Eliminate poverty with universal basic income and flat income tax (UBI-FIT)
Armut abschaffen mit bedingungslosem Grundeinkommen und pauschaler Einkommenssteuer
Richard Parncutt 2011
Another text about the same idea: html 
Presentation at BIEN Munich 2012 - pdf - ppt

Flat income tax: A crazy right-wing dream?

Modern income tax scales are generally progressive. People with higher incomes are supposed to pay higher proportions of their incomes in tax. There are several income "brackets" within which a different rate of income tax applies. This idea is based on the general principle that taxes should be primarily paid by those who are in a good position to pay them. The more you can pay, the more you should pay.

Flat tax is the opposite of progressive tax. In a flat-tax system, everyone pays the same rate of tax, regardless of their income. This is fundamentally unfair and tends to increase the gap between rich and poor. In many countries, that gap has been steadily increasing over the past few decades. It has become far, far bigger than it should be, which is one of the causes of the "global financial crisis" that we have been experiencing. If the rich paid more tax, national governments could pay their debts.

I am assuming that a gap of some kind between rich and poor is necessary to motivate people to work. But the rich-poor gap does not have to be very big to achieve that goal. If the rich are ten times richer than the poor, by whatever measure (income or wealth), the goal has surely been achieved. Perhaps a ratio of only 2:1 would suffice. After the gap reaches a certain size, increasing it further does not further increase the incentive to work, because it is already near to its maximum value. In scientific jargon we would say that incentive saturates or approaches an asymptote. But in most countries today the gap is far bigger than 2:1 or even 10:1. The rich are hundreds, thousands or millions of times richer than the poor. However you measure the ratio (by wealth or income, for example), it is far too big. For that reason, a flat income tax of the kind proposed by the far right is completely out of the question.

But still there are people out there who believe in flat tax. Why? There are two main reasons. First, they are selfish: they want to pay less tax although they are rolling in money. Second, they habitually distort the truth: they claim that the poor are poor because they are lazy, so they deserve to be poor. Evidently some people really believe this to be true. In fact, no-one wants to be poor, so of course the poor want to work and earn money - at least as much as the rich. Poverty is created by economic systems, not by individuals. 

Unconditional basic income and flat income tax: A rational centre-left dream?

In this article I present a surprising and radical approach to flat tax. I will show that flat tax can be the solution to poverty, but only when both of the following conditions are fulfilled. 

• The flat rate must be relatively high (e.g. 35 to 50% - instead of the 10 to 20% commonly advocated by flat tax fans).
• The flat income tax must be combined with an unconditional basic income that corresponds approximately to the poverty line.

If that is true, the implications are enormous. The political left now has the historic opportunity to eliminate poverty - not merely reduce it. The combination of unconditional basic income and flat income tax (UBI-FIT) is a path to that goal. 

In this article I address only one kind of tax: income tax. Another way to address poverty is to increase government revenue through wealth, inheritance and transaction taxes, which can then be used to balance the budget and improve social security. There is an urgent need to increase the level of all these taxes at a global level. This article is also confined to industrial countries but the basic principles may also applied to any country (e.g. basic income could be financed globally through carbon credits). I consider the problem of poverty in developing countries in more detail elsewhere.

Incidentally, in recent years media and politicians have been presenting the "international financial crisis" as a mysterious economic problem that only economists can understand and only large payments of public money to private banks can fix. But the basic problem is relatively straightforward. National economies have fallen too far into debt. Governments have been living beyond their means. Meanwhile, the rich have been getting richer. They have been doing that in part by speculation on global markets that should have been taxed, but was not. Of course it is always possible to make governments more efficient, but that will not make a big difference. It is also possible to regulate markets, to some extent. But the most efficient and appropriate solution in both cases is simply taxation. The rich should pay more tax on wealth and income and we urgently need tax on international financial transactions. I will return to these points below.

The basic idea

Below is a graph of net income against gross income. If we are genuinely interested in eliminating poverty, this is the central relationship that we need to consider. In discussion of this proposal it is important not to get sidetracked by considerations of the separate rates of tax and welfare. In the end, the separate tax and welfare rates are not the primary issue. What matters primarily is the final relationship between gross and net income. As one supermarket chain said in their advertisements, it is "total of the tape"that counts, not the prices of individual products.

Under UBI-FIT, everyone would get the same basic income, regardless of any other form of income. That is where the diagonal line intersects the vertical axis. The value of 500 Euros per month is arbitrary. It is a round figure that has been chosen to simplify the calculation. Of course it would need to be adjusted in a political process; it would depend on changing democratic and financial constraints. If it is too low there is poverty, and if it is too high the motivation to work is reduced.

Even the rich would get basic income, which is unconditional. But for them the amount of basic income would be small by comparison to the amount of income tax. If we want to extract more money from the rich, we must focus attention on the tax rate, not basic income. We must also simplify the taxation system to make it more transparent and increase the chance that taxes will be paid and not evaded or avoided by cunning accountants. UBI-FIT is a step in that direction, but many other simplifications are possible.

Under UBI-FIT, the amount of basic income would not be the same for everyone. The main exception is people with disabilities that prevent them from working or reduce their ability to work. Their basic income would be increased accordingly. Some people also think that basic income should depend on age (children getting more, special deals for pensioners) but others argue it should be as simple as possible and therefore independent of age. On the whole, UBI-FIT would radically simplify social security payments. Many of the bureacrats who currently investigate the "willingness to work" of unemployed people would find themselves unemployed.

Everyone would pay the same rate of tax on all income ("flat tax"). That is represented by the gradient of the line in the graph. The lower the tax, the faster your net income increases as your gross income increases, and the steeper the line. For the purpose of argument and for drawing the graph, the flat rate has been set at 50%. The exact value would be determined by democratic processes and financial constraints. It could be 40%, and with significant increases in wealth, inheritance and transaction taxes it could even be 30%. The recent financial problems of Western countries suggest that if the rich continue to avoid paying wealth taxes, income tax at the highest levels of income must be increased to 50%. If we had UBI-FIT, this argument would apply to everyone. But I promised not to get sidetracked by a discussion of tax separate from welfare of vice.versa. The main thing is not the size of this number (the flat rate of income tax) - the main thing is the relationship between gross and net income on the graph. 

The welfare trap

The first thing to notice about this graph is that it is similar to the current relationship between gross and net income in modern democracies. At the left end of the line, most people get social security payments. In general, net income rises as gross income rises. The change from the current system to UBI-FIT would not make much difference, if we simply drew a line of best fit through the current relationship between gross and net income for the average person, as it already exists in different countries.

But there is an important difference. In the current system of means-tested social security and progressive income tax, the gradient of the line on the graph is not constant. The line is not straight. That is partly because of progressive tax scales, but there is a much bigger departure from linearity at the so-called welfare trap. Currently, if you are on welfare and start earning money, your welfare is reduced accordingly. During this transition, your gross income increases significantly, but your net income increases little. Depending on the system, your net income may stay the same or even fall as your gross income rises. So it is not in your interest to work! There is no incentive.

Sometimes the welfare trap is called the poverty trap, because it perpetuates poverty. A system that motivates people not to work is doomed to fail. The welfare trap is inherent to all modern systems of means-tested social welfare and progressive tax. This inherent fault is a guarantee that these systems will never eliminate poverty. Eliminating this problem would be an important step toward eliminating poverty.

Is UBI-FIT fair?

At first glance UBI-FIT seems unfair. We are used to a system of income tax and social security in which different people are treated differently. The system is periodically twigged before elections in order to attract votes from particular groups. UBI-FIT makes it impossible to win elections this way. Everyone has to be treated equally. If the rate of basic income is reduced, everyone is affected. If the rate of tax is increased, everyone is affected. Is that fair?

Is it fair to tax low income earners at the same level as high income earners? Well, the current system is even worse. Welfare traps mean that for incomes between typical levels of social welfare and typical levels of low-earning jobs, the effective rate of taxation is as high as 100%. Every increase in income is taken away by reducing welfare payments. From this point of view, UBI-FIT is a big step forward for low-income earners.

Is it fair to give basic income to the rich? In UBI-FIT that is unavoidable because UBI-FIT avoids welfare traps. Not giving basic income to the rich would mean finding a cutoff point below which basic income is paid. But that would cause a welfare trap. Giving basic income to the rich is no problem because the only thing that matters in the end is the relationship between net and gross income shown on the graph. Moreover, for the rich basic income is small compared to income tax.

How can UBI-FIT be adjusted to reduce the gap between rich and poor? The solution is to increase basic income and at the same time increase the tax rate to finance it. But this can only be done to a limited extent, because both these actions reduce the incentive to work, which ultimately reduces the total productivity and wealth of the country. To increase productivity, it is necessary to reduce basic income and the tax rate, but this again can only be done to a limited extent, otherwise the incidence of poverty will increase. Between these extremes there is a happy medium in which poverty is eliminated but a moderate rich-poor gradient remains. If the electorate understands how UBI-FIT works (and it is certainly much simpler than the present system) that happy medium can be found by regular democratic processes.

Its simplicity and transparency mean that UBI-FIT is much fairer than the present system. Everyone is treated equally and with dignity, and everyone is encouraged to work. The rules are clear, and it is harder to break them.


Right-wing distortions

It is common for right-wing voters to claim or believe that the poor are poor because they are lazy. In fact, the poor want to work just as hard as the rich - probably more so because they need the money more. It is the system that is causing poverty, not any assumed differences in personality between the rich and the poor. Until the rich and the right wing understand or admit this simple fact, there will be no progress.

The idea that poverty is the fault of the poor is an old one. Before the French revolution in the 18th Century, it was common to believe in inherent differences between rich and  poor people, or between nobility and ordinary people. The aristocracy somehow had aristocracy in their blood. The French philosopher Rousseau was one of those who exposed this idea as nonsense (e.g. in his "Discourse on inequality"), and it was objections of this sort that provoked the French revolution, which of course changed the world. But crazy ideas do not disappear overnight. The modern version of the nobility fallacy is the idea that the poor are poor because they are lazy. Many still seem to believe that if the poor only took advantage of the opportunities that a free society offers them, they could drag themselves out of poverty. We forget that everyone is born with different opportunities and for this reason it is much easier for some people to make money than others. Statistically, there will always be large numbers of people who fail to break through the poverty line. Unless we radically change the system, that is.

The stigma of unemployment

The welfare trap is not only a financial problem, it is also a psychological and social one. Current systems of means-tested social welfare and progressive income tax create two classes of people: employed and unemployed. The employed have many freedoms that the unemployed do not have. The unemployed are stigmatised. They get "handouts", which are embarrassing. They are made to feel like failures. They are given the impression that they must be lazy or stupid or both. If they don't feel like working, or lack confidence in their ability - no wonder. 

These fundamental problems would be eliminated by UBI-FIT. Everyone would be treated equally. Everyone would have the same rights and obligations. Everyone would be equally motivated to work. Everyone would also be free not to work, and take responsibility for the consequences. The poor would be free to do what the rich always expected them to do, namely to drag themselves out of poverty. Just imagine: a system that treats everyone equally, but at the same time eliminates poverty. This is not a strange dream, but a realistic solution to a big problem. 

Of course, the rich would get a  bit of a shock if these things actually happened. The effect on their wealth would be minimal. The psychological effect would be much greater. They wouldn't feel so special anymore, just like the residents of West Berlin did not feel special any more after the wall fell - no matter how much they had wanted to wall to fall.

Effectively progressive income tax

Progressive income tax means that the rate of income tax increases as income increases. The more you earn, the higher the proportion of income that is taken away in tax. 

UBI-FIT is not progressive, because the tax rate is flat. But the following table shows that it is effectively progressive. 

The calculations are very simple, based on a basic income of 500 Euros per month and a tax rate of 50%. These are round figures that have been chosen for convenience and they figures would of course be changed if UBI-FIT were introduced. 

The table shows that when you look at the relationship between gross and net income, the tax rate effectively increases with increasing income. That is what I mean by "effectively progressive". The higher your gross income, the higher the effective proportion of your gross income is paid in tax. In this regard, UBI-FIT is no different from the present system.

Social security and progressive income tax belong to the greatest achievements of the workers' movements of the early 20th century. The appalling poverty produced by the industrial revolution was finally brought under control, without resorting to communism. Poverty still existed, but it was more tolerable.

Today, poverty is no longer tolerable. New technologies of all kinds are gradually increasing the wealth of the entire human race. If this wealth were shared, it would be easy to eliminate poverty while at the same time maintaining free enterprise. Moreover, the rich would still be rich. They have little to fear from UBI-FIT.

Given this historical context it is now possible to see that current systems of means-tested social security and progressive income tax are maintaining poverty. They are based on the assumption that there will always be poverty. They incorporate welfare traps that guarantee that a certain proportion of the population will not enjoy the same incentive to work that most people enjoy, so a certain proportion of them will automatically stay or become poor. UBI-FIT offers a realistic solution.