Safely Through the Storm: An Economic Analysis of the Technological Revolution and the Negative Income Tax Solution
SAFELY THROUGH THE STORM: AN ECONOMIC ANALYSIS OF THE TECHNOLOGICAL REVOLUTION AND THE NEGATIVE INCOME TAX SOLUTION
AUTHOR: Dichuan (David) Gao
David is a freshman studying at Brown University. Hi research interests are mainly in Applied Mathematics, and its intersection with social studies. His current projects include Natural Language Processing for automated prevention of cyber-bullying.
The information age in Canada is in its youth. What awaits us is a revolution comparable to the Industrial Revolution of the 19th century, but far more powerful. As the processing capability of computers continues to grow at an exponential rate, service sector employment – jobs that used to be distinctly human-oriented – will gradually become automated. Let us begin with the idea that somewhere along this revolution every occupation existing in Canada today will become automated. As an extension to Kurzweil’s idea in The Singularity is Near, this point in time will be referred to as “the Singularity” (21). Then there must also be a point in time before the Singularity, at which the technological revolution will be progressing so quickly that the arrival of the Singularity in some finite time can be predicted with certainty. This point of no-return will be called “the Horizon”. Only the years between the Horizon and the Singularity will be considered, because Canada’s economic structure after the Singularity will be completely unimaginable. During this transition period, the replacement of human labour will take place rapidly, but not instantaneously. The resulting economy will be unstable for three reasons: the increase in income inequality, the loss of aggregate demand, and the general inability of the public to support themselves. To increase the chance of a safe transition1 period, the Canadian government must introduce a negative income tax program tailored to the situation.
1. The Worst-Case Scenario
Computers, as the Center for Public Education of the National School Boards Association observes, have become particularly good at tasks that require “information processing”, “following a prescribed set of rules”, and “recognizing simple patterns” (1). On one hand, Derek Thompson, senior editor of economics and labour market at The Atlantic, says that “if the capabilities of computers continue to multiply while the price of computing continues to decline… it will mean great wealth – at least when aggregated up to the level of the national economy” (52). On the other hand, Thompson also recognizes that “machines might be able to perform half of all U.S. jobs in the next two decades” (54). In fact, warnings that “‘the cybernation revolution’ would create ‘a separate nation of the poor, the unskilled, the jobless,’ who would be unable either to find work or to afford life’s necessities” appeared as early as 1964, when both computing powers and the idea of the internet were just beginning to grow (Thompson 53; Baran 1; Computer History Museum). As a forefront for technological developments (Hull & Richardson), Canada is certainly not spared from this coming wave of unemployment.
For economic analysis, the model of aggregate demand and aggregate supply described by Nobel Economics Prize winner Paul Krugman in his book Essentials of Economics will be used. Figure 1 shows the “worst case scenario” after the Horizon. The potential of the Canadian economy (and hence also the long-run aggregate supply ) will be increased due to the enhanced efficiency of automation. Unfortunately, this increase is based on replacing inefficient human service with more efficient machines and algorithms. Any rational, self-interested corporation at the early transition period will choose to cut its employees. Now, according to Keynes’s model in his book General Theory, a decrease in employment will result in a decrease in average wages, which will then cause a decrease in consumption, which will in turn cause a decrease in aggregate demand (63). Therefore, although aggregate demand will rise momentarily after the increase in LRAS, it will then drop dramatically: . This effect will be particularly strong in Canada, since 77.8% of Canadian employees work in the services sector (Statistics Canada “Employment by Industry”). While the nation’s short-run aggregate supply (SRAS) will slowly follow the increase in long-run aggregate supply, this shift is far less immediate. This large decrease in AD combined with a small increase in SRAS moves the short-run macroeconomic equilibrium from to . Even though potential productivity will continue to grow, unemployment will cause such great disparity that most of the population will not be able to afford the products. The resulting price drop will then force corporations to make even more job-cuts.
This vicious cycle will continue until, as Keynes puts it so aptly in his Tract, “we are all dead” (80). If left to develop, this phenomenon will create a paradoxical situation where great wealth at the national level cannot be consumed by the people (Thompson 52). Some form of government intervention will be necessary, and Canada must “embrace a radical new role for government” to have any chance of a safe transition (55).
The challenge is to maintain a high level of AD. Figure 2 demonstrates the ideal “solution scenario”, where the decrease in AD is minimized. Given enough time, short-run aggregate supply will catch up with the long-run aggregate supply, and the equilibrium will settle at a decreased price with an increased real GDP. If the government can achieve this through intervention, the population will continue to be able to afford goods and services, and the transition between the Horizon and the Singularity will be perfectly safe.
]2. Negative Income Tax as a Solution
The most obvious option is to directly address the income inequality resulting from technological unemployment, since its resolution would nullify the negative AD shock. Even though Canada has the option to adopt the job-sharing policies of Germany, which “gives firms incentives to cut all their workers’ hours rather than lay off some of them” (Thompson 60), the corporations that become automated will still decrease their employees’ wages.
The resulting economic disparity will differ from any wage inequality existing today. In his book The Wealth of Nations, Adam Smith affirms that, excluding political influences, differences in pecuniary wages are counterbalanced by circumstantial factors such as “easiness and cheapness, or the difficulty and expence [sic] of learning [the skills]” (101-2). Though Milton Friedman recognizes this line of reasoning in his book Capitalism and Freedom, he points out that some income differences are not “equalizing difference[s]”, but rather “reflects initial differences in endowment”, and that “this is the part that raises the really difficult ethical issue” (134-5). Unfortunately, the disparity caused by automation will not be an equalizing difference. The owner of a completely automated bakery will earn much more than the ex-employees whom he will have fired, even though his job will not be any more difficult than watching the machines work. This gives the government an ethical warrant to utilize “the visible hand of economic intervention” (Thompson 59).
In this situation, negative income tax (NIT), as Friedman puts it, is “the arrangement that recommends itself on purely mechanical grounds” (158). NIT is the idea that the tax-liability function can be negative for some low-income levels. For example, a flat-tax of 33% with a tax exemption of 11,635 dollars (Canada’s current federal exemption) under normal circumstances means:
This is negative for those earning less than 11,635 dollars. Anyone earning less than the tax exemption will receive a “refund” for however much less than the exemption he/she is earning, and the net-earning for every person is guaranteed to be above dollars. To keep a realistic budget, the government would then raise the tax on the higher brackets. This redistributes income and aims at closing “a portion of the income-poverty gap” (Green & Lampman 121).
This arrangement has two main advantages: first, it is “directed specifically at the problem of poverty” (Friedman 158); second, it takes the form of one explicit function rather than a host of special welfare agencies (158). This makes it easier to adjust in real-time to the newest developments in the Canadian economy. Past experiments also show that the NIT is statistically associated with several additional advantages, including a higher 12th grade graduation rate and a lower hospitalization rate (Forget 291-294). Furthermore, the NIT is not a new idea to Canada. As Evelyn L. Forget, Professor of Economics at the University of Manitoba says, “Canada has had a long flirtation with the idea of a GAI [Guaranteed Annual Income] … based on the idea of a negative income tax” (284). In a Royal Commission Report in 1985, the Canadian Minister of Supply and Services concluded that such a program would “[constitute] the most appropriate foundation for Canada’s income-security programs”, demonstrating that Canada has had a long interest in NIT (48).
There are, however, several limitations to this solution. The first and most obvious limitation is that, as former US Secretary of Commerce Juanita M. Kreps points out, any arrangement of this program “would be very costly, even if restricted to those below the poverty line” (107). Advocates for the program, however, argue that this cost could be decreased because “offering all income support… through a single bureaucracy would be more efficient” (Forget 285). Indeed, the aforementioned Royal Commission gave a list of seven current programs that could be replaced by a NIT program (48). As Friedman predicts, “the total administrative burden would surely be reduced” (158). Furthermore, the cost is less for Canada than for the United States, since Canada has a much lower index of income inequality to begin with (World Bank). We can calculate the exact tax revenue (U) of the Canadian government to be the total accumulation of the tax-liability (the function T(Y)) multiplied by the number of people paying this tax (the Population-Income Distribution P(Y)) over all possible income values (Y):
This solution, like any other potential solution to the safe-transition problem, will have a cost, which is made explicit by the formula above. Since a safe transition will benefit the nation in the long run, the government can determine a cost that ought to be spent on this solution. Furthermore, as shown in Figure 3, by using Chi-Squared distributions to approximate the population-income distribution P(Y), we can express economic disparity using only one parameter (see Notes 3). The government can use this parameter to produce an explicit function – presumably it would raise tax on the wealthier population as disparity increases. Note that the more disparity there is to start with, the more the government would need to tax the higher brackets, and the less practical this program becomes. Hence it is also crucial that the program is implemented as soon as possible in anticipation of the Horizon.
The second problem that needs to be addressed is one about incentive. NIT will decrease the monetary incentive to work for those that could still be employed, since “utility maximizing individuals will choose to work less” (Green 280). However, as Friedman explains, “like any other measures to alleviate poverty, [NIT] reduces the incentives of those helped to help themselves, but it does not eliminate that incentive entirely… An extra dollar earned always means more money available for expenditure” (158). Algebraically, monetary incentive will remain positive as long as the net income increases whenever gross income (YG) increases:
According to Karl Widerquist, an Associate Professor of political philosophy and distributive justice at SFS-Qatar, US experiments with NIT have found that work incentive effects are minimal, even though “many newspapers reported the results as if the very existence of [such] effects was a crushing blow to the idea” (96). In fact, if NIT replaces other welfare agencies as the Royal Commission suggested, it would “eliminate the ‘welfare trap’ that discouraged individuals from leaving welfare rolls” (Forget 284). Furthermore, a slight decrease in work incentive will not have a significant effect on the economy during the transition period, because the supply of “human labor” will cease to be “a driver of economic growth” (Thompson 53). All circumstances considered, though the NIT solution will bring a slight decrease in work incentive, it remains the optimal solution for the safe transition problem.
Canada is facing “an era of technological unemployment, in which computer scientists and software engineers essentially invent us out of work, and the total number of jobs declines steadily and permanently” (Thompson 52). During the transition period between the Horizon and the Singularity, the nation will face significant economic challenges. The disparity caused by unemployment will inevitably lead to a decrease in aggregate demand, and most citizens will be unable to afford necessities even though automation should create abundance. To minimize this decrease in AD, the federal government needs to adopt a negative income tax. In general, the steeper the tax-liability function is, the stronger this redistribution method becomes. However, this is bound by two factors: 1) the federal tax revenue, which will need to be kept at a realistic level, is given by
and 2) the monetary work incentive, which will need to be kept positive, is given by
If the government acts quickly enough, a NIT program adjusted to these conditions would be the optimal solution for controlling the economic disparity during the transition period (see Figure 4 and Notes 4). This will ensure a safe transition to the Singularity, an era entirely alien to us today, where we know the nation of Canada will be alive and well.
To model a Population-Income Distribution. The value k gives the degree of freedom. The smaller k is, the greater the disparity.
4. The sample solution tax-liability function in Figure 4 is
This function was designed to closely resemble the current income tax program of Canada, except for the negative part. It also satisfies the conditions, given the current income-population distribution according to Statistics Canada (Statistics Canada “Individuals”).
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