Negative income tax

In economics, a negative income tax (NIT) is a system within an income tax where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government.

Taxation
An aspect of fiscal policy

Such a system has been discussed by economists but never fully implemented. According to surveys however, the consensus view among economists is that the "government should restructure the welfare system along the lines" of one.[1][2] It was described by British politician Juliet Rhys-Williams in the 1940s[3] and later by American free-market economist Milton Friedman.[4][5][6]

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.[7]

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 a 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. It would also eliminate 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 they are newly ineligible for aid. Theoretically, the worker would then be stuck in a welfare trap and would have no incentive to seek higher wages.

A NIT does not disrupt low-wage markets, whereas a minimum wage law makes certain that people whose skills are not sufficient to justify that kind of wage will go unemployed. A NIT would therefore increase the availability of cheap labor, which would enable businesses to do domestically some of the work which they would otherwise have to outsource to other countries.

A NIT could 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 greatly reduced or eliminated. The savings from this could then be returned to the people through spending on different government activities, via tax cuts, or any array of different ways.

Specific models

Various different models of negative income tax have been proposed.

One model was proposed by Milton Friedman.[4][6] 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%, and the family earned $6,000, that leaves $4,000 of allowances unused, and therefore the family would be qualified to receive $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.[5][8]

Others, such as American politician and economist John Moser, have suggested negative income tax acts as an anti-poverty tool and would reduce welfare claims, thus should pair with strong welfare systems as the total expense of welfare would be reduced by an effective negative income tax. With fewer claims, a single administration can operate a comprehensive welfare system, reducing the bureaucratic overhead and providing full service instead of separately-administered programs.

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.[9] 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:

  • The income tax rate is 50%.
  • The tax exemption is $30,000.
  • The subsidy rate is 50% and equal to the income tax rate.

Under this scheme:

  • A person earning $0 would receive $15,000 from the government.
  • A person earning $25,000 would receive $2,500 from the government.
  • A person earning $30,000 would neither receive any money nor pay any tax.
  • A person earning $50,000 would pay a tax of $10,000.
  • A person earning $100,000 would pay a tax of $35,000.

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 the payment or crediting of the income tax at any interval, independent of the amount of the actual income.

Universal Citizens Dividend

John Moser has proposed a Universal Citizens Dividend, essentially a negative income tax bolted onto an existing tax system as a revenue-neutral social insurance by taking a percentage of productive income—gross personal income and net corporate profits—as the social insurance premium and dividing that into uniform, frequent payments made among a class of the whole. For example, the proposed American Citizens Dividend[10] restructures the United States Social Security retirement and disability insurance benefits on top of a twice-monthly payment, adjusted once per year based on the balance of a Trust specifically for the Dividend, paid to all adults. If the flat-rate Dividend FICA is subtracted from the flat Dividend benefit, the net benefit payment is linearly related to the recipient's gross income, with a defined zero point related to nominal per capita income.

This type of NIT is rigid in that the tax exemption is based in the actual revenues, the premium rate is meant to never be adjusted, and the subsidy rate is the sum of all income taxes including the premium rate. These parameters cannot be adjusted. As consequence, the implementation is trivial, requiring only the actuarial administration of the Trust and the details of benefit distribution. Leonard Burman has suggested a Universal Earned Income Tax Credit[11] wherein employees may receive a tax credit advance from their employers; a Universal Citizens Dividend could instate a similar policy of distributing benefits through employer payroll in lieu of tax withholding, and through normal benefits avenues such as unemployment distributions otherwise.

This method acts as a targeted economic stimulus, as the percentage of an individual's or household's income represented by the net benefit increases exponentially as income decreases. Areas of low per-capita income concentrate this effect, and the targeting effectively adjusts at every tax withholding and every benefit payment, roughly every fifteen days when paying twice-monthly. Like all negative income tax policies, such a policy acts as an anti-recession tool and acts against local recessions based on the Capitol Hill Babysitting Co-op model of a liquidity trap, although a Universal Citizens Dividend specifically pays frequently to simulate wage income rather than as an annual tax return.

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 most conventional NIT systems, and the exemption and tax rates must adjust every year based on revenue needs, income distribution, and other economic factors. 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.

In 1971, President Richard Nixon proposed a negative income tax as the centerpiece of his welfare reform program, but the NIT was not approved by Congress; however, Congress did pass a bill establishing Supplemental Security Income (SSI), providing a guaranteed income for elderly and disabled persons.[12]

A policy called negative income tax has been implemented for a certain bracket of low incomes in Israel,[13] but it deviates considerably from the more comprehensive model usually favored by advocates.

Experiments

From 1968 to 1982, the US and Canadian governments conducted a total of five negative income tax experiments. They were the first major social science experiments in the world. 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.[14] The five experiments were in:[15]

  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)[16]
  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)
  5. Manitoba, Canada ("Mincome"), 1974-1979

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.[17]

Advocates

In the United States, Milton and Rose Friedman promoted the idea in 1980 in their book and television series Free to Choose. More recently, a negative income tax was advocated by the Green Party as part of their 2010 platform.[18] American Democratic Politician John Moser ran on a Universal Citizens Dividend as the core focus of his 2018 Congressional campaign. Andrew Yang, a 2020 Democratic Presidential candidate in the United States, ran on a version of the Universal Citizens Dividend that he called, "the Freedom Dividend".

In Australia, a negative income tax is advocated by the Pirate Party as part of their tax policy.[19]

In Slovakia, welfare and tax system reform based on NIT is proposed by classical liberal Freedom and Solidarity party.[20]

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[21][22]

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 when voluntarily unemployed. 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.[23]

The link between NIT and divorce was later determined to be due to a statistical error.[24]

Another criticism comes from the relative expense of the establishment of such a tax. According to a research project conducted by Rutgers University in 2002, a program of targeted job creation would produce similar wealth redistribution with significantly less cost.[25] Some implementations are revenue-neutral and move nearly all of their revenues back to the same taxpayer's hands, with only a small fraction actually transferred between taxpayers.

See also

References
  1. Mankiw, N. Gregory (2014), Principles of Microeconomics (7th ed.), Cengage Learning, p. 32, ISBN 978-1285165905
  2. Alston, Richard M.; Kearl, J.R.; Vaughan, Michael B. (May 1992). "Is There a Consensus Among Economists in the 1990s?" (PDF). The American Economic Review. American Economic Association. 82 (2): 203–09. Retrieved 17 October 2015.
  3. Evelyn L Forget "Advocating negative income taxes: Juliet Rhys-Williams and Milton Friedman."
  4. Friedman, Milton (2002). Capitalism and Freedom: Fortieth Anniversary Edition. University of Chicago Press. pp. 192–194. ISBN 0-226-26421-1.
  5. Friedman, Milton & Rose (1980). Free to Choose: A Personal Statement. Harcourt Trade Publishers. pp. 120–126. ISBN 978-0-15-633460-0.
  6. Friedman, Milton (1987). Leube, Kurt (ed.). "The Case for the Negative Income Tax (a view from the right)". The Essence of Friedman. Hoover Institution Press: 57–68.
  7. Shindler, Michael (7 October 2015). "Replace Welfare With a Negative Income Tax". Economics 21. The Manhattan Institute for Policy Research. Retrieved 10 October 2015.
  8. Frank, Robert H (2006-11-23). "The Other Milton Friedman: A Conservative With a Social Welfare Program". New York Times. The New York Times.
  9. Archived May 14, 2011, at the Wayback Machine
  10. Moser, John. "The American Citizens Dividend". NordicModelUSA.org. Retrieved 2019-08-29.
  11. Burman, Leonard (20 May 2019). "A Universal EITC: Sharing the Gains from Economic Growth, Encouraging Work, and Supporting Families". taxpolicycenter.org. Retrieved 2019-08-29.
  12. "American President: Richard Milhous Nixon: Domestic Affairs". MillerCenter.org. Rector and Visitors of the University of Virginia. Archived from the original on 2010-04-07. Retrieved 2010-04-28.
  13. Zrahiya, Zvi (January 10, 2007). "Knesset approves negative income tax in preliminary reading". Haaretz.com.
  14. "An Overview of Social Experimentation and the Digest". Urban.org. Archived from the original on 2011-11-30. Retrieved 2013-02-13.
  15. "IRP Negative Income Tax Archive". University of Wisconsin–Madison, Institute for Research on Poverty. July 10, 2007. Archived from the original on 2009-12-06. Retrieved 2009-06-09.
  16. Social Experimentation and Public Policymaking By David H. Greenberg, Donna Linksz, Marvin Mandell.
  17. 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. doi:10.2307/145685. JSTOR 145685.
  18. "The Green Party of the United States". Gp.org. Archived from the original on 2013-12-24. Retrieved 2015-08-18.
  19. Archived July 8, 2014, at the Wayback Machine
  21. Martin Luther King jr., Where Do We Go from Here: Chaos or Community? (New York: Harper & Row, 1967)
  22. Shindler, Michael (7 October 2015). "Replace Welfare with a Negative Income Tax". Economics 21. The Manhattan Institute. Retrieved 10 October 2015.
  23. 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, 163149563
  24. Flowers, Andrew (April 26, 2016). "What Would Happen If We Just Gave People Money?". fivethirtyeight.com. Retrieved May 27, 2016.
  25. Harvey, Philip. "The Relative Cost of a Universal Basic Income and a Negative Income Tax". An International Journal of Basic Income Research. 2.
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