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On the Time Consistency of Universal Basic Income

Jang, Youngsoo (2023): On the Time Consistency of Universal Basic Income.

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I examine the effects of government commitment on the optimal provision of Universal Basic Income (UBI) in an incomplete-markets model by characterizing a dynamic game between individuals and a benevolent government according to its commitment technologies. I find that, throughout the transition, commitment determines how the government balances \textit{income redistribution} through taxes and UBI with \textit{pecuniary externalities} from changes in the factor income composition. In a calibrated economy, commitment leads to significant welfare improvements by counterbalancing these forces over the entire time horizon. Commitment enables a substantial long-run UBI provision by increasing taxes, which generates long-run welfare losses from stagnant income redistribution and unfavorable factor price changes for low-income individuals. However, this long-run UBI provision induces front-loaded welfare gains from factor price changes favoring low-income individuals and income redistribution facilitated by reduced precautionary savings. Without commitment, this time-lagged strategy is not credible because the government balances the two economic forces every period in a forward-looking manner, disregarding the long-run UBI impacts on the short-run economy. This time-consistent strategy results in smaller welfare improvements.

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