We Need VAT and UBI

There is a pretty serious gap in how the economy functions right now, has been for decades, and we have to close it.

I’m not here to be all “tax the rich” even though I maybe think that’s a good idea too.

I’m not here to say “free markets are amazing” even though I might have some opinions on that as well.

This is a simple, mechanical problem that needs fixing, and we fix it with VAT and UBI. I’m tired of being calm about this. If you so much as whisper “that’s socialist” or “you’re defending the bourgeoisie” I will beat you to death with a sickle tied to a demand curve.

This is not a political post1

Why do we need this?

Because automation has moved labor markets so much that labor can no longer be the only way that people get money to participate in the economy. We have automated away jobs tied to the most basic goods that we need, and the jobs we create are tied to marginal gains in utility that are poor measures of output. Important necessities have been highly productive for decades, meaning a single person employed by say, the agriculture industry, can feed exceedingly many people. Automation replaces jobs, and yet, the economy is wonderful in that we can and will always create new jobs, we will never run out of work for people. But that is also a runaway train, we need to stop and ask “do we want all those new jobs?”. Here are the main reasons we need VAT and UBI:

We’re squeezing all our economic signalling for highly automated or necessity goods through labor intensive sectors unconnected to those automated industries and this makes our economies brittle, requiring targeted intervention. We need alternative signalling.

The mechanism for creating new jobs is not instantaneous, it creates instability proportional to the speed of automation.

Some new jobs just, aren’t that useful? Do we really need foodora drivers or escalator attendants?

Why UBI?

This one is quite easy: Because it’s the fairest. You get money for existing. Whether you work or not, you are given some money to participate in the economy, to buy the things you want and to signal to the economy which things you want. It’s simple to administer because there are no checks or barriers you need to pass, and it discourages working less than most alternatives because your income doesn’t go down if you start working.

Why VAT?

This is a little harder but not too hard: Because it’s the mirror of UBI. The UBI will fund consumption, VAT taxes consumption. A 50% VAT raises the price of bread by 50%. The existing economy sitting underneath goes untouched, the base price of bread is set by scarcity and is paid by labor income, as before. The additional VAT on top funds the UBI in a circular fashion. (For questions about saving as opposed to consumption, I talk about that later in “what about saving?”)

Wait the price of bread will go up???

Yes, and a bit more than 50% (or whatever the VAT increase is), at least in the beginning. Here’s some examples of some people:

No Income: This person receives the UBI after having not had any money. They can now buy something, at least. Maybe not enough to live off, but more than before, probably at least some bread even though it is “expensive”.

Some income: This person was making some money, from benefits or working or whatever, doesn’t matter, but they find that the UBI they receive is completely eaten up by the increased VAT of all the things they used to buy. They are not touched by this change, for them their life is exactly the same and they largely don’t notice. Their savings have eroded somewhat though as they are smaller in relation to both their income and expenses.

A lot of income: This person finds that the UBI is not enough to cover the increase in price for all the nice things they used to buy. They have to decrease their spending. They probably still buy bread because well, that’s a necessity. Maybe they buy fewer luxuries though. Their savings, of which they likely have a lot, have eroded a lot.

So, yes, this is technically a form of redistribution. Buying power is being transferred from the rich, to the poor. However:

Redistribution isn’t the point of this system.

The point of this system is to adjust for the fact that the nature of what jobs can be done is changing. Physical labor, the kind that almost anyone can do, is mostly automated away. Other forms of labor require training that not everyone can obtain or learn, or takes years.

Those jobs are in jeopardy too now, since regardless of what you think about AI it is able to do cognitive tasks to some meaningful degree. That’s not to say we can just wait for mass unemployment before saying “maybe now not everyone needs to work!” because the economy will almost always be able to create new jobs, and that will not save us. Those jobs chase marginal utility over marginal cost, i.e something that wasn’t worth doing before but now is. However, the speed of automation makes this system imperfect2, and the jobs we are creating at the frontier of utility either do not employ many people, or they are very low marginal utility.

Automation replaces jobs, and yet, the economy is wonderful in that we can and will always create new jobs, we will never run out of work for people. But that is also a runaway train, we need to stop and ask “do we want all those new jobs?”.

Won’t people just stop working?

Yes, but not that many. Firstly, costs have risen because of the VAT, for many the UBI is mostly eaten by this increase. Only those that make very little doing a job they hate may choose to quit their job. Secondly, keep in mind that most people actually don’t like doing nothing. Right now, struggling to cover costs with a meager salary means you stay busy hunting for work or working. With support from a UBI people have opportunity to learn, obtain skills, try new things that actually in turn may contribute back to the economy.

Won’t we get massive inflation?

No, because the VAT eats into most of the UBI. This is by design, demand doesn’t actually rise that suddenly or that much because most peoples buying behaviour hasn’t changed much. However, a few points are worth mentioning:

It obviously feels like inflation because prices have jumped, but because the VAT directly funds the new cost it’s not quite the same as inflation we are used to. Whoever calculates the national CPI will have a tiny bit of extra work to do. It also is inflation in terms of eroding savings and assets.

As mentioned, demand for luxuries may drop and for some necessities may rise since there is a component of redistribution. This will drive some inflation as the economy readjusts to produce more of some things and less of others.

Because of that slight rebalancing going on this is still something you do slowly.

If you want a UBI of 40% of median income, you want to raise VAT and UBI in monthly steps, over a period of years.

That’s to say raising the VAT in lockstep with the UBI is what makes the UBI stable. The pressure it exerts on the economy is much smaller as compared to funding the UBI with anything else, both in terms of labor and consumption pressures.

Why not have a smaller UBI and fund it with a different tax?

As I’ve described it the VAT and UBI are circular. They don’t actually extract from the rest of the economy3 in the way that paying labor does. Two points here:

Extraction still happens through labor, people still work and that is how wealth transfers from big pots of money into the hands of people.

You can still tax wealth too if you want to, tax the rich, dividends, profits, land (yeah ok I like the idea of taxing scarce rent bearing things too), whatever, but all of that comes after, downstream of this change.

The point is this:

You can go fight over how much other stuff to tax and how we should redistribute it and how big government should be, I do not care about that right now. This is about fixing the fact that paying for labor isn’t a good enough measure of true economic output anymore.

It works in part because individual consumption rises as a component of the economy in relation to all other economic activity. We are amplifying consumers signalling to the economy to make up for that which is lost from shifting labor. That’s the end of this post. Everything after this is addendum and I promise to stop shouting as much.

How do you actually implement this?

To escape the idea that this is at all tied to government, lets actually have this policy managed by the central bank. The method is this: Chose a target percentage of median income and a timeline. That gives you your target UBI at the end of x years. Calculate the theoretical VAT needed for that, and each month, linearly increase it towards the final value at year x (add it on top of any VAT the government is already collecting, again, we’re sidestepping the politics here). Crucially, the UBI you pay out is whatever was gathered by the VAT in the previous month.

This closes the loop and avoids any discussion on how to fund this or if it will incur government debt. As you approach year x you need to observe how the economy responds. You may need to slow down your timeline or adjust your target UBI and recalculate the monthly VAT increase. Either way this will take time and for that reason we should start now.

Where does this idea come from?

This comes originally from a simple thought experiment that I’ve written on this blog before. In a perfectly stable, automated economy, where all industries are perfectly sized and all work is automated already, how do you give money to people and fund it? The answer is UBI and a tax on rent bearing scarce resources. You might be surprised to hear me say “a tax on rent bearing scarce resources” and not VAT, but that’s because VAT has a key advantage in the area between our current world and this one that is, in truth, impossible to reach. VAT funds consumption through consumption, and therefore is easy to measure and has no “slack” (responding immediately to change). In a perfectly stable economy, you don’t need it. If you try and set up a UBI right now funding it is hard. Hard to calculate. Tax the wrong thing and you will get a big market distortion. Even if you tax the right things, you can expect big market swings that will suck for everyone unless you are exceedingly careful. VAT temporarily sidesteps this problem (although, not permanently). That’s why it’s the apolitical solution that we need right now. The hard stuff, the stuff we fight about in politics, who to tax, how much work is real work, should we encourage business or protect individuals, are all things we built our democracy and governments and election systems and institutions to solve. Those things are becoming harder to do because as work becomes more automated we make these links more brittle and separate people from the complexity that gives them the goods they need or desire.

The lack of slack is also a risk though. A small note on procyclical effects: You might be pointing out now that in a recession, consumption falls and thus our UBI does too, hitting consumption harder, making the recession worse. This is roughly similar to how loss of consumption can spiral into unemployment, as companies cant afford workers, feeding itself. That’s already a problem we try and deal with today.