A Hayekian solution to welfare reform

Here at the IEA, it is something of a rule that if Hayek endorsed an idea then it probably wasn’t all bad. Bearing that in mind, I’d like to bring up a policy that isn’t often heard of nowadays but that both Hayek and that other IEA luminary, Milton Friedman, thought was worthwhile. It’s called the guaranteed minimum income and if Iain Duncan Smith wanted to be really revolutionary, he could consider it as part of his reforms.

The idea is that instead of the mess of various welfare benefits we have now, the state would quite simply pay every single citizen enough to live on without any conditions attached. Everyone from the richest to the poorest would receive the payment, which would be funded through taxation, as welfare benefits are today. Regardless of what you were doing with your life, the government would simply hand you a cheque every year or every month.

It would be an expensive policy, but for the average taxpayer higher tax bills could be more or less cancelled out by the payment. Moreover, since every citizen would be guaranteed to have at least enough income to live on, the state could stop having to provide inefficient services to the very poor, who would be better off with the cash. The nannying tendency of the state would be reduced; since everyone would receive the payment, no-one would be a “scrounger”.

Those are side benefits though. The main appeal of such a system is that it offers a way to alleviate poverty without putting people into welfare traps. The welfare system as it is at the moment is grossly inefficient because means tested benefits severely blunt the incentives to go back to work. Depending on which benefits a person is eligible for, the effective marginal taxation rate faced is typically around 65% and can be as high as 90%. If the same benefits were paid to everyone, not only would the administrative costs of means testing be slashed, the poorest would finally have an incentive to work.

The big question in terms of whether a guaranteed minimum income would work is thus its effect on incentives. The number of people going into work should be more than the number of people who would take their payment and stop working. Whilst people who were previously on benefits might enter employment, everyone else would have to pay higher marginal tax rates – and some would probably choose not to.

Fortunately, the balance would probably be positive. Most recent econometric evidence suggests that marginal tax rates do not have much impact on peoples’ behaviour until they reach relatively high rates – income tax rates in the UK could rise a great deal before they began to deter very many people from working. Conversely, marginal tax rates for the very poor are so high that cutting them would almost certainly have a beneficial effect. Provided that the actual amount of benefit paid wasn’t too generous, then probably more people would move into work than out of it, and so the average taxpayer would end up better off.

Reforming the benefit rules is a pressing priority for the coalition government. Whilst cutting the deficit needs to the primary policy objective, creating a rational, liberal solution to poverty is a monumentally important task, and it is important that it is not sacrificed to political expediency. The battle between those who think of all benefit recipients as “scroungers” and those who think that government genuinely has a duty to actively reduce poverty is good political theatre, but it generally does not lead to good policy. Benefit entitlements create poverty traps, but scrapping them creates poverty – neither approach is ideal. A basic income scheme is an admirably Hayekian solution to both problems, and now would seem as good a time as ever to consider it.

22 thoughts on “A Hayekian solution to welfare reform”

  1. Posted 14/09/2010 at 11:55 | Permalink

    I’m usually fond of Hayekian ideas but I’m sceptical of this one. Firstly, how is one to determine what is ‘enough to live on’? Secondly, while such a system might (perhaps) be better than the current system, that’s damning it with faint praise – the current system is appalling, as we all know. Where is the evidence that (gradually) scrapping welfare schemes actually increases poverty long-term? I’m unconvinced that the government has a duty to alleviate poverty – from where is such a duty derived? – and if it is it is manifestly failing to do so anyway. Thirdly, the extraction and reallocation costs still represent wasted resources and disincentives, so it’s still less than optimal to me.

  2. Posted 14/09/2010 at 12:22 | Permalink

    Firstly, I don’t really see the relevance of the ‘how much’ point. Any welfare system is going to have to have a process whereby the level of benefit is set. That’s not an argument for not having a welfare system.

    Secondly, are you honestly claiming that we could (gradually) dismantle the entire welfare state without creating any poverty? There are always going to be people needing help and private charity will never be able to take up all the slack. This is a liberal solution to that problem.

    Finally, ‘egalitarian’ is not a dirty word. Redistribution often is incredibly counter-productive, but it doesn’t have to be. Free marketeers might not be so unpopular if they realized that.

  3. Posted 14/09/2010 at 12:58 | Permalink

    A basic income scheme could represent a big improvement on the current system, providing the rates were set at a relatively low level and top-up benefits were withdrawn entirely. While housing subsidies represent a major political obstacle to the scheme, this could be addressed by supply-side reforms (i.e. liberalising building regs and planning controls etc.), which would enable Housing Benefit and social housing to be phased out.

  4. Posted 14/09/2010 at 14:54 | Permalink

    @Daniel – The relevance of the ‘how much’ point is very important actually as it shows the absurdity of trying to centrally determine a level of benefit, let alone a universal one. Different groups will try to lobby for more money and the process will be politicised, or the rate might get ’stuck’ at a level which is too low or too high. And that’s without mentioning regional PPPs.
    Now where did I claim that dismantling the welfare state wouldn’t create any ‘poverty’ (a difficult term in itself)? I asked for the evidence to show this was so. I suspect that it might create some poverty, but the level of economic welfare would rise overall if this were done. Lastly, ‘egalitarian’ in this…

  5. Posted 14/09/2010 at 15:03 | Permalink

    …sense is something libertarians ought to be opposed to because (i) it carries with it so many problems e.g. the deadweight cost of administration, the absurd cost of giving universal benefits to those who don’t require them and (ii) because it goes beyond the proper duty of the state which is to uphold property rights, not redistribute incomes.
    Lastly, just because something makes me unpopular doesn’t mind I ought to abandon my principles to achieve popularity, that is the antithesis of liberalism (viz von Mises). I think Hayek contradicted himself – in the Const. of Liberty he attacks universalist benefits of this type.

  6. Posted 14/09/2010 at 15:04 | Permalink

    Richard points out, correctly, IMHO, one of the biggest stumbling blocks to a universal income – housing.

    Although I see the advantages of simplification,

    a) I do think it will be very hard to decide what was “enough”. If people can live on the amount, people will and we risk more and more doing so. £1pw = £2.5bln+ p.a.

    b) As with housing, one should consider localising the decision on the amount, and logically, the tax raising powers to pay for it.

    b) Even more than the amount, the benefits that accrue with children will need resolving, so as to not repeat the mistakes of the existing system.

  7. Posted 14/09/2010 at 15:07 | Permalink

    @Richard (and Daniel). While I don’t doubt there is some merit in the idea compared to the present farce, I can’t support it for the reasons outlined above. I realise that the perfect is the enemy of the good, but I don’t even think this is ‘good’.
    That said, if you’re going to approach the issue from practical politics like Richard, it’s a total non-starter because of the huge upfront costs and administrative changes, so I don’t see the point. Either focus on sensible reform of the current ’system’, or better yet proposed ways of getting rid of it all together and letting civil society do its proper job and traditional job of providing welfare, not the state.

  8. Posted 14/09/2010 at 15:20 | Permalink

    @Tim Carpenter – the problem with localising housing payments, as is done now with Local Housing Allowances, is that it could undermine the incentives for tenants to move to cheaper areas. This can be addressed by ensuring that a percentage of rent is paid out of basic benefits (e.g. JSA) rather than through Housing Benefit (HB). The percentage could be increased year on year until HB was phased out entirely (in combination with the supply-side reforms I mentioned above).

  9. Posted 14/09/2010 at 18:59 | Permalink

    I agree with Whig – determining “what is enough to live on” can be a very big headache. Also, i simply cannot wrap my head around giving such a benefit to people who do not need it.

    The question is: why do people not work? A correct answer(s) will provide us with a real solution to poverty.

  10. Posted 14/09/2010 at 19:16 | Permalink

    With 29.7% of 16-64 year olds economically inactive, Osborne is a jerk if he can’t see that IDS’s reforms are an investment not a cost. But there is so much people don’t want to see….stress test scams, weak banking capital requirements, big German banks scurrying around for money….http://nbyslog.blogspot.com/2010/09/deutsche-bank-postbank-real-story.html

  11. Posted 15/09/2010 at 10:13 | Permalink

    Another (relatively minor) thing in favour of a basic income is that it would increase equality of opportunity, especially for students and graduates.

    Working unpaid for several months is now standard for jobs in politics, the charitable sector, media and even in professions like PR and advertising. That restricts those sorts of jobs to graduates who have wealthier parents or the ability (and confidence) to borrow a lot at commercial rates.

    A basic income would mean that graduates could work for free if they though it worthwhile, whilst it’s universal nature would mean that the government wouldn’t simply be subsidizing employers too stingy to pay their younger employees.

  12. Posted 15/09/2010 at 10:34 | Permalink

    @Richard Wellings,

    I agree with your point on incentives to move from high cost to low cost areas, sort of – I think we should look to remove the disincentives to move and the unintended incentives to stay put. Nuance? Perhaps, but an important one.

    Transition is key. Your proposal is one way and I would not think it wise to dismiss it out of hand for, as you rightly say, it is dependent on other reforms and in conjunction with those the value is realised.

  13. Posted 15/09/2010 at 12:03 | Permalink

    @Daniel – that’s a pretty minor reason really. I wonder, you haven’t been in that situation have you, as it sounds like you’re making special pleading for a particular interest group to me…

  14. Posted 15/09/2010 at 12:32 | Permalink

    @Whig – Oh, I don’t deny that it’s minor. It’s just another interesting point. It needn’t be just graduates though. Maybe people on low incomes could use it as capital to set up businesses that they couldn’t fund through saving or through borrowing, or to fund moving across the country to try to find a job.

    I guess I’m just pointing out that the current welfare system doesn’t just create perverse incentives – it also ties recipients to particular areas and restricts their freedom to get the sorts of jobs they could if they had access to money. A basic income scheme would be incredibly liberating.

    But yes, I agree, young people are a powerful interest group who need to be controlled…

  15. Posted 15/09/2010 at 14:20 | Permalink

    @Daniel – but how do you know that the business set up would be more economically efficient than the activity which would have occurred if the money had not be extracted in the first place? You can’t, and of course it might not be, but your arguments are exactly the false ones that interventionists employ (often they criticise the ‘rich’ for just saving their money, as if saving is ‘bad’! Or they make false arguments like the UK Film Council just did).
    Abolishing the current welfare system would be a sufficient level of ‘freedom’ to allow people to get jobs and free mobility. One doesn’t need to provide money for this, simply remove barriers; millions move from the 3rd world with nothing!

  16. Posted 15/09/2010 at 14:23 | Permalink

    @Daniel Your idea that interest groups can be ‘controlled’ is facile – don’t you understand public choice theory? The only way to prevent the influence of interest groups is to limit the ability of the state to interfere, thus removing the incentive and ability to lobby. You can’t ‘control’ interest groups in other ways and I must say your comment sounds vaguely sinister!

  17. Posted 15/09/2010 at 19:30 | Permalink

    Quite clearly my comment about interest groups was meant to be ironic. Young people are about the least powerful constituency going…

    As to the rest of it, your comparison with the third world is crazy – in the third world people starve because they cannot afford to go even a few hundred miles to find work. Your point about interventionism is a straw man, since this is barely interventionism. And your point about efficiency isn’t even an argument. How do you know that the businesses set up by the poor wouldn’t be more economically efficient? In both cases, the money would be in the free market.

    The real world is not a perfectly competitive Walrasian system. Deal with it.

  18. Posted 16/09/2010 at 08:16 | Permalink

    @Daniel. Ironic or not young people are a powerful interest group – e.g. they get subsidised by the state (i.e. taxpayers) to go to university.
    What I meant was that people are willing to migrate thousands of miles from the third world without any assistance, so the idea that people can’t do this within the UK is nonsense. Barely intervention? It’s an enormous amount of intervention; billions would be confiscated and reallocated. If that’s not intervention, what is??
    I don’t profess to know that; the point is that you’re implying that you can prove it, or how else can you justify reallocating the money? The money would not be in the ‘free market’ in your case because it will have been…

  19. Posted 16/09/2010 at 08:23 | Permalink

    …confiscated from the free market in the first place (and once such a large intervention has taken place, it is not a ‘free’ market in any sense). It is not whether such redistribution might turn out to be more efficient – this is unknowable. In carrying out such redistribution you are effectively stating that you can definitively know such action would be more efficient (even including the deadweight costs!) Unless you favour sacrificing economic efficiency? How can you know that it is maximising the subjective utility of the economy as a whole? Are you (or the govt) an omniscient god?
    For heaven’s sake read some von Mises! The world isn’t perfectly efficient, but why make it even less?

  20. Posted 16/09/2010 at 10:07 | Permalink

    There is so much wrong with your argument that I’m not going to address every point, especially since I think I’ve fed your trolling quite enough now.

    I’ll just say this though. Not everything government does is bad. I imagine even you would accept that we need police and defence – those things have to be funded by taxation, which ‘distorts’ the ‘free’ market. In terms of maximizing liberty and welfare, there is quite obviously a trade-off between government inefficiency and market inefficiency. The ideal point is more pro-market than where we are now. But it is also a hell of a lot more pro-government than you imagine.

  21. Posted 16/09/2010 at 10:29 | Permalink

    Well, that’s a nice way to debate – simply withdraw claiming I’m ‘wrong’. I must say I’m so touched that you’ve chosen to feed me, so gracious of you.
    I’ve never said such a thing and never would – the role of government is to protect property rights and provide public goods. If you allow it to expand further you preach socialism and special interest. Just because there are exceptions doesn’t obviate the rule; but this is all in Hayek and Mises, so you’d better argue with them instead! Actually, this allows for quite a large sphere of government activity. In the private sphere, such a dichotomy is false and is a typical socialist/statist type argument to use. How can government even know…

  22. Posted 16/09/2010 at 10:35 | Permalink

    …where such a trade off could even lie? If you don’t set up strict boundaries about what government should and should not do, it merely puts you on the road to serfdom, even if such an end state seems a long way off. I think you should think about a think tank other than the IEA for views like yours – they seem mildly socialist to me!

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