INCENTIVISING LOW SKILLED HOUSEHOLDS THROUGH NEGATIVE INCOME TAX SYSTEMS

01 Apr 2019

We’ve all heard the Chinese proverb – ‘give a man a fish and you feed him for a day. Give a man an incentive to learn fishing and he will feed himself for a lifetime.’ It summarises new research by Peter Funk published in the April 2019 edition of The Economic Journal. He shows that providing support to the poor that increases with their effort to raise skills and income can incentivise low skilled households. Such schemes, he argues, are beneficial to both the recipients and contributors.

While many countries, such as the UK and the US, have introduced tax credits or similar tax and transfer schemes aimed at incentivising poor households, there has been little theoretical economic research to support such programmes. 

The author’s study provides a new rational which emphasises the importance of acquiring skills and which gives support for negative income tax systems – where people earning below a certain amount receive government support instead of paying taxes.

The study explains that households choose the level of effort to invest in to raise the skills of the household and eventually settle on stationary levels of effort and skill. This level of skill not only depends on inborn characteristics, such as learning abilities, but also on starting conditions. Therefore, in a group of children with identical innate abilities, children born to low skill parents will remain unskilled and poor. In contrast, children born to skilled parents remain skilled and rich.

The researcher argues that the reason low skilled households remain unskilled is not because they cannot afford education through loans but because doing so it too arduous rather than too expensive. This means that transfers to poor individuals without conditions will not help them leave their low-skill trap. Such transfers also reduce their incentives and undermines their motivation to educate themselves.

Instead, the researcher explains that welfare transfers that increase with effort and income can raise their skills. This can help them reach a threshold which activates formerly low skilled households once and for all.  The study also argues that a strong case can be made for such schemes if there exists a common interest in educating the poor.

'Human Capital, Polarization, and Pareto-improving Activating Welfare' by Peter Funk is published in the April 2019 issue of The Economic Journal.

Peter Funk

Center for Macroeconomic Research, University of Cologne | +49/221/4704496 | funk@wiso.uni-koeln.de