The economics of a Universal Basic Income

Originally published in Economic Review magazine which provides articles to make recent academic research accessible for A-level students, apply economic theory to real-world situations and sharpen students’ skills.

The single biggest expense in the UK government’s budget – more than spending on health, education, and defence - is social security. In 2024-25 the state will spend over 10% of GDP on social security payments, which take money from taxpayers in general and give it to specific groups of individuals. Just under half of these payments are made to working-age individuals and children, while the rest are for pensioners.

These transfers are intended for a range of purposes – insuring us against risks like job loss or illness, alleviating poverty, and incentivising activities the government wants to encourage like looking for work.

However, as large economic shocks become more frequent, some commentators have suggested the current working-age benefit system is no longer fit for purpose. Instead, they have advocated perhaps the simplest imaginable welfare system - a Universal Basic Income.

What is a UBI?

A Universal Basic Income (UBI) is a flat payment provided by the state to all citizens, regardless of income or work status. Unlike traditional welfare systems, a UBI is simple and unconditional.

Beyond the obvious appeal - who doesn't want free money? - proponents argue it would enable people to pursue careers more for self-fulfilment and enjoyment rather than financial necessity, and that it might help to support people who choose not to be employed in order to do non-market work like caring for relatives.  It could also encourage people to take more career risks, like starting their own business.

We do not have a UBI in the UK and they are not common worldwide. The most similar schemes are universal dividends paid by energy-rich governments like Alaska, USA. The Alaskan scheme is not especially generous – generally around $1,500 per year – and doesn’t totally replace other transfer schemes. Were the UK to adopt a UBI, we would be by far the largest economy in the world to embrace such a scheme.

How does it differ from the current system?

The largest element of the UK's working-age welfare system is an income-replacement and unemployment benefit scheme called 'Universal Credit'. It seeks both to alleviate poverty among the poorest and to insure us all against the risk of job loss.

Despite the name, Universal Credit is far from universal.

Only people with low incomes are eligible and it often comes with additional strings attached. If you’re unemployed you have to look for a job or you can lose your benefits. If you’re in work, Universal Credit will give you a top up to your wages, but above a threshold this top-up is withdrawn gradually, until it hits zero and people are no longer in the scheme. In the withdrawal zone, people lose 55p of Universal Credit for every additional £1 they earn.

In a means-tested system, this is necessary to avoid a sudden 'cliff edge' in benefit entitlement. If benefits were not withdrawn gradually, some people would face a situation in which earning more would reduce their benefits so much that they would lose money.

The amount of Universal Credit people receive can also depend on  a range of other factors. Many people receive extra support for housing, which is associated with housing costs in their areas. Low-income parents also receive some money for their children.

There are also many other welfare schemes which add to or replace Universal Credit. For example, there are specific programmes in the UK for people with disabilities, which typically impose fewer conditions and are more generous than basic Universal Credit. This reflects a desire among policymakers and the public to treat some people, who they view as needier or less able to provide for themselves, differently to others. It creates a complex web of eligibility, with people receiving payments according to a vast range of different variables.

A UBI, meanwhile, would not impose conditions on claimants at all.

What Would be the Benefits of a UBI?

A UBI could reduce the complexity of the welfare system, improving take-up, and cutting administrative costs. It may improve work incentives by removing benefit withdrawal as earnings rise. You would keep more of each pound you earn, which might persuade you to take on more work or look for a better-paying job. 

The Case Against

On the other hand, a UBI at even a relatively low level would be colossally expensive.  There’s no way around it – a UBI would not come cheap. Paying every working age adult a payment matching the basic rate of Universal Credit (~£400/month) would cost over £200 billion annually, more than the entire NHS budget. Furthermore, many advocates of a UBI argue that the level of Universal Credit is not sufficient for most people to live.

Even if the government scrapped our entire means-tested benefit system, they would be left with a large price tag.

In order to finance it, the government would need to raise broad-based taxes such as VAT, National Insurance Contributions, or Income Tax substantially.

Of course, much of that increase would represent taking in taxes from the same people who were now being given a UBI. These people may not be affected much by the change; the government would be taking with one hand and giving with another.

However, this would certainly undo the improvement to work incentives. You may get to keep all your benefits, but you would face much higher taxes.

The more substantive change from our current welfare system to a UBI, then, relates not to the question of a means-test, but the other eligibility criteria imposed by our current tax-benefit system.

Universal Credit requires many people who are out of work to be actively looking for a job. This is a major source of administrative cost. On the other hand, removing the requirement to look for work might make staying out of the workforce more attractive, further reducing tax revenues.

The major appeal of a UBI is its simplicity. But our current system is partly so complex because the government believes different people have different levels of need. A UBI would necessitate much less generosity for the people relatively advantaged by the design of the UK welfare state, like people with disabilities.

Is a UBI a good idea?

Evaluating a UBI requires addressing questions about fairness and need. Should the welfare system treat everyone equally, or target resources toward those with greater needs? How should the government assess need?

These questions stray beyond the remit of Economics.

However, the trends in UK policymaking over the last 30 years have been away from broad-based or universal benefits and towards more means-testing and targeting. Governments from all major political parties have chosen to target scarce public funds towards the segment of population they most want to help. In a reversal of that trend, a UBI would instead move us towards a more needs-blind welfare state.