Mutual obligation + high EMTRs = suxxor

By skepticlawyer

It’s not very often that you get a neat summary of one of the most inspiring libertarian arguments in one short piece, but Jason Soon has done a great job on mutual obligation over at Catallaxy. I agree with him – and I also think mutual obligation is an utterly pointless exercise in time-wasting that allows Centrelink bureaucrats to behave like martinets, as this post ably outlines.

‘Mutual obligation’ (‘work for the dole’ and such like) is intended to avoid the problem of moral hazard: people in receipt of government benefits are made to do something in return, thus reducing the attraction of ‘sit-down’ money. This ‘something’ is usually pointless and demeaning and, as Jason points out, when combined with other (libertarian) arguments for economic reform (like the abolition of the minimum wage, for example) serves only to make us all look like Victorian-era bastards:

I think on purely tactical grounds that tacking mutual obligation onto a liberal reformist agenda hinders the promotion of more pro-market policies. The most important part of the free market agenda isn’t imbuing people with a Victorian work ethic, it is selling the idea that people should be comfortable with free labour and product markets including prices and wages not being fixed.

Most free marketeers oppose labour market regulations on the grounds that they destroy jobs and make them scarcer for the less skilled by pricing labour too high among other things. They usually then go on to say that *if* there is a concern with low wages causing poverty, it is more efficient for this to be addressed through the tax and transfer system than by fixing wages or legislating on terms and conditions.

Another issue worth adding to Jason’s discussion of the plethora of regulations that actually inhibit workforce participation is the problem of high effective marginal tax rates. These penalise the poor – especially the disabled – more than any other income group. In the case of a disability benefits recipient, for example, above a paltry sum (£20 per week), the welfare recipient loses £2 for every extra £ of income earned. This is particularly bad when one considers that many of the long-term unemployed are disabled, and very often the only work they can do is part time. It’s difficult to imagine a greater disincentive against trying to find work than this.

The only intelligent response to both mutual obligation and high EMTRs and the expensive and punitive bureaucratization they create I’ve ever seen is a Friedman-style negative income tax. A NIT guarantees every citizen a fairly (low) minimum income, and he or she can earn above that minimum to a liveable ‘cap’ before any tax is levied. John Humphreys has developed a fully costed version of this system for Australian conditions – a backgrounder is available here.

Of course, the argument that conservatives (of both left and right) raise is that our society is characterised by strong reciprocity (possibly biological in origin) that leads even otherwise kindly people to divide the world into the ‘worthy’ and ‘unworthy’ poor. People don’t like free-riders, basically. Talk-back radio rants directed at ‘dole-bludgers’ are cited as evidence of this tendency. However, I remain convinced that people would not be as irritated about welfare recipients if those welfare recipients were allowed to enter the job market on equal terms (no minimum wage) and were not penalised for having a couple of part-time jobs. At least they’d be working, rather than painting rocks in the middle of roundabouts white – as work for the dole recipients still do in Rockhampton.

UPDATE: Jeremy Sear also has a good write-up on this issue, while there’s a fascinating discussion of one version of the NIT going on at Club Troppo.

12 Comments

  1. derida derider
    Posted June 13, 2008 at 3:16 pm | Permalink

    As someone who has a long career in tax and welfare policy, I can say I basically (sic) agree with you. But the problem is that most Australians (and therefore most politicians) won’t.

    When I’ve modelled a true BI/FT in the past , using better models than those available to any Australian private commentators, I’ve found you would need the Flat Tax to be of the order of 40-45 cents in the dollar if the BI is to be set at current pension levels. And that is calculated assuming that we continue with the full panoply of work tests, etc for receipt of the BI.

    Doing that would mean the “working poor” and (to a lesser extent) the very rich would be the big winners compared with the present system. But middle-income people – who happen to be the swinging voters – would be the main losers. So politically it is just never going to happen, here or in any other democracy.

  2. Posted June 13, 2008 at 4:30 pm | Permalink

    DD – the libertarian proposal is always coupled with a drop in tax and pension levels.

    There is a risk of moral hazard when pension rates are set too high. The Saunders solution is to leave them at their current high rates and spend a fortune chasing recipients around and making them feel miserable. I think it’s possible to win the argument against that on the merits – difficult, but possible.

    Middle-class and corporate welfare is a whole other irritation, as the recent Toyota largesse pointedly illustrates.

  3. TerjeP
    Posted June 13, 2008 at 4:34 pm | Permalink

    DD – was the modelling static or dynamic?

  4. derrida derider
    Posted June 13, 2008 at 6:44 pm | Permalink

    Static in the “comparative statics” sense, Terje, dynamic in the “dynamic scoring” (to use the US budget jargon) sense. There is no time dimension, but there is a full labour supply response. Being static, though, it can’t have a savings/investment response but then the structure (as distinct from aggregate level) of income tax is not usually believed to have a large effect on this margin outside of a few US supplysiders.

    It’s also true there’s no compliance response, but you would have to assume we currently have a truly massive black economy for that to make a noticeable difference.

    If you’re assuming massive non-welfare spending cuts, then of course you could get a lower tax rate. But that would apply to your base case – the present system – too.

    BTW the reason the models are better than those of outside commenters is not my superior modelling skills, but my superior access to detailed tax and welfare data for calibration. If it was up to me outsiders would have the same access, but it’s not.

  5. TerjeP
    Posted June 13, 2008 at 8:46 pm | Permalink

    DD – I don’t mean to speak for all advocates of the supply side school when I say this but whilst the supply side theory does anticipate that a cut in income tax will cause a savings/investment response the primary benefit predicted is in terms of an improvement in allocative efficiency. In short households trade more with eachother when the tariff on interhousehold trade is reduced.

    I personally believe that a cut in income tax rates will have very little impact on revenue over any timeframe longer than a few years. I can’t find any account from any nation in the last 100 years which has suffered a drop in overall tax revenue in response to cuts in the rate of income tax. The Reagan income tax rate cuts hardly caused the dramatic increase in revenue claimed by some more strident supply siders however neither did they lead to any notable sustained decline in overall revenues. And the tax rate reductions delivered by the Howard government in recent years have had no success at all in halting revenue growth.

    In short I think the models typically underestimate the dynamic response. However if we did assume no dynamic response then your BI/FT estimates seem reasonable enough.

    For what it is worth John Humphreys 30/30 proposal (a negative income tax but essentially identical to a basic income plus flat tax) also assumed little in the way of a dynamic response and paid for the effective tax cut by assuming reduced government spending.

    In terms of spending it is interesting to note that if John Howard had kept per capita government spending fixed in real terms during his time in government we could have elliminated the bulk of personal income tax. And thats based on purely static modelling.

    Instead he increase per capita government spending by around 34% (without even including GST revenue). So even if I bought the idea that tax rate cuts are expensive in terms of the government budget I don’t buy the idea that they are unaffordable.

    Here is the political version:-

    http://www.youtube.com/watch?v=5FidBATOQ_Y

  6. Sinclair Davidson
    Posted June 13, 2008 at 8:51 pm | Permalink

    “is not usually believed to have a large effect on this margin outside of a few US supplysiders.”

    are you including Edward Prescott in that?

  7. DeusExMacintosh
    Posted June 16, 2008 at 4:08 am | Permalink

    Slight correction to your benefits rules & figures SL. All people receiving means-tested benefits are kept to the £20 a week earnings limit after which they are docked pound for pound for any additional earnings (so those who receive income support AND housing benefit AND council tax benefit would actually lose £3 per pound earned). Incapacity Benefit, which most people associate with those with disabilities, is not in fact means tested. People with disabilities who are not in full time work usually qualify for premiums on top of the basic rate of Income Support that means their Incapacity Benefit gets topped-up with Income Support (despite all this rubbish about IB rates being too high). IB claimants also have the possibility of earning a bit more through what they call “Therapeutic Work” which is limited in scope and duration but are still caught by the means-test rules if they receive anything else.

    Dr Tom Shakespeare came up with an interesting proposal recently that the additional costs of being disabled could be defrayed by waiving VAT. If the LDP’s 30/30 style income tax proposals for low earners seem too radical for the UK the same exemption might be usefully applied to those who qualify for Income Support (which includes the working poor) and would make an administratively cheaper alternative to Gordon Brown’s labyrinthine and error-prone tax credits.

  8. Posted June 16, 2008 at 6:52 am | Permalink

    Good grief, so it’s even worse than I thought, DEM. That’s what comes of trying to combine John’s Australian calculations with British EMTRs. One thing that has emerged in the discussion over at Club Troppo on this is how much worse the UK is than Australia on EMTRs (and Australia is nothing to write home about).

    I like the waiving VAT/GST idea – that has potential, although I’d be curious to see what the compliance costs would be.

  9. DeusExMacintosh
    Posted June 16, 2008 at 10:14 am | Permalink

    I keep expecting it to come up as a back-door way to facilitate the introduction of ID cards. 🙁 You could try just forcing them on claimants as an anti-fraud measure, but you’d have better luck ‘sweetening’ the deal.

  10. derrida derider
    Posted June 16, 2008 at 8:04 pm | Permalink

    Sinclair, I am including Prescott. His case (which I’ve critiqued at some length on Andrew Leigh’s blog here) is predicated on the level, not the progressivity or otherwise, of European taxes. So my comment stands.

    And I repeat that we are trying to compare like with like here – if you have massive spending cuts to make the 30/30 idea stack up then you have to then compare it with what the current tax/benefit system would look like if it also benefited from those cuts.

    All that said, I’d like to repeat that I am a long term (~20 years) supporter of the BI/FT approach. But I don’t think I’ll ever see it put into practice.

  11. TerjeP
    Posted June 16, 2008 at 9:46 pm | Permalink

    I am a long term (~20 years) supporter of the BI/FT approach.

    Best vote for it in the short term then.

  12. DeusExMacintosh
    Posted June 16, 2008 at 10:14 pm | Permalink

    You know what they say, Terje… vote early, vote often!

3 Trackbacks

  1. […] There’s been a bit of to and fro over the LDP’s 30/30 policy at Catallaxy, Skepticlawyer and Club Troppo. Ken Parish has now written the mother of all critiques over at Troppo. I think […]

  2. By Club Troppo » Missing Link Daily on July 22, 2008 at 6:53 am

    […] Helen “skepticlawyer” Dale agrees that mutual obligation is nonsense and adds a call for a negative income tax to Jason’s case for labour market deregulation/abolition of minimum wage.44. KP: And very […]

  3. By Club Troppo » Not so persuasive after all … on July 22, 2008 at 6:58 am

    […] a marginal note to Missing Link the other day, I expressed the view that Jason Soon and Helen Dale’s advocacy for the LDP’s Negative Income Tax + abolition of minimum wage policy was […]

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