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UK: New research simulates labour market effects of tax and benefits reform options

Satelite picture over Europe. Credit to: TechCrunch.

A new working paper from the Institute for Social and Economic Research at the University of Essex reports on research using the EUROMOD microsimulation programme to simulate the labour market effects of several different tax and benefits reforms in countries in different parts of Europe.

The reform options tested are as follows:

  • An unconditional Basic Income – correctly defined
  • A general Negative Income Tax – that makes a payment if earnings fall below a threshold (the payment being proportional to the amount that wages fall below the threshold), and deducts tax above the threshold
  • What the researchers call a ‘conditional basic income’ – which is a means-tested benefit that is withdrawn at a rate of 100% as earnings rise, thus constituting a guaranteed minimum income
  • In-work benefits – means-tested in-work benefits without a relationship with the income tax threshold.

All of the reforms assume a flat income tax.

The research finds that the General Negative Income Tax usually promises the most efficient employment market: although in the context of the UK there is almost nothing to choose between a General Negative Income Tax and an Unconditional Basic Income. The research did not take into account the administrative complexities of a Negative Income Tax. If it had been possible to simulate the effects of administrative complexities on labour market decisions then they might have found that in the UK an Unconditional Basic Income would have turned out to be the most efficient option.

The working paper is entitled The case for NIT+FT in Europe: An empirical optimal taxation exercise, and is by Nizamul Islama and Ugo Colombinob.

Click here to read the working paper; or here to download the paper as a pdf.

Abstract

We present an exercise in empirical optimal taxation for European countries from three areas: Southern, Central and Northern Europe. For each country, we estimate a microeconometric model of labour supply for both couples and singles. A procedure that simulates the households’ choices under given tax-transfer rules is then embedded in a constrained optimization program in order to identify optimal rules under the public budget constraint. The optimality criterion is the class of Kolm’s social welfare function. The tax-transfer rules considered as candidates are members of a class that includes as special cases various versions of the Negative Income Tax: Conditional Basic Income, Unconditional Basic Income, In-Work Benefits and General Negative Income Tax, combined with a Flat Tax above the exemption level. The analysis shows that the General Negative Income Tax strictly dominates the other rules, including the current ones. In most cases the Unconditional Basic Income policy is better than the Conditional Basic Income policy. Conditional Basic Income policy may lead to a significant reduction in labour supply and poverty-trap effects. In-Work-Benefit policy in most cases is strictly dominated by the General Negative Income Tax and Unconditional Basic Income.

Malcolm Torry

About Malcolm Torry

Malcolm Torry has written 2 articles.

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