(Illustration by iStock/mj0007)
The idea of universal basic income (UBI) is to provide a regular cash payment to all members of a community without any work requirements or other preconditions. Andrew Yang, a candidate in the 2020 Democratic presidential primary, popularized UBI on the campaign trail, turning it into his signature policy. A flood of commentary and analysis followed as voters wondered whether UBI could reduce economic inequality and provide security for millions of Americans living under precarity and facing the threat of automation.
Among economists studying UBI at the time were Diego Daruich, a professor of finance and business economics at the University of Southern California’s Marshall School of Business, and one of his former advisors, Raquel Fernández, a professor of economics at New York University. Watching mounting evidence of the beneficial effects of short-term cash transfers in small-scale settings, the researchers realized that studying larger-scale UBI, which promises payments in the long term, even forever, called for a new, dynamic model. How could economists capture the macroeconomic effects of the US government giving money to all Americans in perpetuity?
The researchers constructed a macroeconomic life-cycle model to account for many individuals of differing ages, the investments that parents make in their children’s education, how much people work, how much they save, tax payments, consumption patterns, and the interactive effects of all these factors. Using a UBI policy financed by labor income taxation that provided each adult with $8,000 annually, drawing on US data that follows households over time, and incorporating many of the costs and benefits associated with UBI to carry out several exercises, the researchers found that the policy decreased overall welfare.
“We asked why our findings turned out that way, while others have found the opposite,” Daruich says. “That’s when we began playing with our model, turning on some features and turning off others. We saw that when UBI is introduced, taxes must be increased to finance it, and those taxes are large, which lowers the return to investments because taxes are higher, leading to lower capital accumulation. In addition, since individuals know they will always have some money from the government, they don’t need rainy-day savings. These two forces lead to lower capital in the economy, which leads to lower wages. If there are no firms, and there are no jobs, wages go down.”
Less capital also shrinks tax revenues from businesses, necessitating additional increases in other taxes to foot the bill for UBI. “All these dynamic, long-run effects take time to appear,” Daruich says. Sharp tax increases, economists have shown, influence the decisions that parents make, such as educational investments. When spending on education diminishes, the result is lower skills in the economy, and declining skills spell welfare losses.
To understand behavioral changes following cash transfers, the researchers looked to empirical studies that track the work norms and spending habits of lottery winners. Since 2020, commentators have expressed concern that UBI will cause Americans to work less. One analysis of lottery winners in the United States, for example, charted a drop in their average annual labor earnings during the five years following the reward. The researchers tested labor market responses to lottery winnings using their life-cycle model and found that cash windfalls led to lower labor earnings and a decline in overall labor supply.
And yet the researchers’ findings do not preclude progressive taxation, Daruich insists. Instead, the evidence suggests that there are better ways to mitigate inequality than UBI, a blunt instrument that gives money to everyone, whether rich or poor. More directed transfers to finance high-quality early childhood education, for example, or even cash distributed in targeted ways, are much more likely to be effective.
“This excellent paper provides an analysis of the effects of UBI programs by concentrating on the dynamic effects of skill formation across generations,” says Gustavo Ventura, professor of economics at Arizona State University. “It complements recent work that shows, in macroeconomic settings, that UBI is generically a bad idea.”
Find the full study: “Universal Basic Income: A Dynamic Assessment” by Diego Daruich and Raquel Fernández, American Economic Review, vol. 114, no. 1, 2024.
Read more stories by Daniela Blei.