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Using microsimulations this paper analyzes the poverty and tax implications of replacing current transfers and subsidies by a budget-neutral (no change in the fiscal deficit) universal basic income program (UBI) in
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Using microsimulations this paper analyzes the trade-offs between the generosity of a budget-neutral (no change in the fiscal deficit) universal basic income (UBI) and the implied tax burden in five emerging countries:
While UBI programs have advantages, their costs are larger than targeted transfers; hence to evaluate their impacts a detailed incidence analysis that takes into account both the spending and required increase in taxation is necessary. Moreover, if the main objective of transfer programs is poverty reduction one should consider UBI transfers that are generous enough to maintain or exceed the poverty impacts of existing social transfers, as the poor should not be worse off than under the existing transfer programs. If the aim is to both reduce poverty and create a social protection floor, then the generosity of a universal transfer program should be even higher, to allow pre-UBI poor households to live out of (extreme) poverty.
To the extent that a budget neutral UBI program requires an increase in taxes, its benefit needs to be calculated net of the loss due to higher taxation. If the bulk of higher taxation were to come from taxes on consumption, for example, poor people may end up losing from a UBI reform.
Overall, a UBI would need to be sufficiently generous and financed in such a way that the welfare of the poor is higher in the post-UBI scenario after the additional taxes and spending cuts (from programs replaced by the UBI) are taken into consideration. However, to achieve the latter may be quite expensive and come at significant efficiency costs. As Salanie (2011) puts it: “If such a reform [a UBI] were adopted, part of the middle classes would face an increased marginal tax rate, which would discourage its labor supply–not to mention the political difficulties this would entail.”/4
In fact, when Daruich & Fernandez (2020) model the implications of a UBI equal to the poverty line in an intertemporal general equilibrium framework, they find that “the higher tax rate required to finance this policy reduces investment in skills, lowers the share of agents with college education, and decreases saving, requiring even higher taxes over time. (p. 2).”/5
Thus, there is a trade-off between efficiency and the size of the universal basic income floor: the higher the floor,
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3/ UBI programs are also consistent with welfarist (Fair, 1971; Mirrlees, 1971) and non-welfarist optimal tax theory (see Kanbur et.al, 2018; Kanbur et.al, 2006) which in the derivation of the optimal tax schedule assume that redistribution will take place through lumpsum uniform transfers. For a survey of the optimal tax theory, see, for example, (Tuomala, 1990).
4/ Salanie (2011): paragraph 19 in section 9.3.1 “The Negative Income Tax”.
5/ Their results occur regardless of whether the additional tax comes from a progressive income tax or a neutral (flat) tax on consumption.
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the larger the potential losses in efficiency due to the increase in tax burden but the lower the floor, the smaller the ability of a UBI to reduce poverty and act as a genuine safety net./6
The main objective of this paper is to study the potential trade-off between the generosity– hence, the poverty impact– of a UBI and the concomitant tax burden in five countries with diverse government sizes and characteristics of their welfare system:
We simulate the first-round effects on post-UBI incomes and tax burdens that result from replacing the existing social assistance cash transfers and consumption subsidies by alternative UBI scenarios in a budget-neutral form./8
To moderate the required increase in tax burden, we assume in the simulations that both current social transfer programs and consumption subsidies are replaced by the UBI, and that the funds from both are reallocated to the UBI program./9
Our microsimulations use household surveys and administrative information housed in the
We start by reporting inequality and poverty in the “baseline scenario:” that is, in the existing transfer and fiscal system. We then simulate a “spending neutral” UBI reform. Specifically, we take the current levels of spending on direct transfers and consumption subsidies and reallocate them to all the population with everyone receiving the same amount. It should be noted, however, that a budget neutral spending neutral scenario may still require a change in taxes because gross incomes change when a UBI replaces current transfers and subsidies since, in our simulations, the amount of taxes paid depends on the applicable tax rates on corresponding incomes (gross income or disposable income, as explained below)./10
The next scenario is the “poverty gap” scenario. Here too the UBI replaces existing transfers and consumption subsidies but the size of the universal transfer is set equal to the average poverty gap measured with prefiscal income (i.e., income before taxes and transfers). Taxes are adjusted accordingly to ensure budget neutrality. We also consider a scenario in between the spending neutral and the poverty gap scenarios: the “equivalent benefit”
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6/ In their article on UBI in advanced countries, Hoynes & Rothstein (2019) find that “…A UBI would direct much larger shares of transfers to childless, non-elderly, non-disabled households than existing programs, and much more to middleincome rather than poor households. A UBI large enough to increase transfers to low-income families would be enormously expensive. (page 6).”
7/ The reference years and data sources are in Table 2. The classification of countries by category of gross national income per capita in 2011 purchasing power parity is based on
8/ Budget neutrality includes the automatic change in direct and indirect taxes that results from changes in gross incomes and expenditures as a result of changes in direct transfers.
9/ In contrast, Rigolini, et.al, (2019) did not consider subsidies as a source of financing nor impose strict budget neutrality.
10/ For example, if the tax rate on gross income of two individuals are 10% and 20% respectively, transferring
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scenario. In this scenario, the UBI also replaces existing transfers and subsidies but the level of the universal transfer is set equal to total spending on transfers and subsidies divided by total beneficiaries of at least one of the existing transfer programs. Again, we achieve budget neutrality through adjusting taxes.
Our simulations consider two broad tax options: direct taxes on personal incomes and indirect taxes on consumption (VAT, excise and sales taxes, etc.). In total, we consider therefore seven scenarios: the baseline and two for each of the spending neutral, equivalent benefits, and poverty gap scenarios depending on whether budget neutrality is attained through direct or indirect taxes./11
Note that the concentration shares of taxes change mechanically from one scenario to another because of the change in the size of UBI. However, in each scenario we make sure that the adjustment to the direct or indirect taxes to achieve budget neutrality does not introduce any additional change to the concentration shares. This additional adjustment is proportional, through an identical percentage change in the corresponding tax rates for each scenario./12
The welfare concept used in our analysis is income per person after both direct and indirect taxes net of cash transfers and subsidies./13
In the literature, this income concept is known as consumable income. While data on inequality and poverty is usually reported for disposable income (income after direct taxes net of cash transfers), we consider consumable income the relevant welfare concept because it captures what people are really able to consume after one takes into account what they pay in consumption taxes and receive in the form of consumption subsidies when they use their disposable income to make purchases./14
For the poverty impact, we used the World Bank Income Class International Poverty Lines, which vary by countries' income levels. In addition, we measure not only the incidence of poverty (headcount ratio) but its severity: that is, we use the squared poverty gap index which captures what happens to the poorest rather than those close to the poverty line (a drawback of the headcount ratio).
The choice of countries analyzed here is driven by various criteria. First, we aimed to include countries with distinct welfare systems regarding their cash transfers programs: countries with poverty-targeted cash transfer programs but relatively limited generosity (
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11/ The spending neutral scenario may also require an adjustment in taxes, and — unlike Rigolini et al. (2019) — our calculations also take this into account.
12/ See the methodology section for further discussion.
13/ In the cases of
14/ Think about two households in different countries with identical disposable incomes but in one country food is exempt from VAT and in the other the VAT rate is 10 percent. Clearly, the welfare level of these two households would not be the same.
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of the state measured by the share of primary government spending to GDP./15
At the lower end of the spectrum is
There are, of course, a large number of countries which would fit under the above criteria that are available in the databases of ASPIRE and the
The simulations are carried out applying the so-called “accounting framework:” that is, we ignore behavioral and general equilibrium effects. In other words, we capture the first-round effects. While this is a limitation, first-round effects are considered a reasonable approximation for the short-run. Furthermore, for the purposes of our analysis, they are enough to assess the fiscal feasibility of the options considered here. If the policy alternatives are viewed as potentially not feasible (due to efficiency costs and/or political resistance) in the absence of labor supply and other behavioral responses, they would be even less feasible if the latter were taken into account.
In order to assess the desirability and feasibility of the simulated UBI programs, we first identify the scenarios in which the poor are no worse off than in the baseline with two types of poverty indicators: the conventional (anonymous) incidence and severity of poverty and the nonanonymous fiscal impoverishment (Higgins and Lustig, 2016)./17
We find that even if the headcount and the severity of poverty are lower under some scenarios, in most cases some of the prefiscal poor are made worse off. For scenarios that pass the “poverty test,” we assess their fiscal feasibility by first looking at the increase in the tax incidence (average tax rate) by decile. In our five countries and across scenarios, the least increase in taxes required for poverty to be lower than in the baseline is around 25% (
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15/ Data is from the Commitment to
16/ The reference years and data sources are discussed in appendix D in (Rigolini et al., 2019). The classification of countries by category of gross national income per capita in 2011 purchasing power parity is based on
17/ The nonanonymous indicator is the change in consumable income per person by decile for individuals ranked by their prefiscal income where the change is the difference between consumable income in each scenario and the baseline.
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feasibility. We also explore whether the fiscal gap could be absorbed through a higher deficit (lower surplus) or a reduction in government spending on other items, but both options appear to be challenging.
Our analysis suggests that budget neutral UBI reforms that do not make some of the poor worse off may require excessive increases in taxation; on the other hand, implementing a feasible budget neutral UBI that is funded by taxes without incurring major increases in taxation and high efficiency costs may entail that some of the poor will be made worse off comparing to the existing system of transfers and subsidies.
It is worth noting that our decision to include some specific UBI scenarios in this paper (leaving out others) is guided by the fact that our analysis is focused on the feasibility of a UBI reform not only as an income floor for all, but also as a poverty reducing instrument. We believe our scenarios capture the two important ends of the range of possible scenarios that are designed to reduce poverty as well as one interesting in-between scenario. On one end (the lower end), we have the spending neutral scenario in which the total expenditure on UBI is exactly equal to the current expenditure on transfers and subsidies. On the other end, we have the poverty gap scenario in which the size of UBI is set equal to the average poverty gap in a country. These two scenarios set reasonable boundaries for the size of the average transfer under a UBI that a country may opt for, especially if the objective is to combine the social protection and poverty reduction goals. While there are many options to choose from for an in-between scenario, we analyze one of the more interesting ones which we refer to as equivalent benefit scenario: we set the universal transfer equal to total spending on transfers and subsidies divided by total beneficiaries of at least one of the direct transfers programs considered./18
Our study builds upon existing studies that simulate the impact of a UBI on inequality and poverty. Among others, Browne & Immervoll (2017) use EUROMOD data to simulate the effects of existing means-tested cash transfers versus a UBI. Hoynes & Rothstein (2019) review the distributional and behavioral effects of a UBI in
Our main contributions are the following. Most cross-country analyses for middle income countries focus on the spending side without taking into account the implications on tax burdens,
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18/ We opted for calculating the equivalent benefit transfer considering the beneficiaries of at least one direct transfer program (and not both transfer and subsidy programs) because, as it is discussed in our methodology section, our simulations allocate subsidies to each household based on the decile of income distribution its members belong to so, implicitly, every individual in the decile receives the average benefit of the subsidy. In other words, the number of beneficiaries from subsidies equals the total population in the survey which would put us in the spending neutral scenario.
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and what the latter mean for the post-UBI poverty and inequality indicators./19
Second, the existing analyses do not always assume budget-neutrality. Third, prior research focuses on the impact on poverty and inequality measured with disposable income rather than consumable income: that is, it does not consider the negative impact on living standards caused by higher consumption taxes. To the best of our knowledge, ours is the first paper that does all three: looks at tax burdens, assumes budget neutrality, and uses consumable income as the welfare indicator. In addition, our paper makes two further contributions. We rely on a clear set of conditions to select feasible UBI scenarios based both on poverty impacts and the required increase in tax burdens. By analyzing the budgetary conditions prevailing in our selected countries, we also consider whether a UBI could be financed through a higher fiscal deficit or lower spending in other items.
The paper is organized as follows. Section 2 discusses the microsimulation methodology of this paper and renders more details regarding the household survey data and administrative accounts of the five countries considered in this paper. Section 3 presents our results regarding the impact of each budget neutral UBI scenario on the inequality, poverty, and tax incidence in all five countries. Finally, section 4 provides our concluding remarks.
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19/ Exceptions are Lustig et.al (2019) and Rigolini et al. (2019).
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The results shown in this article reinforce the view that, even in middle income countries, it may be very challenging to design a UBI program that would leave the poor no worse off than under the existing transfers and subsidies schemes and simultaneously keeps the increased tax burden in check.
Thus, it would seem that whenever reducing poverty is the primordial goal, targeted transfers (either means tested or categorical) will be a superior option. Many decades ago, Akerlof (1978) formally showed that if beneficiaries could be selected (“tagged,” using his terminology) without a cost, a welfare system that gives transfers to people with special needs or characteristics (e.g., the poor) would be superior to a uniform negative income tax that gives the same benefit to everyone.
This rationale is the basis for targeted programs. In categorical targeting, the benefits are provided to people with characteristics that are exogenous in the sense that these characteristics are more difficult to manipulate or change through behavior (e.g., social pensions to the elderly). In means-tested targeting, the benefits are provided to people with, for instance, incomes below a certain threshold. The problem is that people can change a characteristic such as income through behavior: e.g., nonbeneficiaries could decide to work less in order to become eligible./36
The evidence for developing countries, however, does not show that transfers targeted to the poor result in a reduction in adult labor supply (see, for example, Fiszbein & Schady (2009), chapter 4 and Bastagli et al. (2016)).
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36/ Hence the amount of effort that governments place in defining eligibility criteria that are complicated and nontransparent. The more complicated and obscure, the more difficult it is for people to change their behavior to become eligible. In
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