Comparing Tax-Benefit Systems
Keith Rankin, 6 October 1998
Much of the debate between advocates of targeted benefits and advocates of universal benefits is conducted in an atmosphere of rhetoric and ignorance. The differences are a matter of faith and assumption. Performing empirical comparisons is too much work when you already know that you are right.
The same applies to the various rival views of Universal Basic Income (UBI). I am to some extent guilty myself, in that I have in the past made no attempt to investigate variations of the targeting option. Further, I have not always presented the differences between different versions of UBI clearly.
The form of UBI that I have consistently favoured - a form with a two-tier benefit structure - is in fact a reconciliation of universal- or entitlement-based provision and a targeted- or needs-based provision. This recognises that there are two kinds of equity: horizontal equity in which equals are treated equally, and negative equity in which unequals (ie people with different needs) are treated unequally. Thus, while my favoured UBI proposal - as exemplified my modest proposal for the year 2000 - is fully consistent with the three key UBI principles, it also represents a pragmatic solution to the present welfare mess. (See Policy Discussion Paper by Susan St. John and myself "Quantifying the Welfare Mess".)
While I still favour this UBI solution over all others, I have since discovered another equally practical proposal that, at first sight, is fully targeted.
With respect to the dichotomy between universal and targeted benefits, let me quote from Ian Templeton (Sunday Star-Times, 27 September 1998):
The thrust of the Shipley government is to shift the role of the Government towards a needs-based approach. As one authority put it, a needs-based approach is generally more equitable and efficient than an entitlement approach because people on low to modest incomes are not taxed to increase the incomes of retired millionaires. State welfare programmes, applied universally, are costly, impose a high tax burden and are a drag on growth. Simply, why should the poor be taxed to give more to the well off?
Why do the poor prefer the allegedly inequitable option, and the rich prefer the allegedly more equitable? And do equity and efficiency go together? The usual argument from economics texts is that equity and efficiency are subject to a trade-off: more equity means less efficiency and vice versa.
Templeton's assertions are quite incorrect. Targeting is favoured by the rich because it means lower taxes. Or, put another way, targeting means high tax benefits. Tax benefits disproportionately favour the rich. Targeted benefits only favour the poor if they are set at higher amounts than are universal benefits. That is rarely the situation in practice. Targeting doesn't mean higher social welfare benefits. Rather, it means fewer people get them. Thus, theoretically, universal benefits favour those on middle incomes while a regime of targeted benefits favours the very millionaires (through lower taxes) that Templeton claims are favoured by universal benefits.
With respect to the issue of equity and efficiency, an entitlement system is more efficient, by definition, because all income is distributed according to entitlements (eg in accordance with private or public property rights and labour contributions) and is therefore free of what economists call "distortions". (Public property rights are entitlements based on some concept of citizenship.) In a universal welfare state, welfare payments have the same standing as do wages and company dividends. On the other hand, a needs-based targeted system is based on redistribution via transfer payments. "Redistribution", to libertarians, is a euphemism for theft, and is necessarily inefficient.
From the preceding two paragraphs, it is clear that, conceptually, universal welfare systems are both more equitable and more efficient than are targeted systems; exactly the opposite of what Templeton claims.
To be fair to Templeton, I understand he has a concept of 'competitiveness' in mind, and not the true concept of economic efficiency. Thus, he favours lower taxes because they enable New Zealand producers to compete advantageously against other countries' producers. The logic of competitiveness is that taxes worldwide would be reduced to very low levels, which would lead to grossly underresourced public sectors and therefore to an inefficient global economy.
How does the analytical evidence relating to equity stack up? Interestingly, one variant of UBI has an inequitable look, whereas one version of targeting looks to be very equitable.
In these comparisons, I have included the flat rate ACC levy of 1.2% as a part of the tax structure. The four systems considered are:
The four proposals have been costed in accordance with costings I made following the May 1998 budget. Thus two UBI proposals require tax rates of 39% and 49%, whereas the two targeted proposals are based on the present income tax rate of 33%. All examples with targeting include accommodation supplements as a part of the benefit, calculated at the Wellington rate.
The following two graphs compare the net incomes of a single person who would today be eligible for an Accommodation Supplement at the Wellington rate where his/her income is low enough. They also apply to each individual of a childless couple.
The UBINZ full UBI gives a slightly lower income to this person when unemployed. The present system gives a marginally higher net income for incomes of up to $100 per week, but falls away badly after that. It is the worst option for persons grossing from $160 to $520 per week. The UBINZ full UBI does best for those grossing $400 to $500 of privately-sourced income. The GMTB option pays better than the KR UBI proposal for those persons grossing less than $400 per week. The present system is best for those receiving more than $650 per week, whereas the targeted GMTB system is worst for most middle-high income recipients. At incomes higher than $65,000 per annum, the UBINZ full UBI option yields the lowest net income, reflecting the higher tax rate. The KR UBI proposal is more equitable than the GMTB option at single person gross incomes of over $110,000 per annum. Overall, the KR version performs consistently, in that it is almost never the one that returns the highest or the lowest net income. At $600 per week, about the average wage, the KR proposal just inches ahead of the present system and the UBINZ full UBI.
Figure 3 below shows the situation faced by a sole parent with three children. The KR UBI proposal protects low income single parent families, while leaving high income sole parent families a little worse off than at present.. The UBINZ full UBI proposal disadvantages low income solo mothers, while advantaging those grossing over $900 per week. The GMTB proposal is very favourable to middle-income sole parent families, giving those earning from $600 to $1,000 per week about $100 per week more than at present after tax.
Figures 4 and 5 show the impact of the 4 systems on a single income two parent family. The UBINZ full UBI proposal clearly favours such a household. Where gross privately sourced income reaches $1,000 per week, this family improves its after tax income by nearly $300 per week. Figure 5 shows that this option becomes equal to the others at gross incomes of around $3,000 per week, or $150,000 per annum. It pays least of the four options for single income families grossing over $4,000 per week.
The KR UBI proposal clearly gives single income two parent families a significant advantage over the present system, for incomes up to $2,500 per week. On the other hand, the GMTB option favours those on lower incomes relative to the KR UBI, and delivers lower disposable incomes to most high income earners. Yet, for very high income earners, the KR UBI is more equitable, on account of the 39% tax rate. A key advantage of the KR UBI proposal over the GMTB only system is that effective marginal tax rates are lower for gross weekly incomes in the range of $850 to $1,900 per week. ($40,000 to $100,000 per annum).
For two-income two-parent families, the UBINZ full UBI gives huge gains to families, especially families with market incomes around $900 per week. It is on account of these gains to such families that the tax rate has to be as high as 49 percent. The KR UBI proposal gives significant but affordable gains to lower income two income families, while the GMTB proposal is once again highly redistributive. With this option, most high income recipients are worse off than at present because, while still paying tax at 33%, they lose all their tax benefits.
Finally, Figure 7 shows that low income retired couples are advantaged by the KR UBI proposal and by the GMTB proposal, while being significantly disadvantaged by the UBINZ full UBI option. On the whole, the UBINZ full UBI option clearly gives too much extra to households with children, and penalises most households without children. The KR UBI proposal protects superannuitants, while also simulating the controversial super surtax that was abolished earlier this year. As incomes exceed $1,000 per week, the KR UBI proposal becomes the second-most generous. The present system is clearly very generous towards retired couples grossing more than $300 per week. This arises from their tax benefits and accommodation supplements that come in addition to their pensions.
Overall we can say that the present system relatively favours the old, high income recipients, and, to some extent, the childless. It disadvantages those without privately-sourced income, not by paying them less, but by giving them less incentive to procure legitimate income from sources other than their benefits.
The two-tier UBI proposal that I favour, with its targeted second tier, is conservative in its redistributive effects relative to the present system. It clearly provides more disposable income to families, and has no anomalous effects.
The present targeted system is associated with a more inequitable income distribution than the other options, giving lie to Ian Templeton's claim. The UBINZ full UBI is hard to characterise with respect to equality, because it favours middle income recipients while disadvantaging both rich and poor.
For the income ranges of the bottom 95% of the population, the targeted GMTB proposal is more equitable than the universal KR UBI proposal. Thus targeting can be equitable when tax benefits are removed. To make targeting fair, higher income recipients should pay the mandated tax rate (eg 33%) on all of their income, rather than paying less tax on the first $38,000 of privately sourced income.
The main weaknesses of the GMTB proposal are the persistence of the effective marginal tax rate of 59.2% (including ACC levies) throughout all of the income range of most earners, and the significantly worse position that would be faced by single middle-income earners grossing between $30,000 and $50,000 per annum.
It should be noted that the "GMTB only" option is more like a UBI than it first appears. For the targeted population, which means at least 80% of us, it offers a benefit combined with an effective tax rate of 59.2%. It differs from a true UBI in that the 59.2% tax rate only applies to the "targeted' population, and the amount of benefit payable is variable rather than fixed. Thus it achieves vertical equity, but no measure of horizontal equity. For many beneficiaries and wage earners with children, an effective marginal tax rate of less than 60 cents in the dollar is less than they face at present.
The UBINZ full UBI option charges a 49% effective marginal tax rate for all income recipients. The KR UBI proposal, gives an EMTR of 64.2% to all persons receiving the second-tier GMTB, and 40.2% to all others. For a large group of middle income earners, the KR UBI offers a lower marginal tax rate than do any of the other options.
To conclude, I find that the KR UBI option and the GMTB option are the fairest proposals within their genres (ie universal or targeted). Both integrate the tax and benefit systems and provide consistent formulae for benefit and tax payments. Neither sets a maximum level of benefit assistance. Both are flexible, in that they can accommodate special circumstances simply by raising the GMTB. Furthermore, both can be integrated with the ACC, enabling ACC benefits to be incorporated into the GMTB.
The KR UBI option is probably best, because it reflects both entitlement and need. And also because it can fully integrate with the student loan scheme, another intractable tax-benefit problem of the 1990s.
Note: I should note that many activists do not favour income tax funding. This variant simply recognises that whatever funding system is used, it would have to be equivalent to a 49% income tax in order for the budget to balance. [back]
Rankin File | 1998 titles