The impossible trifecta

Kevin Milligan says a Guaranteed Annual Income cannot simultaneously satisfy three goals. Instead, you have to pick two among the following:

1. low tax rate
2. high benefit
3. balanced budget

Treasury here in New Zealand modelled a GAI for New Zealand on the request of the Welfare Working Group (HT: Lindsay Mitchell). What did they find? A GMI paying $300 per week - the mean benefit income among those on benefits - would cost $44.5 billion, or $52.6 billion if we extended it to superannuitants as a replacement for NZ Super. The former could be covered by a flat personal income tax rate of 45.4%; the latter, 48.6%. But full fiscal neutrality would require tax rates of 50.6% and 54.4% - the lower tax rates would be just enough to cover the transfers, but income tax revenues are currently also used to fund more than just transfers.

If we recognize that most parents are beneficiaries via Working for Families and compensate them for the loss of our version of EITC with a $86 per child per week payment, we get a $57.1 billion fiscal cost and a personal tax rate of 50% (or 55.7% for fiscal neutrality).

And, even this rather expensive system leaves the worst off worse off, as it kinda has to. Treasury notes:

Although the Gini coefficient improves under all models, many beneficiaries (including the disabled, carers and sole parents) currently receive more than $300 per week and would be made financially worse off under a GMI scheme. Therefore the GMIs considered could distribute money away from those most in need of government assistance and toward those who have choices and opportunities but choose not to work.

Treasury also warned about potential adverse labour supply responses to the necessary personal tax rates. And, the induced gap between company and personal tax rates would increase IRD's enforcement costs.

Treasury concludes by reiterating Milligan's impossibility:

From the international examples it is apparent that the more equal a society is in the beginning, the lower the returns to a GMI scheme. That is, a New Zealand specific GMI would either be at a level of income too low to reduce poverty, or a level of income that is high enough to reduce poverty but is therefore expensive and hence distortionary through higher tax rates. 

I don't think Gareth Morgan's Big Kahuna scheme is able to escape the trifecta by imposing new taxes on capital or land. Why? Because those aren't free lunches either. If it's worth having a land tax, it's worth doing it regardless of whether we have a GAI. So in the first stage we set the optimal tax structure - and I'm completely unconvinced that a capital gains tax is all that hot an idea anyway (see Seamus's posts here here and here.) But whatever the optimal tax structure, we implement it in stage one. Then, we still have to increase all the tax rates by enough to pay for a GAI if we're going to have a GAI. And the impossibility reasserts itself.

Morgan squares things with a cheaper GAI paying $11k instead of Treasury's $15k. But I have a hard time believing that's a stable political equilibrium. Could NZ politicos really avoid the temptation of adding targeted benefits for the many folks currently on benefits totalling well over $15k? If not, how quickly do we wind up having a GAI on top of a targeted benefit system?

Morgan and Guthrie’s Modest Taxation Proposal

Gareth Morgan and Susan Guthrie have proposed a radical shake-up of New Zealand’s tax and welfare system, summarised in this article in the Herald last week. The main features are as follows:

• an “unconditional basic income” (UBI) of $11,000 for every adult, applying to everyone and replacing all other benefits including superannuation;
• a flat income tax rate of 30% applying to all income earned by individuals, trusts, or companies; and
• a “comprehensive capital tax” (CCT), which effectively imposes a minimum tax on all capital excluding financial assets equal to the tax that would apply if the capital earned a rate of return of 6%.

I assume also that they assume maintenance of a broad-based GST, and full dividend imputation of corporate tax.

Some things in their proposal I like. Having a single system implementing transfers and income taxes is long overdue. I wouldn’t go so far as to have a single minimum income that is the same for every adult, irrespective of need, as the level that would be needed to guarantee an acceptable income to the most needy would be unaffordably high if given to all. An integrated tax and transfer system, however, needn’t be as hands off as in their proposal; there could still be a role for a body like WINZ to adjudicate on levels of benefits according to need, and provide other support services; the most important thing is to integrate the systems so that the impacts of policy changes on horizontal equity and effective marginal tax rates are transparent.

Aligning the corporate tax rate, tax rates on trusts, and the marginal rate of income tax for the majority of taxpayers is also long overdue. I wouldn’t have a single rate all the way down to zero income, in order to allow differences in the guaranteed minimum income based on need to be phased out at higher incomes. Again, the point of difference here is small relative to the main point. A system in which there was a common rate applying to corporate income, trusts, and the income above, say, $30,000 would probably achieve almost all of the benefits of a single rate in terms of eliminating the distortions and compliance costs that multiple rates can bring.

On the other hand, the comprehensive capital tax has me flabbergasted, for a number of reasons:

First, the contrasting motivations for the UBI and CCT seem incongruous. Under the UBI, an able-bodied pre-retirement adult with no dependents would be entitled to choose to not work and still receive the UBI, and pay no tax. Their justification for this is that “[w]e are a rich society so to compel people to opt for paid work or face the stigma of qualifying for a benefit has no logic.” At the same time, however, their CCT does not regard it as a matter of personal choice how people should invest their savings; instead it implies a moral imperative to earn a return of at least 6%. There seems to be an underlying value judgement that earning a high return on capital is a social obligation, but one that only applies to those who choose to save at all.

Second, an effective minimum tax represents a massive deviation from the admirable principle of having a common rate of tax on all income, and brings with it the distorting effects of multiple rates. As an illustrative example, consider someone choosing whether to invest in an asset with a guaranteed return of 6%, or one with even odds of returning either 0% or 15%. The risky asset has a higher expected return to the economy, but under the non-linear tax system it would have a lower expected after-tax return. This is a strange incentive structure for a proposal designed to better allocate capital.

Third, a CCT seems likely to have some quite insidious properties. The proposal calls for the CCT to be applied to all non-financial assets including the family home. They don’t specify in the article how the capital value of the asset is to be determined. Is it the purchase price or the current market value? If it is the purchase price, then the tax would create the same sort of distortion as a capital gains tax applying only to realised gains—an incentive to hold on to appreciated assets in order to avoid the tax rather than choosing a portfolio because of their underlying value. If it is on the market value, then homeowners would be subject to large fluctuations in their tax liabilities from year to year independent of their income streams, at the whim of property valuers. This, of course, is already an issue with local-body rates, but the amount levied in rates each year is trivial compared to a 30% tax on 6% of the valuation of a house.

Finally, a CCT would bring about a one-off capital loss on the value of houses, as future purchasers would have to consider their ability to pay the tax when calculating how large a mortgage they could afford. That is, the shift to the proposed tax system from the status quo would start with a massive takings from property owners. This needs to be borne in mind when thinking about the benefits of a system with a high UGI and low marginal tax rate: Of course, we can have low taxes and generous benefits, if the government can fund its activities from an initial property theft. But I’d rather have a clunky and inefficient tax system coupled with a respect for property rights.

Rot at the centre of New Zealand economic commentary

Matt Nolan over at TVHE takes issue with Gareth Morgan's latest NZ Herald column.

Matt hits some of the problems in that piece. But he's probably pulling his punches out of professional courtesy. As I'm in the academic world instead of the consultancy world, mostly, I don't have to. And so I'm going to smack Morgan around a bit on his history of economic thought.

In particular, Morgan name-drops J.S. Mill in favour of redistributive spending. Morgan writes:

It was during the industrial revolution that grotesque disparities in wealth and intensified impoverishment of the workhouse poor led the economist philosophers of the "enlightenment period" to conclude the purpose of taxation was, as John Stuart Mill put it, to "favour the diffusion rather than the concentration of wealth".

Ok, let's go back and have a look at what Mill advocated then. Mill definitely supported redistribution for the alleviation of absolute poverty and starvation. But he also worried that if the provision of relief made relief more attractive than work, "the system strikes at the root of all individual industry and self-government." Let's go back to source:

In so far as the subject admits of any general doctrine or maxim, it would appear to be this—that if assistance is given in such a manner that the condition of the person helped is as desirable as that of the person who succeeds in doing the same thing without help, the assistance, if capable of being previously calculated on, is mischievous: but if, while available to everybody, it leaves to every one a strong motive to do without it if he can, it is then for the most part beneficial. This principle, applied to a system of public charity, is that of the Poor Law of 1834. If the condition of a person receiving relief is made as eligible as that of the labourer who supports himself by his own exertions, the system strikes at the root of all individual industry and self-government; and, if fully acted up to, would require as its supplement an organized system of compulsion, for governing and setting to work like cattle, those who had been removed from the influence of the motives that act on human beings. But if, consistently with guaranteeing all persons against absolute want, the condition of those who are supported by legal charity can be kept considerably less desirable than the condition of those who find support for themselves, none but beneficial consequences can arise from a law which renders it impossible for any person, except by his own choice, to die from insufficiency of food.

What did Mill favour? Indoor relief in workhouses that was always less desirable than working for wages but preferable to starvation. So far from favouring heavily redistributive income taxation to alleviate the problems of the workhouse poor, Mill favoured the workhouse.

So it isn't just the modern amoral mathematization of economics that leads to opposition to Morgan's preferred policies.

Further, as West points out, Mill opposed progressive taxation. Here's West:

The fact moreover that Mill made it quite clear to the Select Committee on income Tax that he was not in favor of a progressive income tax, separates him from most modern advocates of a negative income tax plan. Mill's objection to the progressive income tax was based partly on his demand for "social justice," and partly upon his concern for incentive effects, not at the lower end of the income scale but, again, at the upper. He objected that "to tax the larger incomes at a higher percentage than the smaller is to lay a tax on industry and economy; to impose a penalty on people for having worked harder than their neighbours."

And what do we find when we go back to source? The line immediately prior to the one West quotes reads:

Both in England and on the Continent a graduated property tax (l'impôt progressif) has been advocated, on the avowed ground that the state should use the instrument of taxation as a means of mitigating the inequalities of wealth. I am as desirous as any one that means should be taken to diminish those inequalities, but not so as to relieve the prodigal at the expense of the prudent.

So Mill favoured using taxes to mitigate inequality but not if it punished the prudent in favour of the prodigal. So all of this hints that maybe, just maybe, Morgan does violence to the Mill quote he initially presented. Let's check. Here's the source, in a fuller context. The initial italicized portion forms the question posed Mill in his testimony before Parliament:

I quite understand the force of your argument as between one portion of the upper classes, and the other portion, that is to say, the distinction that you have so clearly and admirably stated between the owners of permanent and terminable incomes, and the owners of precarious and certain incomes; but then I wish to draw your attention to quite another division, the next division of society, not according to the source of income, nor according to the tenure of income, but according to the quantity of income relatively to the wants of human nature for subsistence and for comfort, and to ask whether it did not appear, that upon the whole, the adoption of this principle, that savings are not to be taxed (setting aside the degree in which you may be able to give it a precise application), and the attempt to frame a law upon that principle, would not be a change in our law favourable to the condition of the poorer classes of society as compared with the wealthier? 

I think it would be favourable to the saving classes, whether poor or rich, compared with the spending classes; and that consideration I think is even paramount to the other. If the rich are to be subject to a greater proportionate amount of taxation than the poor, I think it ought to be done in some other way. A succession duty is the most unobjectionable mode of doing it, because in that way it is confined to hereditary wealth. I think you must allow people to retain the full advantage for their lives of what they have acquired; but the State may deal with it on the occasion of succession. I certainly do think it fair and reasonable that the general policy of the State should favour the diffusion rather than the concentration of wealth, but not, I think, by taxing people twice on the same portion of their income, or by taxing people for the fact of their saving. Taxing people on what they save, and not taxing them on what they spend, or taxing people on a larger proportion of their income, because they are better off, does not hold the balance fairly between saving and spending; it is contrary to the canon of equity, and contrary to it in the worst way, because it makes that mode of employing income which it is public policy to encourage, a subject of discouragement. [emphasis added]

So the line after the one Morgan cites specifically cuts against capital gains taxes and progressive income taxes in favour of progressive estate taxes. In other work, Mill argues in favour of a proportional tax on expenditure above a minimal threshold. Sure, this generates average progressivity, but it's hardly a progressive marginal tax schedule. Morgan can go read Kurer in HOPE.

I'm not a history of thought scholar. But I took enough history of thought in grad school to know that Mill favoured indoor relief. In other words, he worried like hell about "welfare bludging". The debates we're having today over welfare aren't all that different from the ones had a century and a half ago over the British Poor Laws. We can read arguments today about whether women have an incentive to have kids out of wedlock so as to get on the DBP. A hundred and fifty years ago, Mill advocated that the poor in workhouses observe strict separation of the sexes to avoid the Malthusian problem. There is nothing new in current welfare debates. And yet Morgan calls today's debates about incentives facing the poor in the face of relief "dumbed-down".

Like Matt, I'm really frustrated by the article. I'm really sympathetic towards arguments for a guaranteed minimum income in place of the current welfare system. But I sure would know better than to cite Mill as support.