999)
criticizes this work claiming that it involves crude “guesstimates” which are of limited
value to policymakers. He goes on to argue that the presence of an unofficial economy
may represent an endogenous response to the economic policy environment. Thus tax
evasion may signal an “over-taxed” economy while social security fraud would
suggest that actual unemployment levels are lower than represented by a live register
count. These arguments are quite familiar in Ireland. We do not address these issues
in this section. However, it should be noted that the concept of being “over-taxed”
41
requires a precise definition of the optimal amount of tax collection. No such
definition exists. As a consequence “explanations” of tax evasion that rely on
arguments relating to “over taxation” should be considered mere points of view rather
than the product of economic analysis.
What can be said is that tax and benefit withdrawal rates, and their
replacement by a basic income system, affect the incentives to engage in rulebreaking behaviour. The main factors involved are illustrated in Table 4.4 below.
Table 4.4
Taxonomy of Incentives for Participation in Unofficial Economy
Conventional system
Basic income system
“off the books gain is due to high tax-cum-
reduced gain as tax rate is lower
working”
than combined tax-cum benefit
benefit withdrawal rate
while claiming
withdrawal rate
benefit
tax evasion by
working
gain depends on tax rate
increase in potential gain for a
faced
majority of taxpayers, stable for
population
most others (see Table 3.6)
The incentives to conceal income from the tax and welfare authorities depend not only
on the nominal marginal tax rate but on the effective tax-cum-benefit withdrawal rate
on the income concerned. For those involved in “working and claiming” under a
conventional system, the gains would be reduced by a move to a basic income system,
which would replace effective tax-cum-benefit rates of close to 100% with rates of
about half that level. On this basis, a move from rule-breaking to compliance would
be less costly for the individuals concerned, and some such response could be
expected. There would, of course, remain a gain from the concealment of income
from the tax authorities so that a complete end to rule-breaking behaviour of this type
would not be expected simply on the basis of the changed incentives.
As seen in Chapter 3, marginal tax rates rise for a majority of those currently
in employment or self-employment, for whom benefit withdrawal rates are not an
issue. The rise is at least 20 percentage points (from under 30 to about 50 per cent) for
most of those in employment and self-employment. For the remainder, the tax rates
14
See Boyle (198x) for a thorough discussion
42
are broadly similar. This change would increase the incentive to evade tax by
concealing income.
The net impact of the change to a basic income system on the overall extent of
the unofficial economy would therefore depend on a number of factors. Among these
would be the relative size of the two phenomena described in the table above – off the
books working while claiming benefit, versus tax evasion by those not claiming
welfare. The relative responsiveness of the two groups to the changed incentives
would also play a role. A further issue would be the extent to which enforcement of
regulations would be affected by the shift to a basic income system. On the one hand,
the simplicity of the system could be seen as making it easier to enforce. On the other
hand, the removal of conditionality could make it more difficult to detect some forms
of concealed work.
Given the inherent difficulties in obtaining information about the unofficial
economy there are severe limits on what research can tell us about the likely
responses here. But some new evidence on the extent of “off the books” working by
welfare claimants is worth considering.
In 1992 and 1993 the then Department of Social Welfare introduced active
labour market schemes that had as their common element the continuation of out of
work benefits after taking up employment or becoming self-employed. The first of
these – the Area Allowance Enterprise Scheme – was launched in 1992. It was aimed
at facilitating benefit recipients in establishing a business and involved the retention
of primary and secondary benefits for a period. The Back to Work Allowance Scheme
was introduced in 1993 following the creation of the Employment Support Service
within the Department. For our purpose the evaluation of these schemes (Ireland 1997
and 1997a) provide valuable assistance in putting bounds on the possible size of
unofficial economy participation by welfare recipients.
43
The evaluation of the Area Allowance Enterprise Scheme (AAES) collected
evidence on prior involvement of participants in the unofficial economy since “an
implicit if not explicit objective of the AAES is to provide a route out of the black
economy” (Ireland 1997a, 18). Similar data was collected for the Back to Work
Scheme (BTWS). We will make use of these survey results to assess the likely impact
of a basic income.
18% of participants in the AAES (sample size 111) reported working in the
unofficial economy with two-thirds of these working for more than 50 days in the
year. Participation in the unofficial economy was slightly lower for those on the
BTWS at 15.1% (sample size 390) and almost 40% of these worked for less than 50
days in the year. On the AAES average annual income was a little under £2,000 for
those working less than 50 days and just over £3,000 for those working more than 50
days. The corresponding numbers on the BTWS were £930 and £2,900.
If we use the lower of the figures above for participation in the unofficial
economy (15.1%) and apply this to the LR as a means of determining the impact of
the basic income, we arrive at a figure in excess of 15,000 people who would be
reclassified as part of the official economy. However, this is likely an overestimate for
a number of reasons. First, 6% of respondents on the BTWS cited the desire to go
legitimate as their motivation for participating in the scheme. Hence it is likely that
the participants in the AAES and the BTWS are over-representative of participants in
the unofficial economy.15 Second, it may not be appropriate to apply any given
percentage to the entire LR. It may be that significant participation in the unofficial
economy would be more difficult for those who are only short-term unemployed.
These considerations would suggest a figure of less than 7,500.
Even if the highest figures derived here were taken as indicative of the scale of
“off the books” working by welfare claimants, and a high responsiveness to the
changed regime in terms of increased compliance, the aggregate impact would seem
to be relatively limited. It could be offset by a relatively small aggregate response in
terms of income concealment by the 800,000 taxpayers facing an increase in tax rates
of over 20 percentage points. As noted earlier, the lack of hard information in this area
– which is inherent in its very nature – means that any judgement on the overall effect
is subject to a wide margin of error.
44
4.4 The Social Economy
As defined by the P2000 Working Group the social economy would have the
following characteristics:

ownership within a community, and responding to market demand regardless
of source of income, and a focus on the economic or social development of a
community or community of interest;

operation benefiting the community and individual members;

providing for employment experience and employment opportunities which
are sustainable, but which might nonetheless be dependent on State support.
It seems that the proposed basic income scheme would involve net payments of about
£25 per week per person engaged in “socially useful work”, over and above the basic
income payment itself, which would not be linked to work status. The issue which
arises here is whether individuals would be more likely to participate on such schemes
under a basic income system (when the net additional payment is about £25 per week)
or under a conventional system.
A wider definition of the social economy encompasses that aspect of economic
activity that does not get included in national accounts measurement because no
market exchange takes place. That is, exchange occurs through a voluntary
mechanism that may or may not involve reciprocal exchange.
The “Pathways” document argues that the most dynamic effects of basic
income will be manifested in relation to the social economy. Activity in the social
economy includes home activities and community activities. While home activities
will involve some implicit if not explicit arrangement between individuals,
community activity stems from volunteerism. Community activity can therefore be
viewed as having elements of a public good i.e., something from which everyone
benefits (and cannot be excluded from benefitting). While everyone wants the good to
be provided, the ideal situation for an individual is that he or she does not personally
pay for it, but that others do i.e., the individual is a “free-rider”. The factors that
contribute to voluntary activity are not well understood. In economic terms we could
argue that the factors that facilitate private provision of public goods – i.e. those that
curb the free-rider problem - might also encourage volunteerism.
15
This is not to say that the numbers above are an overestimate since people might have chosen to
participate in the scheme for reasons other than going legitimate.
45
Why would the introduction of a basic income encourage volunteerism? It is
difficult to make a case for a reduction in the free riding motive merely as a
consequence of introducing a basic income. That is, it would involve making a heroic
assumption about behaviour to conclude that “community spirit” might change as a
result of a basic income.
An alternative focus would be to think in terms of the implications of the
impact of a basic income on labour market participation. To the extent that individuals
withdraw from labour market participation or reduce their hours of work, they would
have additional time available for other activities. This could include voluntary and
community sector activities, or time spent on caring for the elderly and children in the
individual’s own family. The net effect on the former may be positive, though the
extent is uncertain. The net effect on the latter is also likely to be positive, as we have
seen that women with children are among those most likely to withdraw from the
labour market in response to the changed incentives provided by a basic income.
In evaluating the overall impact of a basic income, it would be necessary to
arrive at a judgement not only on the likely scale of the impact on such activities, but
also on the social valuation attached to them. This requires both a more developed
analytical framework and a more explicit set of policy judgements on these issues
than are currently available, but the broad point that the size of market activity is not
the sole criterion for policy choice must be noted. Non-market activity can be seen as
an alternative way of providing for social needs; while market activity influences not
only the supply of goods and services, but also helps to determine the size of the tax
base.
46
Chapter 5
ASSESSING THE LABOUR MARKET IMPACT
Tim Callan and Brian Nolan
5.1 Introduction
In Chapter 3 we estimated the impact of a move to a basic income on the
financial incentives to work in the formal economy, as faced by three key groups:
those in employment, those currently unemployed, and those who are classified as
being engaged in home duties. Chapter 4 has examined the impact of a basic income
on incentives to emigrate and immigrate, and on the balance between participation in
the formal and informal economies. Here we attempt to draw out the overall labour
supply implications of the changes, and how these labour supply implications will
interact with the demand for labour to produce different labour market outcomes.
Section 2 of this chapter reviews the available evidence on the differential
responsiveness of different groups in the population to changes in financial work
incentives. This informs the discussion of the likely consequences in terms of shifts in
labour supply. Section 3 outlines the key distinction between factors tending to shift
the labour demand schedule, and movements along that schedule caused by changes
in labour supply. Section 4 brings together both demand and supply-side
considerations to examine the potential consequences of a basic income for the level
and composition of employment.
5.2 Labour Supply Issues
Chapter 3 outlined the “first-round” impact of a shift to a basic income scheme
on the financial incentive to work facing different elements of the potential labour
force. The ultimate impact of these changed financial work incentives depends
critically on the responsiveness of the different elements of the potential labour force
to such changes. In this section we review the available evidence on the
responsiveness of key groups.
One key finding in the international literature has been that the labour force
participation of women, and in particular, of married women, has tended to be
significantly more responsive to financial work incentives than the labour force
participation of men. Irish studies of this topic have, until relatively recently, been
47
hampered by the lack of suitable micro data, combining information on labour market
participation, individual and family characteristics, and wages and hours of work. The
large-scale household survey carried out by the ESRI in 1987 was one of the first to
provide the type of microdata required for the analysis of labour supply for a
representative sample of the population as a whole. Analyses using that survey,
including Callan and Farrell (1991) and Callan and van Soest (1996) have provided
useful insights into the relative responsiveness of the labour supply of men and
married women. More recent evidence is available from Callan and Doris (1999).
Before considering the results of these studies, it is useful to clarify the nature of
the measures of responsiveness used in them. The wage elasticity of labour supply
measures the percentage change in labour supply for a one per cent increase in wages.
The aggregate wage elasticity of labour supply includes responses via increased
participation and via changes in hours of work. The wage elasticity of participation
may also be of particular interest, as in many cases it is the dominant element in the
labour supply response. Sometimes wage elasticities are evaluated for hypothetical
cases, at the sample mean. But the wage elasticities reported here for these studies are
based on simulation of a change in wages across the relevant sample, and are
therefore more representative.
Callan and Farrell (1991) focused principally the on labour supply of married
women Their analysis incorporated models both of female participation and of hours
of work, and variables such as industry- and occupation-level unemployment rates
were included to account for demand-side constraints in the labour market. The results
showed a high wage elasticity of participation for Irish married women, ranging
between 1.4 and 2.7. The corresponding figure for men, estimated for the purpose of
comparison, was positive but small at only 0.1-0.2. The analysis did not attempt to
model in detail the impact of tax and welfare structures on the budget constraints
facing individuals.
A more complex procedure was adopted by Callan and van Soest (1996),
which was the first study to look at labour supply responses for Ireland in a broad
estimation and simulation framework which took account of the structure of the taxtransfer system. It represented an adaptation of the basic van Soest (1995) model of
family labour supply where instead of each partner being assumed to choose his or her
labour supply independently, a joint decision is assumed to maximise family utility.
This basic model was extended to deal with involuntary unemployment through a
48
“double hurdle” model, and to incorporate fixed costs of working. Aggregate own
wage elasticities for women were found to be about 0.67, with the corresponding
elasticity for men being 0.15. The participation elasticity for women is similar to the
aggregate own wage elasticity.
Some initial work exploring labour supply issues has also been undertaken
with more recent data. Callan and Doris (1999) use a more recent dataset, from the
1994 Living in Ireland Survey, to analyse participation decisions by Irish men and
women via estimation of probit models. (The focus of this work was on the impact of
the proposed national minimum wage, but the findings are also of more general
interest). Table 5.1 summarises the key results from the study, in terms of estimated
elasticities of participation.
Table 5.1
All
Estimated Elasticities of Participation with respect to the Wage Rate
Men
0.46
0.42
Source:
Women
Single
Married
All
0.36
0.70
0.54
Callan and Doris, 1999, Table 4.4.
Elasticities of participation are similar for men and for single women, but the
highest responsiveness is still found among married women. The results suggest that
the wage elasticity of participation of married women may have fallen significantly
between 1987 and 1994. Further investigation is needed on this issue, but the rise in
participation between 1987 to 1994 may itself be a part of the explanation. The results
for men show a greater elasticity of participation than is usually found, as a result of
allowing the effect to vary with education levels. Men with low levels of education
were found to have very high wage elasticities, indicating that many of those classed
as “not seeking work” would enter employment if the wage rate were sufficiently
high. Men with second-level qualifications or higher, by contrast, are found to be
relatively unresponsive to the wage rate, as they were likely to be in employment in
any event.
We can thus tentatively think of single women and men with higher levels of
education as relatively unresponsive in terms of participation decisions, while married
women and men with low levels of education (no qualification beyond primary) seem
49
likely to be relatively responsive. Now let us consider the evidence from Chapter 3 on
the shifts in financial incentives to work brought about by moving to the basic income
scheme, in combination with this evidence on the relative responsiveness of different
groups of men and women. We saw in Chapter 3 that a substantial majority in each of
these four groupings see replacement rates rise on the shift to the basic income
scheme. In summary, as Table 5.2 shows, between 44 and 54 per cent, depending on
the group, see an increase of 5 percentage points or more in their replacement rate
while only 8-15 per cent see an equivalent fall. We see from the table that married
women make up 36% of all those falling into the four groups, and 54 % of these see a
rise of 5 points or more in their replacement rate. Given that this is possibly the most
responsive group of all in terms of participation, the fact that so many see a significant
decline in the incentive to participate in the paid labour force is particularly striking.
Table 5.2:
Basic Income and Participation for Different Groups
Size of group
%
Married Women
Non-married
women
Men with 2nd.
Level education
Men without 2nd.
Level education
Total
35.9
24.2
Impact on RRs
Fall More than
Rise more than
5 (%)
5 (%)
7.6
53.5
13.3
43.9
Responsiveness
High
Low
30.2
8.9
52.0
Low
9.7
15.3
44.3
High
100
6.2
3.9
We noted in Chapter 3 that, particularly among married women, the impact on
incentives does vary depending on current labour force status. A particularly high
proportion of married women who are currently employees or in home duties see their
replacement rate rise, whereas many of the married women who are currently
unemployed and in receipt of UA or UB see their replacement rate fall. The size of the
numbers in these various labour force status categories then becomes important in an
assessment of the likely overall impact on participation of married women. Of all
married women being considered here, only 1% were currently unemployed and in
receipt of UA or UB – about 55% were in full-time home duties and the rest were
employees. A total of about 325,000 married women see their replace rate go up by 5
percentage points or more, slightly more than half of whom are currently in home
duties and slightly less than half currently employees, whereas only 2,500 see a
50
corresponding decline. One would have to conclude that the incentive to participate in
the paid labour force for this particularly responsive group would be significantly
reduced by the basic income scheme.
Significant numbers of single women and men with second-level education
qualifications or above also see their incentive to participate reduced substantially.
While these are thought to be relatively unresponsive to such incentives, they are also
substantial groups in size and thus one cannot ignore the potential impact on labour
supply. However, it is worth focusing on the smallest of our four groups: men with
lower levels of education. This comprises about 10% of the individuals in our four
groups, and unsurprisingly a high proportion of these – about 30% - were
unemployed. We see from Table 5.2 that overall, replacement rates rise substantially
rather more often than fall substantially even for this group. We may be particularly
interested in the unemployed sub-set: even for them, more individuals see
replacement rates rise than fall, but about one in four do see their replacement rates
fall by 5 points or more. The financial incentive to work does thus improve for some
of this important group. On the other hand, moving away from the “work test”
incorporated in the current system could be regarded as tending to disimprove their
incentive to seek out employment.
Now let us consider the impact of a shift to a basic income system on decisions
concerning hours of work. At the lower end of the scale, the removal of the low
income poverty trap associated with FIS would make extra hours of work more
attractive to those who would benefit from FIS under a conventional system.. This
represents less than 1 per cent of those at work. But more than 55 per cent of the paid
work force would see their marginal tax rates rise by a minimum of 20 percentage
point. A full analysis of the consequences for hours of work would require a more
elaborated labour supply model than is currently available; this would take into
account the impact of the changed tax transfer structure on all hours/incomes
possibilities available to the individual. But consider an individual whose net income
at his/her existing hours of work is not reduced by a basic income,16 and whose
marginal tax rate increases. The net effect for such individuals is likely to involve
reduced willingness to work overtime and/or some inclination to reduce hours of
work. For individuals who, at their existing hours of work, would experience a loss in
16
i.e., an individual whose net income rises or remains constant under the move to a basic income.
51
income under a shift to a basic income system, the impact on labour supply is, as set
out in Chapter 1, in principle ambiguous. The substitution effect (a fall in the net
wage) suggests a fall in labour supply, but the income effect could, in principle
outweigh this. In assessing the likely outcomes for this group we may draw on both
Irish and international evidence regarding the wage and income elasticities of labour
supply. Blundell and MaCurdy (1998) survey the results of a range of papers designed
to estimate such elasticities while allowing for nonlinearities in the budget constraints
introduced by tax and welfare rules. All but one suggest that for married women, the
wage elasticity with respect to hours of work is greater than the corresponding income
elasticity. Irish results (e.g., Callan and Farrell, 1991) suggest a similar conclusion.
The responsiveness of men’s hours of work to both wage and other income changes is
typically less than that of married women, and while there is more ambiguity about
the relative size of the wage and income elasticities, the results surveyed show wage
elasticities as higher than income elasticities in 3 out of 4 cases surveyed.. While these
results cannot be used to predict the outcomes with certainty, they can help in
assessing the likely outcome. While for some individuals the combination of an
incipient fall in income and a rise in the marginal tax rate (fall in the net wage rate)
may lead to a rise in labour supply, it is, in our judgement, unlikely that in aggregate
this will outweigh the negative impact on labour supply arising from the fall in the net
wage.
The other potential channels whereby the shift to the basic income scheme could
affect labour supply are through migration and the informal economy. These have
been considered in detail in Chapter 4. That analysis concluded that the introduction
of the basic income scheme would be likely to have only a very small impact on the
net flow of migrants in the shorter term, though there could be some impact on the
level and composition of outflows and inflows. This impact could be considerably
greater, however, as the European Union expands to bring in countries with
significantly lower income per capita. It seemed likely that there could be two types of
effect on the “unofficial” economy. Some of those benefit claimants currently
engaged in “off the books” working would be more likely to declare such earnings, as
the net loss from doing so would be reduced. But a small rise in the degree to which
other individuals, faced by a rise in effective marginal tax rates of the order of 20
percentage points, failed to declare some of their earnings would be sufficient to
offset this. Even taking these possible channels into account, the extent of the increase
52
in the financial disincentive to work mean that the net impact overall of the basic
income scheme seems more likely to be a reduction rather than an increase in labour
supply.
5.3 Labour Demand
We now turn from labour supply to the impact of the basic income scheme on
the demand for labour. It is helpful to begin by considering a simple aggregate model
of the labour market, with the aggregate supply of labour rising with increases in
wages, and the aggregate demand for labour falling as wages increase. For simplicity,
let us also think of wages and employment being jointly determined in a way that
brings aggregate demand and aggregate supply into balance. We realise, of course,
that this picture is overly simplified; but it is a useful device for thinking about the
impact of a basic income system on the labour market. We have seen that the change
to a basic income system can have an impact on the supply of labour. With no other
changes, a fall in the labour supply schedule will result in a fall in employment and a
rise in wages, and conversely for a rise in labour supply. This would involve a move
along the existing labour demand schedule, rather than a shift in this schedule.
Most of the changes involved in shifting to the basic income system are of this
type – they alter the take-home pay of workers relative to the gross wage, and
therefore influence the supply of labour offered at a given gross wage. Thus, the main
impact of the change to a basic income system is via the shifts in the supply of labour
discussed in Section 5.2 above. We have seen that some of the most responsive
groups face a fall in their incentive to participate in the paid economy, and the net
impact overall seems more likely to be a reduction rather than an increase in labour
supply.
There is, however, one aspect of the proposal that can be seen as affecting the
demand for labour more directly. This is the proposal to abolish employer PRSI and
replace it with a flat rate Social Responsibility Tax, at a lower rate than employer
PRSI but without a ceiling. (The net effect is estimated to be a reduction in revenue of
some £130m., but this would have to be recouped in the basic income tax rate, so we
focus on the structural consequences here). The main impact of this shift would be to
increase employer contributions (now labeled social responsibility tax) for those on
earnings above the conventional system’s PRSI ceiling, and to reduce the liabilities
for those below that ceiling. Thus, it would make high-waged labour more expensive
53
(by about 8 per cent), and low-to-middle waged labour less expensive (by about 4 per
cent in most cases) than under the current system. This would tend to alter the
composition of labour demand, increasing the attractiveness of low or middle waged
labour relative to high-waged labour. The net impact of these changes will depend on
the price sensitivity of the demand for high and low skilled labour, and on the
interaction of these demand shifts with the more extensive shifts in the composition of
labour supply outlined earlier.
The other point to be made about the demand side of the labour market relates
to an important institutional change in the labour market, affecting the context in
which the basic income scheme would be introduced, namely the imminent
introduction of the national minimum wage. Without a minimum wage, a basic
income could in some circumstances serve in effect as a subsidy to employers hiring
very low-skilled labour. Those with very low skills could reduce the gross wage they
demand of employers, given that they will now also be in receipt of the basic income
payment, and the result would be that the latter serves as an employment subsidy. We
have seen that the pattern of replacement rate effects is in fact rather more complex
than this, even for the low-skilled, but the introduction of a minimum wage in any
case rules out the possibility of employers reducing the gross wage below that
minimum with the basic income scheme. Apart from the employers PRSI effect
mentioned above, the basic income scheme would not then be likely to have a major
impact on the demand for low-skilled labour.
Changes in the size and composition of employment, and changes in the
distribution of income arising from such changes and from the shift in tax/transfer
policy could also have indirect effects on the size and structure of labour demand.
While such factors could play a significant role in a relatively closed economy such as
the US, they are likely to play a less significant role in the Irish economy. The
dominant role played by external demand and supply of traded goods and services
means that the indirect effects would arise mainly through the non-trade sector. Even
there, the main effect which could be expected would arise from the impact of a basic
income on the scale of economic activity (employment and aggregate output), with
shifts in the composition of demand playing a lesser role.
54
5.4 Overall Labour Market Impact
If the main impact of the shift to the basic income scheme was a reduction in
labour supply, what would be the overall impact on the labour market? In the current
and projected macroeconomic environment, this would be happening in a context
where the labour market is already very tight. The pace of employment growth has
been quite exceptionally high in recent years, and the latest ESRI Medium-Term
Review (Duffy, FitzGerald, Kearney and Smyth 1999) expects the numbers at work to
grow by more than 2% per annum in the five years to 2005. Compared with 1998, an
additional 430,000 people are expected to be at work by 2010. The demand for skilled
labour is expected to remain very strong, with most jobs being created in the human
capital intensive areas of the economy. A rapid increase in skill and education levels
is also anticipated, with the vast majority of workers educated to at least Leaving
Certificate standard. In contrast, demand for less-skilled labour is expected to fall
continuously over the next decade. Since the supply of such workers is expected to
decline even more rapidly, however, their relative position (in terms of unemployment
rates) is expected to improve vis-à-vis the more highly skilled.
In such a context, a reduction in labour supply main as a result of a shift to the
basic income scheme would add to already considerable pressure on wage levels and
potentially on inflation and competitiveness. The institutional framework within
which wage levels were being determined could then be particularly important. It
must be emphasised, though, that uncertainty about the scale of likely labour supply
responses, and in particular about the potential for counter-balancing inward
migration, makes it very difficult to assess the overall impact of the basic income
scheme on the labour market.
A further consideration is that even if labour supply were to remain roughly
constant in aggregate terms, there could be significant composition effects. Both
supply and demand side factors point towards some expansion of low wage/low
skilled employment, and some contraction in supply and demand of higher wage/high
skilled labour. Thus even if aggregate employment were to remain constant, a fall in
average productivity and output might be expected. It is not possible to quantify this
effect, but it may be useful to recall the results from the Dutch simulation model (de
Jager et al.1994). In their analysis of the Dutch economy, a basic income system with
a lower level of benefit than that envisaged here (and therefore more likely to have a
positive impact on employment) was found to have either a negative or a negligible
55
effect on employment, and a negative impact on productivity. The negative impact on
productivity arose from the fact that increased flexibility in the lower end of the
labour market drew in less skilled workers, while the tax rate implications led to
withdrawal from the labour market of workers (mainly married women) with higher
average skills.
56
Chapter 6
GROWTH, COMPETITIVENESS, INVESTMENT
Gerry Boyle and Tom McCarthy
6.1 The Determinants of Growth
Economists have been concerned to identify the determinants of growth ever
since the foundation of the discipline. However, it was only in the 1950s that a
consensus was reached on a generally acceptable model of growth. This has become
known as the neoclassical or Solow model of economic growth. According to this
model a country’s rate of long-run growth depended on its rate of technological
progress. Living standards would increase faster in countries with higher levels of
technical progress. An understanding of the determinants of growth therefore requires
an explanation of the determinants of technological progress. In the early literature,
however, the main concern was to measure rather than explain technological progress.
This was accomplished by treating the residual element of output growth not
accounted for by growth in capital and labour inputs as the measure of technological
progress.
In recent times economists, encouraged by theoretical advances and the greater
availability of internationally comparable datasets, have sought to explore this issue of
technological progress in a more meaningful way. A number of different approaches
have been used. One strand has attempted to construct a model explaining the process
of technical change.
Another approach involves augmenting the original Solow
growth model. This is essentially an empirical exercise. The basic Solow model
attributes output growth to growth in capital and labour inputs with the residual being
interpreted as technological progress. In the augmented version new explanatory
variables are introduced. The context for much of the work on the augmented Solow
model is an attempt to explain cross-country growth performance. This is the socalled convergence literature that we discuss below.
6.2 Accounting for Growth in Ireland
It is useful to start by decomposing a country’s growth performance into a
number of components. This exercise is not in itself an explanation of the
determinants of growth. Instead it serves as a useful classification. Using GNP per
57
capita as the measure of a country’s performance we can decompose this measure into
four elements: productivity, employment rate, participation rate and dependency rate.
Productivity is measured as GNP divided by total employment, the employment rate
is total employment divided by the size of the labour force, the participation rate is the
labour force divided by the working age population (those aged 15 to 64), while the
(inverse) of the dependency rate is the working age population divided by the total
population. The product of these four elements equals the GNP per capita.17
This decomposition is implemented for Ireland by Fitzgerald, Kearney,
Morgenroth and Smyth (1999: 40). For the period 1961 to 1997 productivity growth
has been the dominant component of per capita GNP growth. This trend was broken
in only one period. Between 1981 and 1985 the employment rate fell by over 2%
while the rate of productivity growth, while positive, was less than 2%. In the most
recent years (1996 and 1997) improvements in the rates of employment, participation
and dependency have all been strongly positive. However, each of these individual
components only grew at a third of the rate of productivity growth.
In order to explain these trends we need to understand the factors that influence
the growth of each of these components. The employment rate is driven both by
demand side factors and supply side factors as was discussed in chapter 5. The
relative influence of demand side factors, in turn, is determined by those factors
influencing growth in potential output as well as competitiveness which influences the
growth in actual output. The important supply side factors are the change in the
participation rate and in the dependency ratio. In chapter 5 we investigated the impact
of basic income on participation decisions and noted that the major effect of a shift to
basic income would be to reduce the participation of married women in the labor
force. The contribution of increases in participation to recent growth has arisen largely
due to increased female participation. Basic income would therefore, at least,
contribute a once off decline in this element of growth. However, this growth impact
would be unlikely to persist. That is, the labour market consequences are likely to
work through within a relatively short space of time and the negative contribution to
measured growth would not persist.
The dependency ratio in Ireland has been improving because of long-run
demographic factors. In effect Ireland is now enjoying the benefits of an earlier
17
It must be stressed that this is an accounting decomposition, not a theory of growth.
58
“baby-boom” and is likely to do so for some time. In contrast other developed
countries, particularly our EU partners had their “baby-booms a number of decades
ahead of us. As a consequence they have reached a stage where dependency is
increasing due to retirements. The only route through which basic income could
influence growth is through migration. As we saw in chapter 4 the introduction of a
basic income is unlikely to induce significant migration.
In the light of the foregoing we see that it is again that element known as
productivity or technological growth that is the dominant contribution to growth. In
terms of sustained impacts on growth we need to determine whether a shift to a basic
income will influence productivity/technological growth.
6.3 Explaining Growth Differentials
We need to understand that “black box” element labeled productivity or
technological growth in order to be able to explain rather than merely describe the
broad components of economic growth. This can be done using the analytical devise
of the augmented Solow model described in section 6.1 and the internationally
comparable datasets now available.
We begin by recasting our question. Instead of seeking to explain the growth
performance of a single country we instead try to explain differential growth
performance. That is, why do some countries grow faster than others? The Solow
model suggests that we should observe similar growth rates for countries with access
to similar technology and possessing similar attitudes towards saving. Now let us take
it that knowledge about technology is mobile and that savings rates are similar. We
can then test the Solow model explanation by testing whether per capita growth rates
converge across countries. In general we will find that there will be a lack of
convergence across countries. The analysis then proceeds by introducing elements
which might differ across countries such as schooling, which would be a measure of
investment in human capital. If it is found that convergence in per capita GNP is
observed once such a variable is introduced we conclude that growth differentials can
be explained by divergence in this variable. In this way we move from the vague
(productivity or technological change) to the more specific (extent of schooling)
explanation of differential growth paths.18
18
There are a number of theoretical and empirical questions raised by this approach. These are
discussed in Boyle and McCarthy (1997 and 1999).
59
In recent years a large number of studies have followed this approach. Each has
introduced a different type of variable and sought to determine its relative
contribution to explaining growth differentials. This work has also examined
interaction among variables as well as indirect routes of causation such as the impact
of these variables on investment in physical capital. Temple (1998) provides an
overview of this literature.
In addition to the schooling variable four other broad areas have been analysed:
public finance, macroeconomic policy, income distribution and social factors. Under
public finance analysts have sought to determine whether elements such as taxation,
the size of government, public good investment (such as infrastructural spending) and
trade policy are significant. Macroeconomic policy effects have concentrated on
budget deficits, inflation and real exchange rate instability. One of the most
interesting aspects of this literature in relation to explaining growth performance in
very poor countries is the literature on social aspects such as ethno-linguistic
differences (Easterly and Levine (1997)).
6.4 Basic Income and Growth
Three hypotheses can be distilled from the literature on basic income which may
open up a link between basic income and growth. There are two elements to this link.
On the one hand we have the factors identified in the previous section as influences on
growth. On the other there is the question as to whether the introduction of a basic
income has an influence on any of these variables. We start with this channel.
The following three hypotheses suggest a link between the introduction of a
basic income and a variable that may influence the growth process.

A basic income promotes a more flexible labour market.

A basic income promotes a more stable macroeconomic environment by
encouraging a corporatist rather than a competitive model of wage determination.

A basic income generates a fairer distribution of income.
The question is whether these arguments are reasonable and whether in turn the
influence of the “growth variable” is itself significant.
One aspect of the labour market flexibility argument is that the guaranteed
income provided by an unconditional basic income would make it easier for
individuals to finance periods of return to full-time education or training raising their
60
productivity and incomes in future. On the other hand, the rise in the marginal tax rate
would tend to make such investments less financially attractive, as a greater
proportion of the increased future income would be taken in tax. The exact balance
would vary depending on individual circumstances.
The introduction of a basic income represents a change in a country’s
tax/benefit system. In much of the literature the effects of taxation on growth are
difficult to isolate empirically (Easterly and Rebelo (1993)). However, Boyle and
McCarthy (1996) recast the analysis and found that labour taxation had a significant
influence on growth. They decomposed the growth rate for OECD countries into
movements along and movements towards the productive frontier. They then use the
inter-temporal change in their index of movement towards the frontier as the
dependent variable in an analysis of the role of taxation, among other influences. They
found a strong negative relationship between movement towards the frontier and
changes in the rate of labour taxation. On this basic we would argue that the effect on
growth of a switch to a basic income is likely to be negative since it would result in an
increase in the marginal rate of direct taxation.19
It is more difficult to draw a firm conclusion in relation to the second
hypothesis. For one it is clearly not the case that a basic income is required in order to
have the partnership model of wage determination that already exists in Ireland. It is
also an open question as to whether a switch to a basic income would marginally
improve or provide a more solid foundation for partnership. Even if we do posit a
positive influence for the basic income on partnership we have no firm measure of the
influence of partnership on growth. What we can say is that there is an emerging
literature that traces a link between macroeconomic factors and growth. However, the
empirical work in this area has been disappointing to date. As a consequence the
belief in a link between macroeconomic factors (where we take it that partnership has
a positive influence on short-run macroeconomic performance) and growth continues
to be a matter of belief rather than empirical demonstration. In view of the foregoing
it is best to take it that the basic income would be neutral through this channel.
Perotti (1996) has investigated the influence of income distribution on growth.
He investigates the impact through a number of channels. He finds strong empirical
support for two types of explanation, one linking income distribution to growth via its
61
influence on sociopolitical instability and the other via education and fertility
decisions. However, he finds that there is less empirical support for an influence of
income distribution on growth via its impact on fiscal policy. Now the former routes
are the ones most likely operative in less advanced and emerging economies while the
latter is the route through which we might expect income distribution effects in
developed countries. According to this work we cannot expect to find an independent
impact on growth stemming from more equality in the distribution of income.
The net conclusion from this discussion is that the main channel through which
we might expect to find a sustained influence for basic income on growth is through
the effect identified by Boyle and McCarthy (1996), which is negative. Thus, while
there is considerable uncertainty about the impact of a basic income on economic
growth, it seems more likely to be negative than positive..
19
This empirical analysis does not, of course, include any country with a basic income system, as no
country has yet introduced one.
62
Chapter 7
Conclusions
Tim Callan and Brian Nolan
7.1 Introduction
This study, for the Partnership 2000 Working Group on Basic Income, has
examined the potential dynamic impact of the introduction of a basic income in
Ireland. It builds on earlier reports to the Group (Callan et al., 1999; Clarke, 1999),
which examined the cost, revenue and distributional implications of the Basic Income
proposal on a static or “first-round” basis i.e., before any individuals or firms changed
their behaviour in response to the introduction of the scheme. This study has gone
beyond that framework to consider the likely changes in decisions by individuals and
firms as a result of the basic income scheme.
7.2 International Evidence
Before turning to a detailed consideration of the particular basic income scheme
proposed for Ireland, the study began with a review of available international
evidence on the dynamic impact of basic income or negative income tax schemes.
This first outlined the evolution over time of the related concepts of basic income and
negative income tax. It then examined evidence from various negative income tax
experiments, and the lessons one might be drawn from this experience in assessing the
potential dynamic impact of the proposed basic income scheme for Ireland.
In broad terms, the results of large-scale negative income tax experiments in the
USA suggest that their impact was to reduce the supply of labour, but that this effect
was quantitatively small. In comparison to elasticities obtained from nonexperimental evidence, the size of the labour supply elasticities derived from these
experiments is lower. The results also confirmed the conclusions reached using other
methods that the labour supply of men is much less sensitive to changes in the wage
than the labour supply of married women. Analyses of a Canadian experiment yielded
similar results. As well as actual social experiments, simulation studies have also
examined the impact of basic income-type schemes. A Canadian study, for example,
simulated a basic income scheme with a flat tax rate of 45% and found that the mean
number of hours worked fell by about two weeks per year.
63
7.3 The Impact on Labour Supply
The study then turned to the core task of assessing the impact of the actual basic
income scheme being studied in the Irish case on financial incentives to work, for
those either currently or potentially in the labour force. This includes not only those
currently in employment, but also those who are unemployed and those who classify
themselves as fully engaged in “home duties”. A key focus of this analysis was on the
balance between incomes when in paid work and income when not in paid work, and
how this balance is altered by the move to the basic income scheme proposed. The
concrete measure used is the replacement rate, which expresses out-of-work income
as a proportion of in-work income.
About 1% of those who are currently employees face a replacement rate of over
100 per cent, and this is eliminated by the basic income system, with no-one then
facing such a disincentive. However, more employees see their replacement rates rise
than fall. Focusing on what would generally be regarded as high replacement rates,
under the conventional system just over 15 per cent of employees face a replacement
rate of over 70 per cent. Under the basic income scheme this rises to 18-19 per cent,
so the number of employees facing such high replacement rates rises by between
30,000 and 40,000 For those who are unemployed and in receipt of unemployment
assistance or benefit, the incidence of replacement rates over 70 per cent falls, from
about 16 per cent to 6-7 per cent, so the number of unemployed people facing those
replacement rates falls by about 12,000. For those (almost exclusively women) who
classify themselves as “engaged in home duties”, however, once again replacement
rates rise more often than they fall. The percentage facing replacement rates of more
than 70 per cent goes up from 36 per cent to close to 50 per cent, so the number of
individuals in home duties and facing replacement rates of over 70 per cent rises by
about 60,000. None of these results proved sensitive to a 3 percentage point
exogenous reduction in the tax rate required to finance a basic income.
Married women were seen to be particularly likely to see their replacement rate
rise, with one-third of married women currently employees or in home duties having
their replacement rate rise by 10 percentage points or more. For many of these,
entitlement to a full personal basic income payment would mean their income when
not in paid work would be a good deal higher than under the current social welfare
system.
64
Replacement rates seek to capture the financial incentive to take paid
employment, but changes in marginal tax rates could also affect decisions about
working more rather than less hours. The estimated tax rate for the basic income
system lies between 51.4 and 52.9 per cent, and the precise impact on top rate
taxpayers was seen to be sensitive to the exact figure for this basic income tax rate.
The broad picture was much clearer however. The main impact of the change to the
basic income scheme was on the 57 per cent of taxpayers with tax rates of below 30
per cent under the conventional system, whose marginal tax rates would rise to about
50 per cent under the basic income system. The move to a basic income system would
also reduce the tax-cum-benefit withdrawal rate facing the small proportion of cases
affected by FIS withdrawal under the conventional system.
7.4 The Impact of on Migration and the Informal Economy
The study then considered the impact of the introduction of the basic income
scheme on financial incentives for emigrants and migrants, and the complex issue of
the changes in the incentive to participate in the informal rather than the formal
economy. Broadly speaking, a basic income scheme will increase the attractiveness of
Ireland for low-skilled migrants who might expect to depend on it, while reducing
after-tax income for those nearer the top of the skills/earnings distribution. Available
evidence on the sensitivity of migration to financial incentives suggested that the
introduction of a basic income would, in the near term, have a very small impact on
the net migration flow, though this could mask changes in the level and composition
of outflows and inflows. However the entry of poorer countries into the EU could lead
to more significant immigration in the longer term.
As far as the informal economy is concerned, the basic income scheme could
encourage some to move from the unofficial economy into regular employment.
Quantifying the scale of this effect is by its nature problematic, given the difficulty in
knowing how much work currently goes on in the black economy. At the same time,
the incentive to conceal income would rise for a very large number of those currently
in employment and self-employment. A small response from this large group would
be enough to offset a large per person response from those currently drawing welfare
while “working off the books”.
65
To the extent that individuals withdraw from labour market participation or
reduce their hours of work, they would have additional time available for other
activities. This could include voluntary and community sector activities, or time spent
on caring for the elderly and children in the individual’s own family. The net effect on
the former is likely to be positive, though the extent is uncertain, as the factors that
contribute to voluntary activity are not well understood. The net effect on the latter
may also be positive, as we have seen that women with children are among those most
likely to withdraw from the labour market in response to the changed incentives
provided by a basic income.
7.5 Impact on the Labour Market
The potential impact of the basic income scheme on behaviour in the labour
market relates much more to the supply than the demand side. Research on labour
supply behaviour, both in Ireland and elsewhere, shows that the labour force
participation of women, and in particular of married women, tends to be significantly
more responsive to financial work incentives than that of men. Irish evidence also
tentatively suggests that men with low levels of education may be rather more
responsive than those with second-level or higher qualifications. This evidence on
responsiveness can then be combined with the results of the earlier analysis of the
impact the basic income scheme would have on replacement rates. It is thus
particularly striking that a substantial number of married women who are currently
employees or working full-time in the home would see a significant increase in their
replacement rates. The incentive to participate in the paid labour force for this
particularly responsive group would be significantly reduced by the basic income
scheme. From a labour market perspective this would tend to reduce labour supply
and put upward pressure on wages, downward pressure on employment. It should be
noted in a broader context that many of these women would be better off under the
basic income proposal irrespective of their labour market choice, so that their overall
choice set can be seen as having expanded.
Significant numbers of single women and men with second-level education
qualifications or above also see their incentive to participate reduced substantially.
While these are thought to be relatively unresponsive to such incentives, they are also
substantial groups in size and thus one cannot ignore the potential impact on labour
supply. Even for men with lower levels of education, replacement rates rise more
66
often than they fall, but about one in four of unemployed men with low education
levels do see their replacement rates fall significantly. On the other hand, moving
away from the “work test” incorporated in the current system could be regarded as
tending to disimprove their incentive to seek out employment.
As far as decisions concerning hours of work are concerned, the removal of the
low income poverty trap associated with FIS would make extra hours of work more
attractive to those benefiting from FIS, who represent less than 1 per cent of those at
work. But more than half of the paid work force would see their marginal tax rates
rise by about 20 percentage points. The net effect of this increase is likely to involve
reduced willingness to work overtime and/or some inclination to reduce hours of
work.
Most of the changes involved in shifting to the basic income system alter the
take-home pay of workers relative to the gross wage, and therefore influence the
supply of labour offered at a given gross wage. The proposal to abolish employer
PRSI and replace it with a flat rate Social Responsibility Tax, at a lower rate than
employer PRSI but without a ceiling, could however affect labour demand more
directly. The main impact of this shift would be to increase costs to employers for
those on earnings above the conventional system’s PRSI ceiling, and to reduce the
liabilities for those below that ceiling, increasing the attractiveness of low or middle
waged labour relative to high-waged labour. The fact that a national minimum wage is
to be introduced shortly has an important impact on the setting in which the basic
income scheme would be introduced, since without such a minimum wage basic
income could in some circumstances serve as a subsidy to employers hiring very lowskilled labour.
In the current and projected macroeconomic environment, the basic income
scheme would be introduced in a context where the labour market was already very
tight. Demand for skilled labour is expected to remain very strong, and a rapid
increase in skill and education levels is also anticipated. Demand for less-skilled
labour is expected to fall over the next decade, but the supply of such workers is
expected to decline even more rapidly. In such a context, an overall reduction in
labour supply as a result of a shift to the basic income scheme would add to already
considerable pressure on wage levels and potentially on inflation and competitiveness.
However uncertainty about labour supply responses, and in particular about the
67
potential for counter-balancing inward migration, makes the overall impact of the
basic income scheme on the labour market very difficult to assess.
The results do suggest some compositional shifts in employment. The basic
income proposal involves factors tending to increase both the supply of and demand
for low wage, low skilled labour and to reduce the supply of and demand for higher
skilled, higher waged labour. Thus, even if total employment were to remain constant,
productivity and output might be expected to fall.
7.6 Impact on Economic Growth
Assessing the broader impact of the basic income scheme on growth and
competitiveness is even more difficult, since it requires at the outset an understanding
of the determinants of growth and in particular the determinants of technological
progress. It has been argued that basic income could affect growth by promoting a
more flexible labour market, by promoting a more stable macroeconomic environment
through encouraging a corporatist rather than a competitive model of wage
determination, and by generating a fairer distribution of income. The existing
evidence for these potentially positive effects was judged to be rather limited, with the
negative effect on growth resulting from an increase in the marginal rate of direct
taxation judged to be the most significant channel of influence.
7.7 Some Broader Considerations
Before drawing
together the main threads of the analysis concerning the
dynamic impact of the proposed basic income scheme, we consider a number of
additional forms of dynamic impact. The areas to be considered are education and
training (briefly touched on in Chapter 6); the financial independence of women
(drawing on the findings from Phase 1 and Chapters 3 and 5 of this study); selfemployment; and rural living.
Looking first at the potential impact of the basic income proposal on
individual’s decisions regarding investment in education and training, we can see two
distinct, and opposing influences. On the one hand, the guaranteed basic income may
provide allow individuals who could not otherwise finance (a return to) further
education and training to participate in such schemes. On the other hand, the financial
incentive to forego current earnings in the anticipation of future increases in income
may be seriously affected for those individuals (a majority of current employees) who
68
see their marginal tax rates rise by about 20 percentage points. The net impact for any
one individual will depend on a range of factors including the level of earnings and
the discount rate applied to future earnings. We can expect that for some individuals
the lower cost of financing a spell in education or full-time training will dominate,20
so that they will be able to choose a higher level of education under the basic income
system, while for others the reduced returns to investment in education will induce
them to choose a lower level of education and training than under the conventional
system. The net impact on the skill level of the workforce is unclear.
One of the claims made about basic income is that it increases the financial
independence of women. There are two major features of the basic income system
which support this claim. First, women who are currently treated as “qualified adults”
in the social welfare system would receive a higher payment than at present, and
receive it directly in their own right. While the current system allows for split
payments, this is somewhat unusual. The change could be seen as increasing the
financial resources of many such women, and potentially increasing the extent of
women’s control over those resources. Second, for married women described as
“engaged in home duties”, whose husbands are in employment, the change in system
would bring about a direct cash payment instead of a transferable tax allowance
reducing the husband’s tax bill. The impact on the net financial resources of the
couple may be positive or negative, as seen in Phase 1.21
There are, however, other perspectives on the financial independence of women
which would stress the role of employment in providing women with longer-term
economic independence. The combined impact of the basic benefit and the basic
benefit tax rate is to raise the replacement rate for a large number of women engaged
in home duties, and for a substantial number of women in employment. A likely
consequence is that fewer women will choose to participate in the paid labour market.
This may have negative long-term consequences for women’s financial independence.
Those wishing to re-enter the labour market at a later date would tend to find the wage
which they could command would be adversely affected, with the size of the impact
depending on the length of the period of withdrawal.
20
If capital market imperfections meant that a loan would not have been forthcoming for a profitable
human capital investment in the conventional system, the basic benefit may break that liquidity
constraint.
21
About 175,000 single earner couples would gain while some 110,000 would lose.
69
In what ways might a basic income affect the extent and nature of rural-urban
migration? One element of the change is the removal of the work test, requiring
individuals on unemployment assistance to seek work. If, under the current system,
moving to a rural area is inhibited by the application of this condition, then
individuals inhibited by the condition might be more likely to move under a basic
income scheme. However, the costs of moving and difficulties in finding
accommodation, and the relative likelihoods of finding employment would not
suggest that the extent of such flows would be large. More generally, the framework
for analysing migration outlined in Chapter 4 suggests that rural-urban migration is
influenced by the gap in expected income in the different locations. The redistribution
involved in basic income could be expected to reduce the average gap, and to the
extent that migration responded to this gap some reduction in the trend towards
urbanisation might be expected.
Finally we consider the potential impact on self-employment. Why might a basic
income stimulate self-employment? Perhaps the best parallel here is with schemes in
the existing system (such as the back-to-work allowance) which allow individuals to
retain a part of their benefit for a limited period while taking up employment or
starting self-employment. The benefit thus provided can be seen as a subsidy towards
small start-ups which might not otherwise be able to attract commercial funding in the
early years. Under the existing system, only a limited number of individuals qualify
for such schemes, but they have the advantage that tax rates on the income generated
would tend to be low. Under the basic income system, there would be no limitation as
to the numbers using the basic benefit to fund a small business idea, but the initial tax
rate on the income generated would be higher. Typically, the income position of a
small start-up would be higher under the basic income system; but so too would the
income of the same individual in low income employment. Whether the shift to a
basic income system would stimulate such start-ups depends not only whether it
would improve the likelihood of being able to survive the start-up period, but also on
its longer-term impact on the reward for undertaking the risk, relative to other, less
risky options. These influences work in opposite directions.
7.8 An Overview
There is a considerable element of uncertainty in predicting the likely dynamic
effects of the introduction of a basic income system. Our analysis has shown some of
70
the complexity of the forces at work. At this stage it is useful to summarise the main
thrust of the findings. Looking first at the issue of financial incentives to work, we
find some improvement in the financial incentive to work for the unemployed, as
measured by replacement rates. But the incidence of high replacement rates rises for
those in employment and women engaged in “home duties”. These findings are not
particularly sensitive to the tax rate required to finance the basic income. The
marginal direct tax rate for those in employment is roughly constant for top rate
taxpayers, but rises by about 20 percentage points for the majority of those in
employment. Combining these findings with the available evidence on labour supply,
we conclude that a fall in labour supply is more likely than an increase, and a fall in
the skill composition of the labour force is also likely. As far as the “unofficial
economy” is concerned, there are countervailing influences on tax evasion and
welfare abuse, with the net effect unclear. The impact on net migration is thought to
be small, though it may increase in future years, and the impact on the composition of
gross flows may be more significant. The direct impact on labour demand is more
limited, but could tend to shift somewhat from high skilled to low skilled
employment. The most likely outcome is that aggregate employment would fall or
remain constant, while average productivity and output would fall. The longer term
impact on growth is even more difficult to assess, but the most significant channel of
influence identified (that of the marginal direct tax rate on growth) seems likely to be
negative. A rise in the time allocated to some “social economy” activities can be
expected as participation in the paid labour market falls.
7.7 The Tax Rate
The final issue to be addressed here, drawing on the material presented in
previous chapters and summarised in this concluding one, is the potential impact of
the range of dynamic effects on the tax rate actually required to finance the basic
income proposal. If these dynamic effects added significantly to economic growth and
thus to the tax base, then the tax rate required to finance the specified level of basic
income would be lower than that suggested by the static analyses in Phase 1. We
cannot rule out that possibility. However, the evidence discussed here does not
provide a basis for confidently anticipating such an outcome and planning on that
basis: indeed, the impact of changes in behaviour on the size of the tax base seems
more likely to be negative. Economic growth is not of course an end in itself, but a
71
means of increasing people’s living standards and range of choices. Basic income can
itself be seen as contributing to the enhancement of such freedoms via structural
change rather than economic growth per se: focusing narrowly on the implications for
the tax rate produced by the static analysis, however, a prudent approach could not
assume that dynamic effects would permit a lower tax rate.
72
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