- Negative income tax
Part of a series on Government Public finance Taxation An aspect of fiscal policy
In economics, a negative income tax (abbreviated NIT) is a progressive income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. Such a system has been discussed by economists but never fully implemented. It was developed by British politician Juliet Rhys-Williams in the 1940s and later United States economist Milton Friedman combined NIT with his flat tax proposals.
In a negative income tax system, people earning a certain income level would owe no taxes; those earning more than that would pay a proportion of their income above that level; and those below that level would receive a payment of a proportion of their shortfall, which is the amount their income falls below that level.
A negative income tax is intended to create a single system that would not only pay for government, but would also fulfill the social goal of making sure that there was a minimum level of income for all. It is theorized that, with an NIT, the need for minimum wage, food stamps, welfare, social security programs and other government assistance programs could be eliminated, thus reducing the administrative effort and cost to a fraction of what it is under the current system, as well as eliminating the perverse incentives created by these overlapping aid programs, e.g. when a minimum wage worker who earns a little more nets out with less income because he is newly ineligible for aid. The worker is stuck in a welfare trap and has no incentive to seek higher wages.
A NIT does not disrupt low-wage markets, whereas a minimum wage makes certain very low end jobs impossible (as anyone whose labour is valued at less than the minimum wage must be unemployed). A NIT would therefore increase the availability of cheap labour, which would enable businesses to do domestically some of the work which they would otherwise have to outsource to other countries.
A NIT would reduce administrative overhead, since the large bureaucracies responsible for administering taxation and welfare systems, with the multitude of rules, thresholds and different applications required, could be eliminated. The resources saved by eliminating these bureaucracies could then be spent on more productive government activities, or returned to the people via tax cuts.
A NIT is also expected to have an immediate stabilizing effect as well as a positive influence on the cycle of economic "boom and bust" (during recession, the minimum income aids individuals' confidence whilst businesses are aided by option to lower wages).
The main drawback is one commonly found in almost any income-based tax system: it requires considerable reporting and supervision in order to avoid fraud. The incentive to commit fraud may be increased with an NIT, since the monetary reward for fraud could be larger than a taxpayer's total tax liability. The added expense of policing fraud could offset the benefit from reducing administration costs resulting in a net increase in costs.
Another criticism is that the NIT might reduce the incentive to work, since recipients of the NIT would receive a guaranteed minimum wage equal to the government payment in the absence of employment. A series of studies in the United States beginning in 1968 attempted to test for effects on work incentives. The studies showed minimal disincentives, but were difficult to analyze, as the monetary benefits were rarely as generous as those already received through the traditional welfare system. These results lead to an apparent dilemma of maintaining the benefits of existing programs through an NIT without creating significant disincentives and while restricting coverage to any manageable portion of the population.
Various different models of negative income tax have been proposed.
One model was proposed by Milton Friedman, as part of his flat tax proposals. In this version, a specified proportion of unused deductions or allowances would be refunded to the taxpayer. If, for a family of four the amount of allowances came out to $10,000, and the subsidy rate was 50% (the rate recommended by Friedman), and the family earned $6,000, the family would receive $2,000, because it left $4,000 of allowances unused, and therefore qualifies for $2,000, half that amount. Friedman feared that subsidy rates as high as those would lessen the incentive to obtain employment. He also warned that the negative income tax, as an addition to the "ragbag" of welfare and assistance programs, would only worsen the problem of bureaucracy and waste. Instead, he argued, the negative income tax should immediately replace all other welfare and assistance programs on the way to a completely laissez-faire society where all welfare is privately administered. The negative income tax has come up in one form or another in Congress, but Friedman opposed it because it came packaged with other undesirable elements antithetical to the efficacy of the negative income tax. Friedman preferred to have no income tax at all, but said he did not think it was politically feasible at that time to eliminate it, so he suggested this as a less harmful income tax scheme.
Initially Friedman lobbied hard for NIT, but ended up fighting against it when the NIT proposal was going to be added to the current system instead of replacing it.
Flat tax with negative income tax
The effort for reporting and supervision can be significantly reduced by combining basic income with flat income tax. The relationship between gross and net income for individuals can be adjusted to correspond roughly to current relationship at all income levels, implying that income tax is effectively progressive. A flat rate income taxation with tax exemption implements a negative income tax as well as maintaining an actual tax rate progression at extremely low administrative cost. This is achieved by paying a tax on the tax exemption to all taxpayers, e.g. in monthly payments. The tax on the tax exemption is computed by applying the nominal flat tax rate to the exemption. The tax on the income is drawn directly from the source, e.g. from an employer. The tax on income is computed by applying the nominal flat tax rate to the income.
This simple method results in an effective progressive rate taxation (although the tax rate for the taxes drawn at the source is flat) which is positive once the income exceeds the tax exemption. If, however, the income is less than the tax exemption, the effective progressive rate actually becomes negative without any involvement by any tax authority. As for the positive progression, only very high incomes would lead to an actual tax rate which is close to the nominal flat tax rate.
The tax on tax exemption also can be understood as a tax credit, which is paid back once an income has reached the level of the tax exemption. This level marks the point where paid taxes and the tax credit are equal. Above that point the state earns taxes from the taxpayer. Below that point the state pays taxes to the taxpayer.
Flat tax implementations without the provision of a negative income tax actually need an additional effort in order to avoid negative taxation. For such a tax, the exemption only can be paid after knowing the earned income. Flat tax implementations with negative income tax allow to pay the tax on the tax exemption independent of the amount of the actual income.
While the notion has long been popular in some circles, its implementation has never been politically feasible. This is partly because of the very complex and entrenched nature of most countries' current tax laws: they would have to be rewritten under any NIT system. However, some countries have seen the introduction of refundable (or non-wastable) tax credits which can be paid even when there is no tax liability to be offset, such as the Earned Income Tax Credit in the United States and working tax credit in the UK. Under President Richard Nixon, a NIT proposal almost made it through Congress.
From 1968 to 1979, the largest negative income tax social experiment in the US was undertaken. The four experiments were in:
- Urban areas in New Jersey and Pennsylvania, 1968–1972 (1375 families)
- Rural areas in Iowa and North Carolina, 1969–1973 (809 families)
- Gary, Indiana, 1971–1974 (1800 families)
- Seattle and Denver, 1971–1982 (4800 families)
In general they found that workers would decrease labor supply (employment) by two to four weeks per year because of the guarantee of income equal to the poverty level.
In Australia, a negative income tax is advocated by the Liberal Democratic Party as part of their tax policy.
- Basic income
- Citizen's dividend
- Earned Income Tax Credit
- Flat tax
- Poverty in the United States
- ^ Friedman, Milton (2002). Capitalism and Freedom: Fortieth Anniversary Edition. University of Chicago Press. pp. 192–194. ISBN 0226264211.
- ^ Jodie T. Allen, "Negative Income Tax." The Concise Encyclopedia of Economics. 1993. Library of Economics and Liberty. 6 October 2008.
- ^ Friedman, Milton & Rose (1980). Free to Choose: A Personal Statement. Harcourt Trade Publishers. ISBN 9780156334600.
- ^ Frank, Robert H (2006-11-23). "The Other Milton Friedman: A Conservative With a Social Welfare Program". New York Times (The New York Times). http://www.nytimes.com/2006/11/23/business/23scene.html?_r=2.
- ^ Richard Parncutt, "Capitalism without poverty."
- ^ "American President: Richard Milhous Nixon: Domestic Affairs". MillerCenter.org. Rector and Visitors of the University of Virginia. http://millercenter.org/academic/americanpresident/nixon/essays/biography/4. Retrieved 2010-04-28.
- ^ "IRP Negative Income Tax Archive". University of Wisconsin-Madison, Institute for Research on Poverty. July 10, 2007. http://www.irp.wisc.edu/research/nit/NIT_index.htm. Retrieved 2009-06-09.
- ^ Robins, Philip K. (Autumn 1985). "A Comparison of the Labor Supply Findings from the Four Negative Income Tax Experiments". The Journal of Human Resources (University of Wisconsin Press) 20 (4): 567–582. JSTOR 145685.
- ^ Zrahiya, Zvi (January 10, 2007). "Knesset approves negative income tax in preliminary reading". Haaretz.com. http://www.haaretz.com/news/knesset-approves-negative-income-tax-in-preliminary-reading-1.209618.
- ^ "LDP tax policy"
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