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Poverty: A Plea for a Free-market Solution

BY JULIUS SEIFERT, 03/05/2016
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In 1795 political philosopher Thomas Paine called for a guaranteed minimum income. In the following centuries, this ideal has captured the imagination of very different men, from emperor Napoleon Bonaparte to civil right activist Martin Luther King Jr. and economist Friedrich Hayek. Today, calls for a basic income from various prominent social scientists have become louder than ever. Why is this so?

 

Markets are successful institutions for communicating information, incentivizing innovation and allocating scarce resources. However, in recent decades they seem to have failed at fairly distributing the fruits of prosperity. The assumption long held by economists, that wealth caused by an increase in productivity  – the pedestal of higher living standards – would lead to higher income for all has failed, according to calculations by the Economic Policy Institute. Whilst the theory of productivity and concomitant wage growth held true from 1948 to 1973, the think tank suggests that productivity is up 80.4 % since 1973, while median hourly compensation has risen a mere 10.7 % (Bivens, 2015) (Gould, 2014). Income inequality, measured by the Gini coefficient, has grown by 7.5 % in the US and 9% in the UK since 1979, and the share in total gross income of the top 1% has more than doubled in the US (Atkinson, 2015). Similarly concerning data reports the Social Protection Committee in 2014 on poverty: “There are 6.7m more people living in poverty or social exclusion since 2008, a total of 124.2m people for the EU28 or close to 1 in 4 Europeans in 2012. Poverty and social exclusion has increased in more than 1/3 of the Member States in both 2011 and 2012” (Committee of Social Protection, 2014).

“The assumption long held by economists, that wealth caused by an increase in productivity – the pedestal of higher living standards – would lead to higher income for all has failed”

Welfare payments devoted to the reduction of inequality and poverty, currently in use in Britain and elsewhere in the EU, are incredibly inefficient and costly to administer. They are based on faulty assumptions concerning the welfare receivers, and deprive them of their free choice in many consumption decisions. Moreover, they risk incentivising people to rely on benefits – a phenomenon known as the welfare trap. In such situation the opportunity cost of employment is greater than its financial returns. Furthermore, for most receivers, the welfare payment system is nearly impossible to understand, due to its growing complexity. The issues with redistributive efforts do not, however, only interest benefit claimants. There are, in fact, growing concerns that the progressive rise of the minimum wage, as it is applied across the UK and Europe, will soon become unsustainable to businesses, further aggravating working conditions and unemployment. It would be nonsensical to implement the minimum wage if the measure is going to harm the very people it should help.

 

Clearly, the underlying problem is that policymakers are trying to address the challenges of the 21st century with the solutions of the 20th century.

 

So what is the answer to today’s issues? The idea endorsed by Nobel laureate Sir Christopher Pissarides at the World Economic Forum in Davos is a universal basic income paid out to everybody, unrelated to labour-market status or income and possibly differentiated only on grounds of age or disability. What I will advocate for in this article is another version of a guaranteed income, the negative income tax (NIT) promoted by Nobel laureate Milton Friedman in his book ‘Capitalism and Freedom’. His idea is best illustrated by a hypothetical example: let us imagine that the government would set the tax exemption for a household at £10,000 and the NIT at 50%. Similar to what currently is the case, a household with an income of £10,000 would pay no tax, and any household earning more than that will have to pay tax on iSeifert 1ncome exceeding the £10,000 exemption threshold. However, under the NIT system, if a household had no income at all it would receive £5,000 – that is, 50% of the amount by which its income fell short of the exemption threshold. If this household brings in £2,000, the government subsidy would be £4000 – again, 50% of its income shortfall – adding up to a post-tax income of £6,000. Earnings of £5000 would receive £2,500, for a total of £7,500 (Friedman, 1962). It is important to note that these numbers were chosen for reasons of arithmetic simplicity, actual thresholds and tax rates would have to be based on experiments throughout the country and on what the community can afford.

 

Whilst sharing all the advantages of the universal basic income, the NIT has the perk of not involving cash transfers to those who might not necessarily need them, and thus allows for a less costly and more efficient redistribution of income. Furthermore, the NIT eliminates the ‘welfare trap’, because it replaces the current all-or-nothing model of perverse incentives by gradually withdrawing payments for those who are self-sufficient. ‘The payment scheme is structured so that the claimant is always better off working more hours or taking higher wages than in their current position’ (Adam Smith Institute, 2015). Even though the NIT is solely need-based, it reduces invidious distinctions between the rich and the poor because it is already integrated into the existing ‘pay-as-you-earn’ tax system. The stigma attached to benefits claims would therefore be reduced, because the entitled subsidy would be paid out as part of the wage. In this case individual consumers would enjoy an increased degree of independence in their consumption choices.

 

The NIT would replace the existing working age benefits, such as the Jobseekers’ Allowance, council tax relief and the Employment and Support Allowance. This, according to the Adam Smith Institute, would allow the government to substantially reduce the size of the Department for Work and Pensions, take many of its 34,000 staff off the payrolls and save up to £6bn in administration costs (Adam Smith Institute, 2015).

 

The adoption of the NIT has two further benefits. Firstly, it does not discriminate between recipients, thus not favouring special interest groups. As Friedman claims, ‘there is every reason to help the poor man who happens to be a farmer, not because he is a farmer but because he is poor’ (Friedman, 1962). The NIT would be the defect of farm programs, general old-age benefits, tariffs and the like. Secondly, the NIT operates through the market but, unlike price supports, minimum-wage laws and tariffs, it does interfere with its functioning. Once a basic level of income is guaranteed, the minimum wage becomes obsolete: as businesses are not forced to pay artificially inflated wages, unemployment falls.

 

Nonetheless, the NIT is not exempt from criticism. The main objections to this system are concerned with the problem of incentivising work and responsible consumption choices. Indeed, experiments from the 1970s suggest that there would be a fall in the average number of hours worked and in earnings (by around 4%), yet such experiments provided no evidence of a large number of people completely withdrawing from the labour force (Widerquist, 2005). Furthermore, Stanford’s Eric Hanusheck found that “for youth the reduction in labour supply brought about by the negative income tax is almost perfectly offset by increased school attendance”(Hanushek, 1987). Another study found substantial improvements in reading scores for children in families receiving welfare from the NIT (Murnane, 1979). It’s also worth questioning whether working less should always be negatively connoted, or whether consuming more leisure generates substantially positive externalities. What if individuals chose to work 4 hours less a week, in favour of using the time to write poetry or care for a chronically ill relative?

 

Experiments concerning consumption choices revealed overwhelmingly positive outcomes to the implementation of the NIT. In 2009 a local charity in London conducted a small experiment involving thirteen homeless men. They each received £3,000, free to decide what to spend it on and with no requirements for counselling services. Whilst expectations were low, a year after the experiment had started eleven out of thirteen had a roof above their heads. They enrolled in education, got treatment for drug use, visited their families and made plans for the future. In addition to giving eleven individuals another shot at life, the project saved a large sum that would have otherwise been spent on welfare provisions (The Economist, 2010).

 

Our existing welfare system pushes many of its beneficiaries against capitalism. The aforementioned experiments prove that if consumers were treated as responsible individuals and allowed to make decisions on their own, the basic principles of the capitalist ideal might be more appreciated and shared.  

 

 

JULIUS SEIFERT

is a first year Political Economy student at King’s College London.

 

REFERENCES:

 

Adam Smith Institute (2015). Free Market Welfare: The case for a Negative Income Tax. London: Adam Smith Institute.

 

Atkinson, A. B. (2015). Inequality: what can be done? Camebridge, Ma: Harvard University Press.

 

Bivens, J. (2015). Understanding the Historic Divergence Between Productivity and a Typical Worker’s Pay. Economic Policy Institute. Economic Policy Institute.

 

Friedman, M. (1962). Capitalism and Freedom. Chicago: University Press of Chicago.

 

Gould, E. (2014). 2014 Continues a 35-Year Trend of Broad-Based Wage Stagnation. Economic Policy Institute. Economic Policy Institute.

 

Hanushek, E. A. (1987). Lessons from the Income Maintenance Experiments. Federal Reserve Bank of Boston and the Brookings Institution, Boston, MA.

 

Hayek, F. (1994). Hayek on Hayek: An Autobiographical Dialogue. University of Chicago Press.

 

Herold , J. C. (1955). Mind of Napoleon: A Selection of His Written and Spoken Words. Columbia Univ Pr;.

 

King Jr., M. L. (1967 (2010)). Where Do We Go from Here: Chaos or Community? . Beacon Press.

 

Murnane, R. J. (1979). The Effects of a Negative Income Tax on School Performance. Journal of Human Resources.

 

Paine, T. (1795 (2010)). Agrarian Justice .

 

Social Protection Committee (2014) Social Europe: Many Ways, One Objective. Luxembourg: Publications Office of the European Union.

 

The Economist. (2010). Cutting out the middle men. from http://www.economist.com/node/17420321
Widerquist, K. (2005). A Failure to Communicate: What (If Anything) Can we Learn from the Negative Income Tax Experiments? The Journal of Socio-Economics .

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