The Effect on Households of Different Methods of Financing a UBI

To evaluate the potential effects of a hypothetical $1.5 trillion Universal Basic Income (UBI) program, PWBM conducts analyses of the program under three different financing policies. Each of the three financing options has different effects on household savings, consumption, and labor decisions, which leads to significantly different effects on the aggregate economy and household welfare:

Deficit Financed: In the deficit financed policy, the federal government borrows money to finance the $1.5 trillion in annual UBI transfers. The UBI transfers to households generate a positive income effect, whereby households decide to work less because they are receiving additional income. Furthermore, the higher deficits used to finance this transfer crowd-out productive investment, which leads to lower capital services. Lower capital and lower labor lead to GDP that is 6.1 percent lower in 2027. In this case, lower GDP is reflected in lower total household consumption, which means that the average household is worse off under this policy.

Payroll Tax Financed: In this experiment, the federal government levies an additional 11.25% payroll tax on all labor income to finance $1.5 trillion in annual UBI transfers. As in the deficit financed policy, the UBI transfers generate a positive income effect which is reflected in lower household labor, however, this positive effect is partly offset by a negative income effect from higher taxes under the new payroll tax. Since a flat UBI transfer is more progressive than a linear payroll tax, the net income effect comes from shifting some resources from lower marginal propensity to consume households to households with higher marginal propensities to consume. The payroll tax also generates a substitution effect: Lower after-tax wages incentivize households to work less. The substitution effect from the payroll tax is smaller than the net income effect, leading to a smaller decrease in labor compared to the other policies. Furthermore, since the payroll tax covers the cost of the UBI program, there is no direct crowd-out of productive investment. Combined, these effects lead to a smaller (1.7 percent) decline in GDP, and a smaller decrease in household consumption compared to the deficit financed policy.

Externally Financed: In this experiment, households receive a transfer of $1.5 trillion annually from an external source, so there is no direct crowd-out of private capital. Like the UBI in the deficit financed policy, these transfers to households generate a positive income effect, but no offsetting negative income effect. There is also no substitution effect. The positive income effect from the UBI transfer, which is larger than the substitution effect from a payroll tax, leads to a larger decline in labor compared to the payroll tax financed policy. Lower labor leads to a smaller economy: GDP is 3.4 percent lower in 2027. However, the externally financed policy has different effects on the components of GDP: consumption, government spending, investment, and net exports. Government spending remains constant. Less wage income reduces investment. Of course, household consumption increases. However, the increase in consumption is effectively offset by a decline in net exports because the UBI is externally financed, thereby acting like a free import. Although GDP declines, households consume more and work less, which improves households’ well-being. The externally financed policy is a good example of why changes in GDP do not necessarily reflect changes in household welfare; even though GDP goes down, the average household is better off because they work less and consume more.