Economic Impact of a Minimum Income Guarantee: Analysis of economic theory and policy evidence

Summary of key findings from economic theory

Market and policy ‘failures’: Need to address issues of rising poverty, current inadequacy of the social security system, changes in the labour market and current work incentives, and high – and rising – household costs.

Groups impacted: The effects of Minimum Income Guarantee-type policies can be very different between groups and sometimes entirely reversed. For example, Minimum Income Guarantee-type policies may make women more likely than men to exit the labour market, which underscores the importance of a Minimum Income Guarantee combining social security reform with tackling barriers to labour market access, such as childcare.

Expected microeconomic impacts: Change in work incentives caused by changes to effective marginal tax rate and participation tax rate lead to labour market effects; distributional effects can be big but depend on policy details and group dynamics. However, there is also some evidence that more generous welfare systems may improve job matching quality and reduce the likelihood of people withdrawing from the labour market in the long-term. This can potentially enhance productivity.

Expected macroeconomic impacts: Increased consumption/changed pattern of consumption/potential tax increases and the associated income redistribution may lead to a change in GDP; as these effects oppose one another, the direction of change is uncertain. Short-term fiscal costs can potentially be offset in the long-term as more people find and retain employment, which reduces spending on social security and increases government revenue through taxes.

Wellbeing impacts: There is a good evidence base that income security leads to reduced stress and improved health outcomes. Well-being effects are likely to compound over time, but these effects may not be immediately evident – in particular, the impact of a Minimum Income Guarantee on the educational attainment of children in households who benefit from a Minimum Income Guarantee.

Just Transition impacts: A Minimum Income Guarantee can help manage the economic and social consequences of transitioning to Net Zero. Particular focus has been placed on the value of a Minimum Income Guarantee to support retraining. However, evidence is limited on potential impact.

Market and policy ‘failures’ a Minimum Income Guarantee addresses

Interest in the need for a Minimum Income Guarantee to be introduced is driven by a series of perceived shortcomings within the Scottish (and UK) economy and the limited impact of existing policy in dealing with these shortcomings. Within the literature, there are five major ‘failures’ – in both market, economic and policy terms – that a Minimum Income Guarantee is seen to address.

Stubbornly high poverty rates: As the Poverty Strategy Commission has outlined, poverty in the UK has sat between 21% and 24% since the early 2000s – although some groups have seen reductions at points over the last two decades (child poverty, pension-age adults and lone parent families).^[8] According to Scottish Government National Statistics, it is estimated that 21% of Scotland's population were living in relative poverty after housing costs in 2019-22. While child poverty and pension poverty in Scotland have reduced sizably across the 21^st century, working-age poverty has seen a small increase over this period.^[9]

Inadequate financial support via the social security system: Since 2010, UK government welfare reform has seen reductions and freezes applied to core benefits, leaving a social safety net that has been characterised by some as unfit for purpose.^[10] The Scottish Government has recognised these UK-wide challenges, and has sought to mitigate some of the impacts through targeted supported for the most vulnerable groups, such as through the Scottish Child Payment for low-income families with children^[11] or the Carer’s Allowance Supplement for unpaid carers.^[12]

Labour market changes and barriers: The structure of the UK labour market has seen significant changes in recent years with an increase in wage polarity and employment, especially at the lower end of the labour market, which is increasingly insecure and precarious. Moreover, there is also concern for the potential of unemployment due to technological change and automation and the effects of this on the distribution of income, consumption and potentially a loss of GDP.^[13]

Failure to maximise work incentives within the UK social security system: The existing UK-wide social security system is not well-suited to support work. The current social security system fails to maximise work incentives, as benefit withdrawal rates deter individuals from seeking or increasing employment. Within the UK context, a major issue is the ‘any job’ approach of employment support, which has failed to provide adequate or long-term employment for jobseekers and exacerbated other issues a Minimum Income Guarantee is seeking to address.^[14]

Rising cost of essential household goods and services: A lack of sufficient financial support from the Universal Credit system has led to an increased reliance on food banks and a significant portion of low-income households unable to afford essentials and falling into arrears with multiple bills.^[15]

Groups impacted by the introduction of a Minimum Income Guarantee

The introduction of a Minimum Income Guarantee, setting a minimum income level under which no one can fall, would provide societal-wide benefits. However, there are six groups whose current circumstances would most benefit from the introduction of a Minimum Income Guarantee:

Low-income households: Individuals who work but earn low wages are often in a precarious financial situation and struggle to make ends meet. A Minimum Income Guarantee can provide them with additional financial support, supplementing their incomes and helping them meet basic needs – especially if the Minimum Income Guarantee provides support with household costs, accessing essential services and reforming employment.

Unemployed individuals: Those who are unemployed or unable to find stable employment may face financial hardship and insecurity. The current standard allowance of Universal Credit is widely recognised as insufficient to meet basic needs. A Minimum Income Guarantee can serve, therefore, to boost the safety net afforded to unemployed individuals, providing them with a secure floor that means they have access to a minimum level of income to cover essential expenses while they search for work or participate in labour market access schemes.

Minority ethnic individuals: Minority ethnic individuals often face significant issues in the labour market and economic outcomes when compared to white workers. Latest published estimates show that Scotland’s ethnicity pay gap was estimated to be 10.3%, while the ethnicity employment rate gap was estimated to be 11.7 percentage points.^[16] In addition, the employment rate gap for minority ethnic women is consistently much larger than this gap for men and is especially striking amongst Pakistani and Bangladeshi women. A Minimum Income Guarantee can therefore function not only to help bridge the ethnicity gap in incomes, but could also be specifically targeted at ensuring ethnic minorities are better supported into work where appropriate.

Single parents: Single parents with dependent children often face financial challenges due to the additional expenses and responsibilities associated with raising a family on a single income – as well as challenges accessing the labour market. The majority of single parents are women and the introduction of a Minimum Income Guarantee could help reduce gender inequalities by alleviating some of the financial strain singe parents experience. Moreover, a Minimum Income Guarantee provides more realistic work expectations and support, while also rethinking the value of parenting as a social and public good that should be appropriately financially remunerated.

People with disabilities: Individuals with disabilities encounter barriers to employment and may require additional support to meet their financial needs. Currently, the level of support provided by extra cost benefits for disabled people is inadequate to meet their needs and tackle the extra costs that they face.^[17] A Minimum Income Guarantee can provide disabled people with greater financial independence and access to essential services and resources, as well as better tailored support to support those disabled people who can enter the workforce.

Retirees: Retirees living on fixed incomes may struggle to afford basic necessities, particularly if they do not have sufficient savings or pension benefits. A Minimum Income Guarantee can help supplement their retirement income to enable people to live with dignity in old age. The UK has seen a significant decline in pensioner poverty, and the UK does currently have a policy targeted at helping bring the weekly income of low-income pensioners up to a minimum amount in the form of Pension Credit. While not explicitly a Minimum Income Guarantee-type policy, issues with the low take-up of Pension Credit signal some of the potential challenges with the design of a Minimum Income Guarantee-type policy and its effectiveness.^[18]

Expected microeconomic impacts of a Minimum Income Guarantee

There is an ongoing debate about the impact of a Minimum Income Guarantee on financial work incentives and the expansion or contraction of labour, which is influenced by factors like the Participation Tax Rate (PTR), Marginal Effective Tax Rate (METR), and Replacement Rate (RR).^[19] Definitions of these terms are provided below.

Marginal Effective Tax Rate (METR): The proportion of gross earnings subtracted through tax and withdrawn from benefits for a given increase in income. This signals the motivation to increase earnings.

Participation Tax Rate (PTR): The proportion of gross income subtracted through tax and withdrawn from benefits after moving into work. This signals the motivation to work.

Replacement Rate (RR): The ratio of net income between an individual being out of and in work. This signals the motivation to work.

In practice, the impact of a Minimum Income Guarantee on PTR, METR, and RR will be dependent on the overall policy formation and, in particular, how and whether the benefits of a Minimum Income Guarantee are withdrawn as earnings increase. A Minimum Income Guarantee might also increase reservation wages (the minimum rate of pay at which individuals are willing to take a job), which could act as a disincentive to enter the labour market or take jobs that might be available but are not paid well enough.^[20] Again, the impact of this will depend on the precise specification of the policy.

One important consideration with the theoretical literature is that high METR and PTR can create ‘poverty traps’ through the social security system and an increase in reservation wages.^[21] However, academic research exploring the effect of generous welfare benefits on unemployment has suggested that while welfare systems with higher benefit payments do raise reservation wages, which reduce the rate of transition out of unemployment, increasing unemployment rates overall, there may also be a “job search subsidy” which improves the quality of job-matches and, in the long-term, reduces separation rates and potentially improves productivity.^[22] Evidence suggest that both effects are in play, but institutional considerations determine which dominates. In countries with flexible, accessible and transparent labour markets, there can be value in longer job searches. In countries with inflexible and inaccessible labour markets, individuals may become disengaged and discouraged, with the disincentive effect dominating and long-term employment and productivity scarring becoming an issue.^[23]

In addition, the introduction of a Minimum Income Guarantee could lead to various responses from employers and the functionings of the labour market. The New Economic Foundation has suggested that a Minimum Income Guarantee could reduce the risk of a ‘poverty trap’ for low-income households by improving incentives to work by putting pressure on employers to raise pay.^[24] Moreover, a Minimum Income Guarantee may open up vacancies for those who may currently be struggling to find work. A Minimum Income Guarantee could allow some workers to reduce their hours to undertake other valuable activities, such as caring responsibility, which opens up employment opportunities for others through a ‘re-shuffle effect’ within the labour market.^[25]

To some extent, any disincentive effects created by a Minimum Income Guarantee could be (and, as we show later, have been) ameliorated by policies that enforce “conditionality” (requirements around work search activity, for example). While there is mixed evidence on the efficacy of such approaches, particularly in supporting people into long-term and well-paid employment, this is another factor to consider when assessing the overall impact of a Minimum Income Guarantee on the labour market.^[26]

Overall, while there are a range of theoretical implications for labour supply, empirical evidence suggests that effects are generally small.^[27] However, they do vary between different groups. For example, an OECD assessment of replacing existing cash benefits with a basic income-style social security policy would severely weaken work incentives for second earners and be especially pronounced for childless couples.^[28] Research from the Fraser of Allander Institute on the introduction of a Citizen’s Basic Income further supports this suggesting the labour market impacts are most pronounced for second earners, both younger and older workers, as well as those with lower levels of educational attainment.^[29] The IMF has explained that adjustments to benefit withdrawal rates could incentivise work for certain household types – in particular, lone parents and single-earner couple households – preventing them from falling into poverty and potentially lifting them further above the poverty line over time.^[30] This means that the distributional and equalities implications of a Minimum Income Guarantee need to be considered.

Looking beyond work incentives and labour supply, implementing a fiscally neutral Minimum Income Guarantee could redistribute income to consumers with higher marginal propensities to consume – most commonly those at the bottom end of the income distribution.^[31] Distributional effects show that while the poorest decile would gain substantially, certain income groups might lose out, highlighting the complexity of designing effective poverty reduction policies.^[32]

Depending on the design of the policy, one of the ways in which the cost of implementing a Minimum Income Guarantee could be met is through a potentially significant increase in tax rates. Modelling suggests changes in employment due to these policies would vary across income groups, with higher earners experiencing the most significant increases in tax burden. However, adverse employment effects could result for every income group due to higher taxes needed for fiscal sustainability.^[33] However, it is important to stress that increasing taxes – and exactly which taxes to increase – is just one option that policymakers would need to consider when deciding on how to fund and implement a Minimum Income Guarantee.

Expected macroeconomic impacts of a Minimum Income Guarantee

The section above highlights that the theoretical effects on labour supply are ambiguous, with debates surrounding the degree and likelihood of expansion or contraction in labour supply. If the effects were positive, depending on policy implementation design, a Minimum Income Guarantee could reduce social security spending, with more people entering the labour force and staying in work. The expected economic and fiscal benefits of this include lower unemployment and higher tax revenue. Increasing in-work support through a Minimum Income Guarantee will likely result in a higher immediate fiscal burden. Yet, in the long-term, this should be reversed as more people are incentivised to find and stay in work.^[34] In contrast, a negative labour supply impact of a Minimum Income Guarantee could lead to the opposite effects.

Research from the Fraser of Allander Institute on the introduction of a Citizen’s Basic Income explored the expected demand- and supply-side impacts of introducing this policy.^[35] The research found that:

• · On the demand side, the overall impact of a Minimum Income Guarantee can be modest, with tax increases offsetting higher transfer payments. There is a positive effect due to a shift in demand toward lower-income households, who generally have a higher marginal propensity to consume. However, this is offset by changes in the composition of consumption, which involves an increase in the capital and value-added intensity of consumption. Moreover, the analysis found that increasing government spending by the same amount as the cost of implementing a Citizen’s Basic Income would have more of an impact on overall demand in the economy.
• · On the supply side, with the assumption that a Minimum Income Guarantee is funded through increased taxation, the impact of a Minimum Income Guarantee is primarily seen in a reduction in employment in response to increased tax rates. The scale of the reduction in supply is determined by the bargaining behaviour of workers. The reduction in GDP varies from 8.8% (under conventional bargaining) to 1.7% (under bargaining adjusted for family CBI income). In models with migration, larger reductions are possible: one gives a reduction in GDP of 15.2%. Some mitigating channels exist – higher productivity and improved job matching through longer search times, but these channels have a weaker evidence base.

Research by the Cambridge Trust for New Thinking in Economics has sought to explore the macroeconomic effects of a tax-funded UBI compared to a Debt-Free Sovereign Money-funded UBI, which provides some useful insight into how differently funded Minimum Income Guarantees may function at the macroeconomic level.^[36] This research found:

• Basic income variants may influence employment protection and labour market regulation, impacting pay and working conditions.
• · Both basic income variants have a small positive GDP impact, with increased consumption being a significant driver.
• · Tax-funded UBI leads to gains for bottom income deciles while top deciles lose.
• · While UBI initially reduces work incentives, higher economic activity eventually leads to overall higher employment.
• · DFSM-funded UBI can offset the negative effects of automation on disposable incomes and improve income distribution.
• · Automation scenarios also have positive impacts on public finances.

Expected wellbeing impacts of a Minimum Income Guarantee

As a result of improvements to both the amount and stability of household income, a Minimum Income Guarantee may improve health outcomes, reduce spending on health and social care, and improve educational outcomes of children in recipient households, which in turn may improve the occupational outcomes of households across generations, as well as improving the earning potential earning’s mobility, reducing inequality.^[37]

An academic assessment of the health impacts of income guarantee trials suggests that the impact on health might grow more positive over time. In the longer-lasting trials, improved health outcomes were sustained over the entire two-year duration. These improved health outcomes included better life satisfaction, better diet, and investment in healthy behaviours. There is also an improvement to mental wellbeing, with reduced mental strain, depression and loneliness. There were also improvements in the health of children – from birth through to the transition into adulthood. This included better birth weights, reduction in minor illness and injury, improved mental health and reduced substance abuse in children.^[38]

This same assessment highlighted that a common concern with the introduction of Minimum Income Guarantee-type policies is that they incentivise behaviour conducive to ill health, not least due to concerns over the disincentive this may have on work and the relationship between economic inactivity and ill health as well as increased cash transfers encouraging ‘bingeing’ activity of alcohol or drugs (from some evidence in Alaska and Portugal). However, the assessment suggested that what evidence exists points to an overall improvement on health outcomes but suggested that the seriousness of concerns around the potential negative health impacts warranted further population-level studies.

Expected impacts of a Minimum Income Guarantee on a Just Transition to Net Zero

One of the significant challenges in achieving a Just Transition to Net Zero – in the case of the Scottish Government, a legally binding climate target of Net Zero emissions by 2045 – is economically supporting those workers and communities who will ‘lose out’. It is important that a Just Transition away from carbon-intensive industries needs to be managed in a way that recognises not only its potential effects on employment and income but also people’s communities and social relations.^[39]

In this regard, a form of a guaranteed income has been considered as a possible policy tool to mitigate any adverse distributional and social effects that may result from the transition.^[40] In particular, there are significant advantages of an income guarantee to not only providing a financial buffer, but that linking this payment to the retraining and reskilling that would be needed in order to be able to take advantage of new opportunities with green jobs.^[41]

An evaluation conducted by the Fraser of Allender Institute found that, at present, there is little consideration within the Scottish Government’s current strategies of the impact of a Just Transition upon low-paid jobs – both directly and indirectly – and the necessary support people need to manage this.^[42]

A systematic review of the economic literature on Just Transitions and the employment and income impacts of this found that there is a scarcity of work devoted to the distributional consequences of the transition, with most work focusing on shifts in employment level – where there is a positive, yet relatively small, impact.^[43] As such, this makes it difficult to explore the role of an income guarantee in supporting this transition.