universal vs targeted transfers

Two Boston economists, Rema Hanna from Harvard and Benjamin A. Olken from MIT, have drafted a paper on basic incomes for the Journal of Economic Perspectives, a publication of the American Economic Association. They argue that, though a universal basic income (UBI) might be appropriate for wealthy countries, it is not appropriate for developing countries.

The paper is well-written, but fails to support their thesis. In fact, drawing on a phrase from William Shakespeare’s play Hamlet, they “hoist themselves with their own petard”.  A “petard” is a small bomb. Shakespeare, writing in the singular, referred to a case in which a bomb-maker is blown up (“hoisted”) with his own bomb. The phrase came to be used more generally, to indicate ironic reversal or poetic justice.

My point is simple: the text of the paper provides abundant evidence that universal incomes should be preferred to transfers that are limited to the poor.

The famous economist Milton Friedman (1912-2006), not known as a champion of left-wing causes, advocated a universal basic income (UBI) in his book Capitalism and Freedom (University of Chicago Press, 1962). Friedman called the UBI a “negative income tax”, and explained in a well-crafted essay that the two are equivalent:

In principle, there always exists a universal subsidy (sometimes called a “social dividend”) plus a tax system that would produce identically the same results as a negative income tax.

Milton Friedman, “The Case for the Negative Income Tax”, in The Essence of Friedman, edited by Kurt R. Leube (Hoover Institution Press, Stanford, California), p. 63. Excerpted from Republican Papers (edited by Melvin R. Laird, Doubleday & Co., 1968).

Friedman never applied his UBI proposal to any country other than the United States. In a much shorter article, he wrote:

I favor the negative income tax because it would be vastly superior to our present [means-tested] guaranteed annual income. It would cost much less, give more help to the truly poor, avoid interference with personal freedom, preserve some incentives to work, and drastically reduce the present bureaucracy.

Milton Friedman, “The Case for the Negative Income Tax”, National Review, 7 March 1967, pp. 239-241.

Surprisingly, Hanna and Olken do not cite Friedman, nor do they include him in their extensive list of references. They did not include an abstract, but the third and fourth paragraph of the introduction (p. 202) provide what seems to be the equivalent of an abstract:

Many countries have implemented transfer programs that seek to target beneficiaries: that is, to identify who is poor and then to restrict transfers to those individuals. In developed countries, because one rarely observes true income-earning ability, targeting is usually based on income. But in developing countries, governments do not observe income for the vast majority of the population who work in the informal sector, which typically includes most of the poor. Imperfect targeting using various proxy measures for income leads to both inclusion errors (giving the transfer to those who are not poor) and exclusion errors (failing to deliver the transfer to poor individuals who slip through the cracks in the targeting protocol).

Given these challenges, some have begun to advocate for “universal basic income” programs, which dispense with trying to identify the poor and instead provide transfers to everyone. A universal basic income program is comparatively straightforward to implement —each individual receives a fixed transfer, regardless of income— so the main challenge is to ensure that each person receives the transfer only once. Although universal basic income programs distribute the same value of transfer to everyone, including the very rich, if they are financed through proportional or progressive taxation, they can still result in a substantial redistribution to the poor.

There is one serious problem with this abstract. It could have been written by Friedman, even though the authors in the body of the paper argue against a UBI, at least in developing countries. At the bottom of p. 204, they even add something missed by Friedman, writing that universal transfers

could provide insurance for individuals to take risks: for example, choosing to plant a crop that could be high-return but has a nontrivial probability of zero income might be a more attractive option with a universal basic income in place. The same ideas could be applied to other types of risky decisions, such as human capital investment.

Following the introduction, there is a section titled “What about Poor countries, Where Tax Systems Are Less Developed?“. Their answer is that “in most poor countries, the government does not observe any information about income for most people, and in particular, for the poor”, so a UBI would have to be paid with higher taxes collected from “those relatively few people inside the tax net” (p. 205).

There is one not-so-small difficulty that the authors ignore. If governments cannot observe incomes of the poor for tax collection, how can they observe incomes to target the poor for transfers? The answer, of course, is that attempts to do so come with bureaucratic costs and measurement errors. Recall the errors of inclusion and exclusion that accompany targeting. The authors measure these errors in a sample of households that receive targeted benefits in Indonesia and Peru:

The key finding … is that narrowly targeted programs —those focused on distributing large benefits-per-capita to the poorest of the poor— appear to achieve much higher utility levels than less narrowly targeted programs, including … a universal basic income. In Indonesia, the socially optimal program calculated in this way targets about 19 percent of the population, with inclusion error of 7.4 percent and exclusion error of 58.2 percent; for Peru, the socially optimal program targets approximately 18 percent of the population, with inclusion error of 6.4 percent and exclusion error of 52.4 percent. (pp. 214-215)

The results for the two countries are remarkably similar. More than half of those who should qualify for benefits do not receive them, while more than six percent of beneficiaries have incomes higher than the cutoff line. There is considerable discussion, in the pages that follow, of the difficulties of targeting. For example, since income is not observed, proxy means-tests are often employed using variables such as ownership of assets, but agents “may strategically misreport or hide assets to make sure they fall under the cutoff” (p. 217).

An interesting historical example is Britain, which, from 1696 to 1851, “imposed a tax on windows, which were easily observable to the taxman— but this led to the construction of buildings with very few windows, low light, and poor ventilation” (p. 220). There is also discussion of alternative ways to target benefits, such as community targeting, workfare programs and conditional transfers, none of which are very attractive.

To their credit, the authors acknowledge, in one small paragraph, that they assume that the budget available for cash transfers is fixed. This assumption most likely does not hold in practice because “political support for redistribution may be much higher if everyone gets a ‘piece of the pie'” (p. 215).

After providing strong evidence in favour of universal basic incomes, the authors have the chutzpah to conclude that targeting trumps universal transfers:

Our evidence from Indonesia and Peru shows that existing targeting methods in developing countries, while imperfect, appear to deliver substantial improvements in welfare compared to universal programs, because they can transfer much more on a per-beneficiary basis to the poor as compared with universal programs. The primary downside of these programs is horizontal equity—-because targeting is imperfect, there will be a substantial number of poor households who slip through cracks and are excluded. Nevertheless, for many developing countries, our simulations suggest the welfare gains from targeting may be substantial. (p. 224, emphasis added)

Rema Hanna and Benjamin A. Olken, “Universal Basic Incomes versus Targeted Transfers: Anti-Poverty Programs in Developing Countries“, Journal of Economic Perspectives 32:4 (Fall 2018), pp. 201–226. Open access.

It is sad to see researchers from prestigious universities conclude that targeted systems are ‘optimal’ when they reach fewer than half of the poorest of the poor.

 

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