Best of Both Worlds: Improving Basic Income with Libertarian Paternalism

This continues a series of posts that I am writing on the basic income. The first post, which speculates on possible unintended consequences can be found here.

One principle which distinguishes the basic income from other welfare policies is that it is unconditional. There are no requirements for receiving the payments (unlike the Earned Income Tax Credit) nor any restrictions on how the funds can be spent (unlike food stamps). The appeal of the basic income as a policy is in its simplicity since administration of the program would, more or less, come down to figuring out how to regularly cut a check to everyone.¹

There are, however, undoubtedly individuals who could use “guidance” in how they spend their funds. Traditional policy tools for getting people to make better decisions, whether that be directly through illegality or indirectly by imposing taxes or fines on undesirable behavior, typically involve restricting individual choice. These paternalistic tools are antithetical to the unconditionality of basic income policy.

So how can policy makers implement a basic income which helps people make better choices without restricting their choices? One solution involves the application of policy that is “libertarian paternalistic”. This type of policy draws on findings in behavioral economics which combines clever policy design with systemic biases in human judgement to furtively influence individuals into better decisions.

The basic income can benefit from existing work that has been done in improving policy with libertarian paternalism. I propose two solutions:

1. Voluntary Food Stamps. Basic income participants are given the choice to allocate their payments between cash and a food stamp-like payment. The cash can be spent on anything while the food stamps, just as they are implemented now, are restricted to being spent only on certain items.
2. Save More (Basic Income) Tomorrow™. Allow basic income recipients to automatically allocate a % of their basic income payments towards retirement / savings accounts with a 401(k)-like structure. Inspired by Thaler and Benartzi’s Save More Tomorrow™ program.

On first glance, it seems like these policies would be ineffective. Why would anyone choose to voluntarily give up some of their choice by choosing to receive food stamps instead of cash? Why would automatically allocating payments into savings improve savings rates?

To answer these questions, it is important to understand the mechanisms by which libertarian paternalism affects individual decision making.

¹Not to imply that this is a trivial task. The logistics of ensuring reliable payments to everyone in a country can be complicated, not to mention the potential fraud and support issues.

The Right to Choose?

As with all practical idea² in economics, the idea of “libertarian paternalism” borrows heavily from other disciplines. This seemingly contradictory term was coined in 2003 by UChicago economist Richard Thaler (whom you may recognize from his self-cameo in The Big Short) and Harvard Law Professor Cass Sunstein to describe governmental policies which have two characteristics:

1. It’s “paternalistic” in the sense that a higher authority (usually the government) attempts to help those it oversees achieve better outcomes through some means of changing individual behavior.
2. It’s “libertarian” in the sense that this higher authority does so without restricting individual choice.

The traditional tools of policy aspire to get people to make better choices through paternalistic means. These are tools that could be applied to the basic income, but each of them oppose the intent of the basic income. These policy tools include:

• Illegality. The most straightforward way to prevent poor purchasing decisions would be to restrict what the basic income could be spent on… which is more or less what food stamps are.
• Mandates with compliance incentives. Basic income recipients could be fined for purchasing certain goods with their payments. This, again, would restrict choices if applied to basic income and functions more or less like…
• Taxes. Artificially increasing the price on goods like cigarettes or soda is an effective way to get people to consume less, but restricts choices by reducing purchasing power.

While these types of policy are likely to be beneficial to many if not most people it affects, there are others that it almost certainly harms. Take a soda tax for example. The tax is there to disincentivize those with poor self control or sugar addictions from consuming sugary beverages, but it inevitably harms the “rational” soda consumer for which an occasional treat is now more expensive. There is an implicit assumption that implementing paternalistic policy produces a net societal benefit — the irrational benefit more than the irrational are harmed.

Libertarian paternalism takes a different approach. Rather than policies that attempt to prevent harmful choices, libertarian paternalism nudges people into better choices by taking advantage of these systematic biases in human judgement:

1. Status Quo / Default Bias. All else equal, people are more likely to go with the option that requires no action. Therefore the selection of the default outcome in policy can be used to influence decision making without restricting choice. Those who don’t like the default choice can always switch to the option that they prefer.
2. Self Control Problems (as modeled by hyperbolic discounting). People are generally poor at predicting how they will behave in the future especially when future choices involve self control.
3. Sophisticates and Naifs. Sophisticates know that they have self control problems and can accurately predict how they will behave in the future. Naifs do not. It is then up to policy to be designed such that sophisticates can take advantage of commitment devices to force their future selves into making better choices.

These mechanisms are what allow libertarian paternalistic policy to function without restricting choice. This makes it especially appropriate to apply to basic income policy and has potential to stretch its benefits for those that need it most.

²This is, coming from an econ major, only half in jest

Stamp of Approval

Imagine a scenario where you are given the choice between three benefits packages:

1. $100 in cash.
2. $50 in cash, $50 in food stamps.
3. $100 in food stamps.

Which would you choose?

It is intuitive that the $100 in cash is, in almost all situations, superior to the other two choices which allocate some fraction to food stamps. Cash allows you to purchase anything (except, maybe, happiness) while food stamps restrict you to items that are more or less approved by the government. So why offer this choice in the first place? In what situations would be advantageous to select a package with food stamps over cold, hard cash?

The answer lies with those who have self control issues, are “sophisticates” (aware of those self control issues), and are willing to take action to prevent their future selves from being tempted. For an individual who is low income and prone to spending their money on alcohol, lottery tickets, or other “wasteful” products, the ability to prevent their future selves from making these poor decisions would be welcome.

This is the paternalistic part of this policy. By allocating a portion of basic income into a food stamp-like payment, the policy can force people into making better decisions. However, in order for this to also be libertarian, beneficiaries must be able to choose how much of their payment to allocate into cash and food stamps. Allowing this choice is key to fulfilling the definition of libertarian paternalism because this allows anyone who wants 100% cash to do so while also allowing others to benefit from choosing to restrict their future choice.

Allowing this choice also presents a question: What should the default allocation between cash and food stamps be? Since this is a libertarian paternalistic policy, we can’t force people to choose and thus must have a default allocation.

As Thaler and Sunstein put it in Libertarian Paternalism is Not an Oxymoron,

We suggest two approaches to this problem. If feasible, a comparison of possible rules should be done using a form of cost-benefit analysis. In many cases, however, such analyses will be both difficult and expensive. As an alternative, we offer some rules of thumb that might be adopted to choose among alternatives. In general, it makes sense to experiment with possible approaches, to identify their results for both choices and outcomes.

When it comes to impact evaluation, there are few substitutes for controlled experiments.

This policy need not be restricted to “food stamps”. At the risk of overwhelming basic income recipients with choice, basic income distributions could be committed to a variety of other means tested social programs such as saving money for education or housing.

The ultimate benefit of providing a food stamp-like alternative to cash is to allow those recipients who are cognizant of their self control issues to act on them without affecting the range of choices for others.

Saving More

While there is evidence that unconditional cash transfers improve the savings rates of those that receive them, there is more that can be done to nudge basic income recipients into optimize their savings.

This second integration of libertarian paternalistic ideas into basic income policy is an extension of a successful set of experiments conducted by Thaler and Benartzi on employees who were eligible to contribute to their 401(k) savings plans. One of the key frictions that they identified in why people did not save as much as they would like is due to the default savings rate of 0% if employees did not explicitly choose a savings contribution rate and that people’s contributions were fixed unless they deliberately changed it. They found that this resulted in employees both start saving later and saving less than they would have liked.

The strategy used by Thaler to encourage greater savings was allow employees to opt into a program to steadily increase their savings contribution as their salaries grew. Employees were, of course, allowed to change this rate — staying in line with the libertarian in “libertarian paternalism”. The program, called Save More Tomorrow™, was successful in getting employees to opt in and quadrupling the savings rate for participants.

The ideas used by Thaler to increase employee 401(k) savings can more or less be directly applied to basic income schemes.

A 401(k) like saving program for basic income funds would need to be established. The restrictions for when a participant is allowed to withdraw also functions as a commitment device for those with self control problems. The period of time required before being able to withdraw could be adjusted (shortened if anything) since the basic income would make saving specifically for retirement less important. Then a default value for contributions would need to be set with increases based on whether a participant’s income increases over time. As with all things libertarian paternalistic, participants should be allowed to change their savings rate.

The Price of Freedom

The proposed additions to the basic income come with drawbacks of their own. The most prominent cost to these additions is that they chip away at the basic income’s claim to being simple. These policies would undoubtedly make basic income policy more complex and would require greater administrative resources to implement. Whether or not that cost can be justified will depend on the expected benefits. Given that the basic income hasn’t really even been tested in the US, I don’t expect any libertarian paternalism inspired modifications to be tested anytime soon. Perhaps Y Combinator will select a researcher with a behavioral economic background to conduct their experiments in the US.

What should also not be ignored is the potential for negative consequences. Even though these proposed policy additions allow individuals to select from all options, the default bias can also inflict harm if the default values are not properly calibrated. There is some cognitive cost to switching. Those who would prefer a different option from the default but do not end up switching to their preferred option due to the bias will inevitably be worse off.

My intuition says that the potential for harm is limited since many basic income recipients will not rely on basic income payments as their sole source of income. Any “accidental” allocation to a food stamp-like instrument or savings is of less and less consequence to individuals as other income increases.

These basic income policy additions are ultimately geared towards benefiting individuals in poverty who may disproportionately suffer from self control issues. By using the principles of libertarian paternalism, we can enhance the impact of basic income policy without enforcing patronizing restrictions and preserving the unconditional freedom of choice that the basic income promises. As the basic income gains support, it will be worth exploring additional applications of libertarian paternalism to complement and reinforce the benefits that this unconditional policy can provide.

Originally published at jonthewang.com on May 10, 2016.