Negative income tax

In economics, a negative income tax (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[1] and later by United States free-market economist Milton Friedman.[2][3][4]

Negative income taxes can implement a basic income or supplement a guaranteed minimum income system.

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.[5]

General welfare

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.

Specific models

Various different models of negative income tax have been proposed.

One model was proposed by Milton Friedman.[2][4] 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 any higher 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 eventually 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.[3][6]

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.[7] 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.

Example:

Under this scheme:

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.

Implementation

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.[8]

From 1968 to 1979, the largest negative income tax social experiments in the US were undertaken. The first experiment was the New Jersey Income Maintenance Experiment, proposed by MIT Economics graduate student Heather Ross in 1967 in a proposal to the U.S. Office of Economic Opportunity.[9] The four experiments were in:[10]

  1. The New Jersey Income Maintenance Experiment: Trenton, Passaic, Paterson, and Jersey City, New Jersey with Scranton, Pennsylvania added to increase the number of white families, 1968–1972 (1357 families)[11]
  2. The Rural Income Maintenance Experiment: Rural areas in Iowa and North Carolina, 1969–1973 (809 families)
  3. Gary, Indiana, 1971–1974 (1800 families)
  4. Seattle (SIME) and Denver (DIME), 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 threshold.[12]

A negative income tax has been implemented for a certain bracket of low incomes in Israel.[13]

Advocates

In Australia, a negative income tax is advocated by the Pirate Party as part of their tax policy.[14]

In Slovakia, welfare and tax system reform based on NIT is proposed by classical liberal Freedom and Solidarity party.[15]

In the United States, a negative income tax was advocated by the Green Party as part of their 2010 platform.[16]

In his final book Where Do We Go from Here: Chaos or Community? (1967), American civil rights leader and Nobel Peace Prize winner Martin Luther King Jr. wrote[17][18]

I am now convinced that the simplest approach will prove to be the most effective — the solution to poverty is to abolish it directly by a now widely discussed measure: the guaranteed income.
— from the chapter titled "Where We Are Going"

Criticism

A common 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. Jodie Allen summarizes the key studies:

The Stanford Research Institute (SRI), which analyzed the SIME/DIME findings, found stronger work disincentive effects, ranging from an average 9 percent work reduction for husbands to an average 18 percent reduction for wives. This was not as scary as some NIT opponents had predicted. But it was large enough to suggest that as much as 50 to 60 percent of the transfers paid to two-parent families under a NIT might go to replace lost earnings. They also found an unexpected result: instead of promoting family stability (the presumed result of extending benefits to two-parent working families on an equal basis), the NITs seemed to increase family breakup.[19]

See also

References

  1. ↑ Evelyn L Forget "Advocating negative income taxes: Juliet Rhys-Williams and Milton Friedman."
  2. 1 2 Friedman, Milton (2002). Capitalism and Freedom: Fortieth Anniversary Edition. University of Chicago Press. pp. 192–194. ISBN 0-226-26421-1.
  3. 1 2 Friedman, Milton & Rose (1980). Free to Choose: A Personal Statement. Harcourt Trade Publishers. pp. 120–126. ISBN 978-0-15-633460-0.
  4. 1 2 Friedman, Milton (1987). Leube, Kurt, ed. "The Case for the Negative Income Tax". The Essence of Friedman (Hoover Institution Press): 57–68.
  5. ↑ Shindler, Michael. "Replace Welfare With a Negative Income Tax". Economics 21. The Manhattan Institute for Policy Research. Retrieved 10 October 2015.
  6. ↑ Frank, Robert H (2006-11-23). "The Other Milton Friedman: A Conservative With a Social Welfare Program". New York Times (The New York Times).
  7. ↑ Archived May 14, 2011, at the Wayback Machine.
  8. ↑ "American President: Richard Milhous Nixon: Domestic Affairs". MillerCenter.org. Rector and Visitors of the University of Virginia. Retrieved 2010-04-28.
  9. ↑ "An Overview of Social Experimentation and the Digest". Urban.org. Retrieved 2013-02-13.
  10. ↑ "IRP Negative Income Tax Archive". University of Wisconsin–Madison, Institute for Research on Poverty. July 10, 2007. Retrieved 2009-06-09.
  11. ↑ Social Experimentation and Public Policymaking By David H. Greenberg, Donna Linksz, Marvin Mandell. line feed character in |title= at position 47 (help)
  12. ↑ 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.
  13. ↑ Zrahiya, Zvi (January 10, 2007). "Knesset approves negative income tax in preliminary reading". Haaretz.com.
  14. ↑ Archived July 8, 2014, at the Wayback Machine.
  15. ↑
  16. ↑ "The Green Party of the United States". Gp.org. Retrieved 2015-08-18.
  17. ↑ Martin Luther King jr., Where Do We Go from Here: Chaos or Community? (New York: Harper & Row, 1967)
  18. ↑ Shindler, Michael. "Replace Welfare with a Negative Income Tax". Economics 21. The Manhattan Institute. Retrieved 10 October 2015.
  19. ↑ Allen, Jodie T. (2002). "Negative Income Tax". In David R. Henderson (ed.). Concise Encyclopedia of Economics (1st ed.). Library of Economics and Liberty. OCLC 317650570, 50016270 and 163149563

External links

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