First published: January 2016
The universal income is gaining ground those days in Europe. After Finland, some cities in the Netherlands might adopt it in a near future. No need to recall that France has offered such a quasi-universal income – young people are not eligible to it – since 1988. The recent report by the CNNum handed over to the French minister of Labor suggests that due to the huge transformations in the economy implied by technologies it is high time considering such a proposal. Yet, those measures raise moral, social and economic issues.
In this post I explore in a neoclassical model the macroeconomic implications of increasing the level of universal income. As it is often argued, such a reform is expected to lower the supply of labour, on the intensive margin – working people supplying less – and on the extensive margin – some people dropping from the labor force. Both partial and general equilibrium effects contribute to its decline. As a consequence, the amount of capital in the economy, output and utility – happiness in this model – decrease. However, those results are highly debatable.
The RANG model
The first benchmark is our friend RANG – Representative Agent Neo-classical Growth – model that features one – but yet price-taking ! – agent optimally smoothing consumption over time by accumulating capital and supplying labor in a flexible price economic system. In this version of the model, the single agent chooses how many hours to supply.
The universal income is unconditional, that is to say, it is given regardless of the working status of the agent. Notice the sharp contrast with the French universal minimum – RSA – which is conditional on “not working too much”. However, as the after-transfers net income of the latter is increasing in the number of hours worked – “working always pays off” -, it is not a bad first approximation to consider that it is unconditionally given.
The financing of the universal income is based on income taxes (capital and labor) and consumption taxes. We alternatively study the case where all the burden lies on income taxes and where all the burden lies on consumption taxes.
The equations of the steady-state flexible price economy write as follows:
They are respectively: the optimal labor supply decision l, as a function of the wage, w ; the long term interest rate, r, as a function of the rate of time preference ρ and rate of depreciation δ ; the demand for capital K; the demand for labor, L ; the good market clearing condition that determines consumption, c, the State-budget equations that ensures that the universal income T is financed by taxes on labor, capital and consumption and the definition of the level of the universal income. κ is the percentage of national income per capital that is guaranteed as universal income.
The equilibrium
Financing through income taxes
The figure below plots the general equilibrium for κ going from 0 to 40% of national income per capita. The key insight is that the supply of labor and capital and therefore output decreases a lot. Output decreases by 30% when increasing the universal income from 0 to 40% of national income per capita. This is due to the fact that in partial equilibrium, increasing the universal income amounts to increasing taxes on labor and capital which deters the supply of those factors – I discuss this strong reaction below.
Financing through consumption taxes
When the universal income is financed through a tax on consumption, the partial equilibrium effect goes through the consumption vs leisure trade-off: by increasing the relative price of consumption, the tax on consumption makes people consume less and have more leisure, and therefore work less. In general equilibrium, this implies a decrease in output and in the return to capital. However, notice that the decline in output is much smaller.
The effect is not very different – contrary to the level – as the (inverse of the) Frisch elasticity θ increases (from dark to light grey).
The HANG model
To talk about unemployment one has to move away from RANG that features only one agent and to introduce Heterogeneous Agents (this is how RA became HA). I modify the previous model along two dimensions. First I consider an economy with a continuum of agents that are heterogeneous in their productivity. Second, the labor choice is no longer on the intensive margin – how many hours to work – but whether to work or not.
The key insight in such a framework is that the less productive agents in the economy will not find worth working and will prefer staying unemployed. As the figure below shows, as the universal income rises, the unemployment rate increases. Again, the effect is magnified when the financing goes through income taxes.
The higher the cost of working φ the stronger the reaction of unemployment and all macroeconomic variables to the increase in the universal income.
Summary and Limits
In a RANG model, we showed that output and consumption decrease with the amount of universal income and that the decrease is magnified when the financing is through income taxes. In a HANG model, a larger portion of the population drops from the labor force.
However, those results are conditional on both the structure of the model and the chosen parameters – chosen to be consistent with conventional value in the academic literature, which is of course not a good justification.
Regarding the RANG model with income taxes, the most important concern is the elasticity of labor and capital to their respective net income. We know that those models imply a far too large long run elasticity of capital to interest rate. Regarding the elasticity of labor to wages, the literature is still struggling to get sensible elasticity of labor supply to wages at a macroeconomic level.
Regarding the RANG model with consumption taxes, who would believe a story in which by making consumption more expensive, people are going to opt for more leisure and work less? (remember that everybody receives the universal income, irrespective of whether she or he is working). I don’t. All this suggests that, should the universal income be financed by VAT, the intensive margin impact on labor should be minimal.
The limits of the HANG model are essentially the same.
This model disregards important issues:
1-it is a supply-side model that cannot say anything about short-run effects – that may have long-run impacts in models that feature hysteresis effects – of such redistributive measure which is expected to boost demand in the short-run. To my knowledge, unfortunately and surprisingly, no model in the literature can rationalize this old Keynesian idea.
2-would labor and capital fly away from the country? This ever-harped on refrain – surprisingly sung from those who are the most likely to be net financial contributors – is relevant – yeah, who knows, I might become rich one day -, has received some attention recently in the academic literature – suggesting that the missing wealth is huge but also that the elasticity to taxes is not that high – and western States are now undertaking measures to cope with this issue.
3-will the decrease in hours supplied decrease output? It may be that the efficiency of labor use will increase to compensate the decrease in hours. As it is often argued, the rate of utilization of labor is far from 100% and in many instances the same amount of labor could be make in a shorter amount of time, even without more effort.
4-should the income taxes increase, how would innovation and creative efforts react? In the long run, this would be my major concern. But again, we have no idea what the elasticity of (interesting) innovations to (financial) rewards is.
Conclusion
The main intuition that labor, both on the extensive and intensive margin, and output might decrease and unemployment rise with the increase in the universal income is justified within a neoclassical framework. However, the decrease in labor heavily depends on its elasticity to wages as well as the reaction of the rate of utilization of labor which are two key unknowns; the elasticity of capital is also crucial for the magnitude of the general equilibrium effect but is far too large in those models; short-run effects might have important positive long-run impacts which are overlooked; creative efforts might suffer from the compression of the income ladder. Overall, there are a lot of uncertainties regarding the macroeconomic impact of increasing the universal income.
Although the macroeconomic questions are important, my major concern regards the social consequences of such a measure. Its proponents argue that it is a necessary step towards an ideal society of idleness in its noble sense, where social interaction, leisure, arts, enriching activities would have replaced working at the center of one’s existence. But the way to it is, to say the least, very long – what is the timing to change mentalities and cultural habits? -, and in the current context, it might, more than anything else, reinforce the division of societies between those who are included – through a stable decently paid job – and those who are on the peripheries of the labor market. Unless one argues that with a higher universal income, being on the peripheries will no longer be going with lower happiness, lesser social integration and health conditions and that the peripheries will merge into the core. Would you believe it?