Basic income grant: more money in poor people’s pockets, but at a great cost to economy

Analyses of the implications of extending income support measures in South Africa, including a basic income grant, have focused on one of three things: how much it will cost, calculations about how much revenue would need to be raised (but without assessing the ripple effects), and how it might affect the incomes of the rich and the poor.

Each of these provide important contributions. But they don’t address the dynamic and long-term implications of basic income support options on the country’s economy and its finances. What’s been missing is a modelling that compares – or tests – the impact of the different policy choices and their permutations and how these are funded and who benefits and who loses.

In a recent paper we attempt to do just that.

Our model allows for both positive and negative economic effects of higher direct transfers to households. The model thus captures feedback effects between government expenditure, taxation, household consumption, firm investment, debt, interest rates and economic growth.

On the one hand, our model shows that a basic income grant would decrease economic growth through three main channels: an increase in borrowing costs, an increase in taxes, and crowding-out of private and other forms of public spending.

On the other hand, it would have a positive impact on economic growth through one main channel: an increase in consumption by poor households.

Overall, the results suggest that the negative economic effects of an expansion in social grants would outweigh the positive. We conclude that, without structural reform of the economy and sustained economic growth, introducing additional permanent social transfers could threaten South Africa’s macroeconomic and fiscal stability.

Three possibilities

The paper considers three basic income grant scenarios. And it estimates different combinations of tax and debt funding.

Scenario 1: This estimates tax and debt outcomes for different grant sizes without imposing any specific “funding policy”. The estimated model based on historical data guides the macro-fiscal dynamics.

The scenario estimates two possibilities for expanding social transfers:

• convert the R350 temporary social relief of distress grant into a permanent basic income grant
• raise the grant in three possible ways – to the food poverty line (R624 in current prices); the lower bound poverty line (R890 in current prices); the upper bound estimate of the poverty line (R1,335 in current prices).

Different eligibility criteria can also be inferred. These include considering four potential eligibility groups. They are:

• covering 8.3 million people
• reaching the same as the current social relief of distress grant (10.5 million people)
• a grant targeting all poor people (33 million).
• a universal basic income grant to the whole population (60 million)

Converting the R350 social relief of distress grant into a permanent basic income grant is estimated to require an increase in public debt of about 3 percentage points of GDP after five years. It would require a marginal increase in effective indirect taxes (mainly the value added tax rate, VAT), an increase in the effective personal income tax rate of about 2 percentage points, and an increase in the effective corporate income tax rate of about 0.25 percentage points.

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The model shows that the consumption of poor households would rise. But it predicts that there would be some job losses owing to the contractionary impact on investment and growth from higher debt and higher taxes.

Introducing a grant at the food poverty line (R624 per person in 2022 prices for an eligible population of 10.5 million at a cost of R79 billion) would lead to higher debt, VAT and personal income tax increases. Debt would rise by 7.7 percentage points of GDP, VAT by about half a percentage point and personal income tax by about 5.3 percentage points.

The model predicts job losses amounting to about 200,000. These come about because of the fiscal impact of a permanent increase in spending (higher taxes and higher interest rates).

The contractionary effects operate through:

• higher debt, which leads to relatively higher borrowing costs and lower long-term economic growth
• direct crowding-out of government expenditure in an attempt to maintain fiscal sustainability
• crowding-out of private sector expenditure through higher taxes.

These effects dominate any expansionary effects from higher transfers.

As a result, a large fiscal transfer of the type proposed by advocates of BIG is not estimated to boost economic growth.

The largest transfer expansion considered is a grant of R840 per month for 33 million households at a cost of R333 billion. This, the model suggests, would increase debt by 42 percentage points of GDP, requiring higher VAT of 3 percentage points and personal income tax to rise by 29 percentage points, essentially a doubling.

The contractionary impact on the economy would be estimated to lead to nearly a million job losses.

Scenario 2. This focuses on a basic income at the food poverty line financed by an increase in taxes (a “balanced budget” scenario). Debt would still rise marginally because the economy would slow. If the new grant was funded by VAT alone, this would require an increase of 7 percentage points in the rate – from 15% currently to 22%.

If funded from a combination of higher VAT and personal income tax, VAT would need to rise by 4 percentage points and personal income tax would rise by almost 3.5 percentage points. For the average taxpayer, who earns R370,000 and pays an effective rate of 21.3%, this would mean an increase in taxes from R79,000 per year to R91,500 per year. This, in turn, would lead to significant contraction in the economy, even though there would be some short-term employment gains from the large direct income effects from higher transfers.

Scenario 3. This models a grant at the food poverty line financed by a combination of higher VAT but also higher economic growth. In this scenario, the assumption is that government simultaneously expands government investment by R60 billion and successfully undertakes structural reforms (such as removing constraints on electricity availability).

In this scenario, VAT would still need to rise (by 9 percentage points without structural reform, and 5 percentage points with reform) to fund the transfer expansion.

This scenario is estimated to lead to job gains but only because the structural reforms permanently raise long-run growth and, therefore, government revenue.

Moreover, by enhancing the economy’s productive capacity, government investment would have long-run growth-enhancing effects.

The take-away

Our paper shows that the introduction of a basic income grant would require significant long-term tax increases and would likely lead to employment losses. We also show that without sustained higher economic growth, much higher social transfers could threaten fiscal sustainability.

Poverty, inequality and unemployment are three interdependent socio-economic challenges South African policymakers are seeking to address. Addressing this triple challenge is critical for the future of the country. But an unfunded expansion of the social transfer system could lead to even worse economic outcomes — the medicine should not be worse than the disease.

Hylton Hollander, Senior Lecturer, Stellenbosch University; Daan Steenkamp, Research Associate, Stellenbosch University, and Roy Havemann, Research Associate, Stellenbosch University

This article is republished from The Conversation under a Creative Commons license. Read the original article.