The impossible trifecta

Kevin Milligan says a Guaranteed Annual Income cannot simultaneously satisfy three goals. Instead, you have to pick two among the following:

1. low tax rate
2. high benefit
3. balanced budget*

Treasury here in New Zealand modelled a GAI for New Zealand on the request of the Welfare Working Group (HT: Lindsay Mitchell). What did they find? A GMI paying $300 per week - the mean benefit income among those on benefits - would cost $44.5 billion, or $52.6 billion if we extended it to superannuitants as a replacement for NZ Super. The former could be covered by a flat personal income tax rate of 45.4%; the latter, 48.6%. But full fiscal neutrality would require tax rates of 50.6% and 54.4% - the lower tax rates would be just enough to cover the transfers, but income tax revenues are currently also used to fund more than just transfers.

If we recognize that most parents are beneficiaries via Working for Families and compensate them for the loss of our version of EITC with a $86 per child per week payment, we get a $57.1 billion fiscal cost and a personal tax rate of 50% (or 55.7% for fiscal neutrality).

And, even this rather expensive system leaves the worst off worse off, as it kinda has to. Treasury notes:

Although the Gini coefficient improves under all models, many beneficiaries (including the disabled, carers and sole parents) currently receive more than $300 per week and would be made financially worse off under a GMI scheme. Therefore the GMIs considered could distribute money away from those most in need of government assistance and toward those who have choices and opportunities but choose not to work.

Treasury also warned about potential adverse labour supply responses to the necessary personal tax rates. And, the induced gap between company and personal tax rates would increase IRD's enforcement costs.

Treasury concludes by reiterating Milligan's impossibility:

From the international examples it is apparent that the more equal a society is in the beginning, the lower the returns to a GMI scheme. That is, a New Zealand specific GMI would either be at a level of income too low to reduce poverty, or a level of income that is high enough to reduce poverty but is therefore expensive and hence distortionary through higher tax rates. 

I don't think Gareth Morgan's Big Kahuna scheme is able to escape the trifecta by imposing new taxes on capital or land. Why? Because those aren't free lunches either. If it's worth having a land tax, it's worth doing it regardless of whether we have a GAI. So in the first stage we set the optimal tax structure - and I'm completely unconvinced that a capital gains tax is all that hot an idea anyway (see Seamus's posts here here and here.) But whatever the optimal tax structure, we implement it in stage one. Then, we still have to increase all the tax rates by enough to pay for a GAI if we're going to have a GAI. And the impossibility reasserts itself.

Morgan squares things with a cheaper GAI paying $11k instead of Treasury's $15k. But I have a hard time believing that's a stable political equilibrium. Could NZ politicos really avoid the temptation of adding targeted benefits for the many folks currently on benefits totalling well over $15k? If not, how quickly do we wind up having a GAI on top of a targeted benefit system?

* Update: Milligan's updated this in a more recent tweet. I think there are a few possible impossibilities here.

@EmmMacfarlane Again, the impossible trinity: choose two of:

* low phaseout rate
* Big basic benefit
* same cost as current system.

— Kevin Milligan (@kevinmilligan) February 5, 2016

Peer effects aren't an externality

Suppose you started hanging out with Canadians. After a couple of months, a social scientist found that you had increased your likelihood of wearing plaid. And, you'd started listening to Rush. Does this mean that a taste for good fashion and good music constitutes a policy-relevant externality and we should subsidize flights to New Zealand from Canada to facilitate these positive interactions?

How about if you started skiing more after you started dating a skier? If folks generally disapproved of skiing, would this provide an argument for taxing skiers' romantic encounters?

Well, poor fitness may be contageous. Now forthcoming in the Journal of Public Economics, here's the paper by Carrell, Hoekstra and West. Air Force Academy Cadets were randomly assigned to residential social networks to test the effects of social connections on fitness.

We find statistically significant peer effects that are 40 to 70 percent as large as the own effect of prior fitness scores on current fitness outcomes. Evidence suggests that the effects are caused primarily by friends who were the least fit, thus supporting the provocative notion that poor physical fitness spreads on a person-to-person basis.

It's not at all implausible that peer effects of this sort matter. If you hang out with a bunch of fitness buffs, an extra five pounds will make you feel like a slob and you'll be more likely to do something about it than if all your friends are twenty pounds overweight and you're the (relatively) thin one.

I'm happy to take the empirics on this one. But I'm pretty sceptical about what folks are drawing as policy conclusion. Here's Kevin Milligan, via Twitter:

Forthcoming in J.Pub. Econ: http://bit.ly/i3GzZK. Finds obesity affected by peers--externality cld be corrected by pigouvian measure?

That's not an endorsement of fitness tax credits. But it does suggest that obesity has more than individual consequences; invites policy.

There's one case where I can agree with Kevin that it could be a policy-relevant externality: where you're coerced into being part of a particular social network. If you're forced to be in a public school where all your classmates are obese, the effect of their obesity on your fitness habits could be seen as an externality. Or, symmetrically, if your classmates are fitness nuts, the costs they impose on you to keep up could be an externality. This breaks down as soon as folks start being able to form their own peer groups as subsets of the people with whom they're mandated to share a class, and it's nowhere shown that the external effect is actually Pareto relevant, but it's not crazy to think about. The same would hold true for prison cellmates.

But out in the normal world, people choose their peers. Interpersonal effects within these voluntary arrangements can hardly be seen as externalities. As always, I follow the Buchanan and Stubblebine delineation of external costs. An external cost is only Pareto-relevant when there is the potential for gains from trade: if the gains to the affected party would be sufficient to compensate the affecting party for a marginal change in behaviour. How could we ever presume that a cost one friend imposes on his peers isn't part of an optimal equilibrium involving potentially complex side-payments? If people voluntarily choose to continue to associate with one another, shouldn't our presumption be that they've sorted things out? We all impose burdens on our friends and family; where the relationships continue, it's pretty likely that the abatement costs exceed the costs imposed.

Now maybe you could start building a case if you added in information market failures: that you didn't know that hanging out with your particular chosen peer group would have you adopt more of their habits. I'm pretty sure a whole chunk of the self-help book industry centres around picking friends who aren't bad influences. But it's still a big leap to claim failure; it's at least as plausible that the person with the less fit peer group realizes that his less fit friends are healthy and happy and that the folks over in that other peer group are wasting their time (and suffering a whole lot) by exercising too much and forgoing too many tasty treats. Further, we can build as strong a case for that too-fit people impose an external cost through peer effects in forcing others to exercise more. The case for a gym tax is as strong as the case for fat taxes if we worry about peer effects and don't want to presume to decide whose norm is the right one.

And even if we were to assume that the external cost existed, and we assume that it's the less fit that are imposing the relevant cost rather than the gym nuts, policy solutions can only be efficient where the burden avoided is less than the burden imposed. Is it really likely that the benefits to the thinner members of peer groups exceed the rather large costs imposed on everybody by any plausible policy targeted at obesity?

I worry when we assume that all interpersonal effects constitute Pareto relevant externalities as the scope for government intervention is then without bound. Suppose the Air Force study cited above sorted people into social network groupings where the behaviour of interest weren't fitness but rather were sexual activity. And suppose they found that being put in a grouping with more promiscuous peers made cadets more likely to become more sexually active. Such a result wouldn't be surprising. Would it make your sex life the legitimate object of policy because of potential effects on your non-participating peers? Only if we're willing to forget the difference between interpersonal effects and externalities.

Parental leave

Extended paid parental leave may be fun for the parents, but doesn't provide any measurable benefits for the kids. Kevin Milligan and Michael Barker exploited a discontinuity in Canada where kids born before 1 January 2001 were eligible for 6 months, and those after 12 months, of parental leave benefits. There was no difference in outcomes for the kids either side of the line.

The paper is here; Milligan also discusses the results in Canada's Globe and Mail.

We look at children born in the years just before and just after the 2001 expansion of paid parental leave through the Employment Insurance system from 25 weeks to 50 weeks. Looking across various measures of child temperament, physical development, and child security, we find very little evidence of an impact of this large expansion of parental leave entitlements. As one example, the pre-reform average age at which the child took his or her first steps was 9.46 months. Our study finds that this changed by only 0.06 months after the reform -- and that result is not distinguishable from zero. Our work in this study builds on previous studies we have written on the labour-market implications of parental leave and on the health implications for children.

New Zealand's Labour Party has been making noises about extending paid parental leave. The Canadian evidence suggests it doesn't provide that much benefit. And, I'd worry a fair bit that the more employers expect that they'll have to fill holes with temporary positions, the less likely they'll be to hire women they think likely soon to have another kid.