How the United States Can Pay for UBI
Prior to the outbreak of COVID-19 the idea of UBI (universal basic income) seemed like a libertarian fantasy. Although the concept has been studied in smaller pilot programs (most notably in Finland), the subsequent government mandated shutdowns and economic fallout has prompted many wealthy countries to take the unprecedented step of replacing income of private citizens through direct transfers. In short order the UBI concept went from an intangible dream to the de facto government policy for several countries. In the U.S. this has mostly come in the form of the one-time $1,200 checks and additional unemployment insurance. This spending (along with other stimulus programs) has blown a gaping hole in the US balance sheet with the federal government spending nearly $3 trillion more than it takes in tax revenue in 2020.
Why the debt isn’t as scary as people think
I’ve seen a lot of hand-wringing about this additional debt and how we are passing on this cost to our children and grandchildren and how we need to drastically cut spending in the future (which American governments haven’t done in a meaningful way since the end of WW2). This subject by itself (what debt is, and what debt load is sustainable) is worth thousands of words and is a hotly debated topic within economics. I can’t hope to end this debate but I will provide some points why I am not worried about the present deficit spending:
Cutting government spending when private spending (corporations and people) fall in a recession is a bad idea, and government deficit spending to patch the temporary shortfall helps the economy recover. To understand this better I would recommend watching this lecture.
The default risk of deficits is not the total amount (principal) but the interest rate on the debt, this is because of compound interest.
If the economic growth is higher than the interest rate of debt the debt will always shrink to zero in the long run because of compounding (all other factors held equal). Look at the chart below of US debt to GDP, notice that the WW2 debt to GDP high of 120% dropped to roughly 30% by 1980.
The interest rate will remain low for the next 20+ years because inflation will remain low (governments raise interest rates to reduce inflation). See this historical chart of inflation vs federal interest rate).
This last point is probably the most contentious, but here are the following reasons I believe this point to be true.
Technology is deeply deflationary. A dollar today will buy more in technology in a year (Moore’s law). Think about it this way, a Spotify subscription costs $120 a year, the equivalent music collection in 1990 cost thousands. This pattern is reproduced across a wide array of consumer and business goods.
We have a generational shift. The baby boomer generation is the largest American demographic and they are all quickly shifting into retirement. Retirees spend less than young people and they drive demand for low-risk investments (i.e. government bonds) both factors keep interest rates and inflation low.
Young people drive consumption spending. However, Millennials are less well off than previous generations and have larger amounts of debt. Debt payments swap future income for present spending. The combination of these two factors mean fewer dollars spent towards consumer goods. This trend is another inflationary headwind.
Compared to the 1970s, de-unionization and open capital markets (globalization and free trade) in 2020 mean that labor has very low negotiating power, which generates downward wage pressures. This is why labor (wage earnings) comprises the lowest share of GDP on record.
The U.S. dollar is the reserve currency of the world. Almost all commodities (oil, gas, etc.) are bought and sold in U.S. dollars as well as 40% of all debt. This means that governments and businesses need U.S. dollars, driving demand even as supply of dollars increases through U.S. deficit spending and quantitative easing.
The combination of these factors meant that in 2019, even with 3.5% unemployment and a $1 trillion dollar budget deficit, inflation barely met the 2% target of the Federal Reserve (at 2% interest rate). In this scenario, the net interest on any money the government borrows is effectively zero (inflation and interest cancel out) and real GDP growth means that long-term debt will be paid out.
Debt management is thus a relationship of three variables: interest rate, inflation, and GDP growth. The US will not face debt related issues as long as the growth rate of the economy + inflation is greater than the interest payments. Since 2008, the data shows that low interest and low inflation rates are more likely in the future. As the U.S. population ages, debt to GDP may continue to expand and inflation and interest rates will remain low (as is the case in Japan where debt to GDP is now 250%).
That being said, let’s imagine a more conservative scenario in which the low interest and low inflation rates are temporary. In this case, the interest rates would move closer to the 4% historical norm. How can we finance programs like social security, medicare, or UBI?
National Sovereign Wealth Funds
One possible solution is national sovereign wealth funds.
This is not a new idea. In fact, many oil rich nations such as the UAE, Saudi Arabia, and Norway have taken excess revenues from their oil operations and used them as long-term investment capital. This strategy has made them very rich.
Norway operates the largest sovereign wealth fund in the world, with an estimated size of $1.1 trillion USD. In 2019 alone, the fund grew by 20% by investing mostly in stocks. This amount is enough to pay each Norwegian citizen $207,000. Draw-downs in this fund can also be used to support the very generous Norwegian welfare state. When interest rates are so low, it makes the possibility of using deficit spending to fund these investments very practical.
This strategy is even more attractive when considering the asymmetric risk-versus-return during a recession. In March 2020 at the peak of the pandemic-fueled market crash investors fled to U.S. treasuries. At the same time the Federal Reserve cut the interest rate to 0% and restarted quantitative easing on a massive scale. This meant that at the same time as markets dropped by 30% the U.S. governments cost to borrow was cut to effectively negative (interest-inflation). Later, Congress passed bills such as the CARES act and the Paycheck Protection Loan program. This prompt government intervention led to a dramatic market upswing.
Instead of providing large, publicly listed corporations with loans (like the Paycheck Protection Loan program) , if the government purchased equity, then these corporations could use the funds from equity sales to cover shortfalls in revenue. Rather than profiting 1% on the loans, the net proceeds from these funds would be nearly 40% (based on the S&P 500 return from March to August). A $500 billion dollar equity purchase program created in March would be worth $700 billion. An additional 30% rise in the market would mean that this investment could pay for itself two fold. This one time investment would provide enough capital to make Social Security solvent for the next 75 years.
In fact, an extension of the Social Security program is probably the best way the U.S. can create a self-sufficient UBI program. Such a UBI program would represent an expansion of the current Social Security system, which only guarantees income to retirees and disabled citizens. This type of investment-based UBI program would effectively provide funding to all Americans. Presently, the social security trust holds $2.8 trillion in reserves (link). This is nearly three times as much as Norway holds in its sovereign wealth fund. Compared to the past when interest rates were much higher, these funds earn very little in interest. In 2019, these reserves generated only 77.9 billion in interest, a rate of return of 2.7%. If interest rates continue to deviate between 0.5 and 2% in the long-term, U.S. treasuries investment income will only continue to decline. By comparison, equities represent a much higher rate of return (SP500 historical average is 8%, and was 15% from 2009 to December 2019).
For a thought experiment, let’s say that the U.S. moved all of its $2.8 trillion in reserves to equities and added $100 billion a year in additional capital to its reserve fund. For the purposes of UBI, a $6,000 payment for all adult Americans paid for by a 3% draw down of the fund would be viable by 2050 (assuming no population growth). If no money was spent for 50 years, the fund would be worth $193 trillion, and a 3% withdrawal from this amount would pay for 100% of today’s government spending with an additional $1 trillion in surplus (almost enough for $6,000 UBI) with $0 collected in taxes. Incredibly, such a fund would eventually eliminate the need for the government to collect taxes!
The scale of such a program is unprecedented but seems to be a logical extension of what other countries and corporations have done. For example, Warren Buffet was able to grow his fortune by using GEICO’s insurance float (insurance premiums paid) to finance stock purchases and compound the companies net worth aggressively.
To conclude, I will briefly highlight some risks:
What about financial risks for retirees? Income from current social security taxes pays for 91.5% of all benefits. Income from the trust was only $78 billion in 2019. Covering the short fall through deficit spending is trivial compared to the $3 trillion dollar deficit we have seen in 2020. This means that Grandma would still get her social security even during market downturns, just like congress or the military.
Would companies accept the U.S. government investing in their stocks? If the U.S. government agreed to act as a passive investor, it is very likely that international companies would accept funding. As I mentioned, countries like Norway, Saudi Arabia and Japan own stocks in private companies.
What would happen if nearly $3 trillion was moved into equities and out of U.S. treasuries? Unfortunately, scale is likely the source of many serious policy implementation issues. The U.S. selling $2.8 trillion of its own bonds would have serious market implications. In real-life, the acquisition of equities would probably need to happen over the course of several years.
On the balance, a U.S. national sovereign wealth fund seems like a practical political solution that creates funding for expensive social welfare programs without increasing taxes or deficits long term. Instead of misguided concern about present deficits in an era of low interest rates and low inflation, policymakers should aggressively spend to invest in future wealth. Contrary to concerns about a nation of debtors, future generations may instead thank us from freeing them of the burden of taxes.