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Portfolio > Economy & Markets > Fixed Income

Note to Swiss: Basic income plans have a basic flaw

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(Bloomberg) – If something sounds too good to be true, it probably is.

That adage comes to mind when discussing universal basic income—that is, cutting a check of the same amount to all citizens, regardless of earned income—the kind of initiative that Switzerland will be voting on in two weeks.

That’s right: Every adult Swiss citizen, even the multimillionaires who sport Breguet watches, could potentially receive an equal monthly payment from the government.

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Proponents of universal basic income argue that giving citizens money directly is an effective poverty-relief measure, can improve incentives to work, and offers a way to streamline a plethora of government-administered, income-support programs, all while removing the stigma associated with receiving them. Theoretically, such a plan could get support from a broad array of politicians, regardless of political affiliation.

Such reasoning, however, can run into serious economic and popular political headwinds, as illustrated by a poll last month suggesting Swiss voters will soundly reject the measure.

In a presentation to the Canadian Association for Business Economics, University of British Columbia Professor Kevin Milligan explained why it’s unlikely that any basic income initiative will receive that level of support or accomplish all of its professed goals. Any such plan will involve trade-offs that should prove distasteful to either the left or the right, if not both.

Milligan noted that in these discussions, it’s important to distinguish between universal basic income and minimum income guarantees.

Under the latter system, there would be a phase-out threshold whereby those who earned in excess of a certain amount wouldn’t receive any income supplement. For instance, under a 100 percent phase-out rate set at $25,000 a year, an unemployed individual would receive $25,000, a person earning $15,000 would get $10,000, and anyone making $25,000 or more wouldn’t get a penny. Canada’s province of Ontario, for instance, plans to pursue a minimum income guarantee pilot program in a select community.

No basic income initiative needs to be that black and white, however; such a system could be designed so that the size of the cash payment decreases gradually as earned income exceeds select thresholds, in the same fashion as marginal rates increase under a progressive tax system. For example, an individual making nothing might receive $25,000, someone earning $25,000 a year might receive an additional $15,000 as an income supplement, and a person who makes in excess of $50,000 might receive $5,000.

The three critical features to take into account when designing a basic income initiative are this phase-out rate, the size of the payout, and the cost of income assistance programs. Therein lies the “impossible trinity” of basic income, as outlined by Milligan:

All these features are desirable, but all three can’t be done at once.

A large basic payment ensures that such an initiative will make a difference in terms of alleviating poverty. Having a relatively low phase-out rate (a high degree of universality in such cash transfers) is a presumptive feature, not a bug, of a basic income system, as it addresses the disincentives to work that arise when workers hit the “welfare wall.” (That’s when returning to work or working more hours causes some to be worse off because of decreased government assistance.)

But if you accomplish both those goals, the costs will be staggering. In the case of Canada, sending every citizen a check for $15,000 would cost $540 billion, almost double the amount of revenue the federal government expects to take in this year. Funding this system would necessarily entail the elimination of other income assistance programs and/or raising taxes on not just the rich, but also middle-income earners—only to return those funds to them by way of a basic income transfer.

Sacrificing the low-phase-out rate—in other words, implementing a basic income guarantee system—means that the initiative doesn’t address the problem of the welfare wall and, in fact, “makes it bigger and worse,” said Milligan. Alternatively, if a government wants to cut a check to everyone without meaningfully increasing the cost, compared with the current income assistance regime, it would be sending peanuts.

“Basic income advocates need to show us their math,” concluded Milligan.

See also:

How to battle irrational financial behavior

Why you should use FIAs in retirement income planning

4 reasons income annuities might be the retirement equivalent of Airbnb


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