Negative income tax
Encyclopedia
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.
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.
, 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 incentive
s 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).
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.
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.
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.
s 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:
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.
A negative income tax has been implemented for a certain bracket of low incomes in Israel
.
as part of their tax policy.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, 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
British people
The British are citizens of the United Kingdom, of the Isle of Man, any of the Channel Islands, or of any of the British overseas territories, and their descendants...
politician Juliet Rhys-Williams
Juliet Rhys-Williams
Juliet Evangeline, Lady Rhys-Williams, DBE, DStJ née Glyn , was a British writer, and a Liberal Party politician who later joined the Conservative Party....
in the 1940s and later United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
economist Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
combined NIT with his flat tax
Flat tax
A flat tax is a tax system with a constant marginal tax rate. Typically the term flat tax is applied in the context of an individual or corporate income that will be taxed at one marginal rate...
proposals.
Negative income taxes can implement a basic income
Basic income
A basic income guarantee is a proposed system of social security, that regularly provides each citizen with a sum of money. In contrast to income redistribution between nations themselves, the phrase basic income defines payments to individuals rather than households, groups, or nations, in order...
or supplement a guaranteed minimum income
Guaranteed minimum income
Guaranteed minimum income is a system of social welfare provision that guarantees that all citizens or families have an income sufficient to live on, provided they meet certain conditions. Eligibility is typically determined by citizenship, a means test and either availability for the labour...
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.
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 wageMinimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...
, 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 incentive
Perverse incentive
A perverse incentive is an incentive that has an unintended and undesirable result which is contrary to the interests of the incentive makers. Perverse incentives are a type of unintended consequences.- Examples :...
s 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
Welfare trap
The welfare trap theory asserts that taxation and welfare systems can jointly contribute to keep people on social insurance because the withdrawal of means tested benefits that comes with entering low-paid work causes there to be no significant increase in total income...
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
Boom and bust
A credit boom-bust cycle is an episode characterized by a sustained increase in several economics indicators followed by a sharp and rapid contraction. Commonly the boom is driven by a rapid expansion of credit to the private sector accompanied with rising prices of commodities and stock market index...
" (during recession, the minimum income aids individuals' confidence whilst businesses are aided by option to lower wages).
Criticism
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.
Specific models
Various different models of negative income tax have been proposed.One model was proposed by Milton Friedman
Milton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
, as part of his flat tax
Flat tax
A flat tax is a tax system with a constant marginal tax rate. Typically the term flat tax is applied in the context of an individual or corporate income that will be taxed at one marginal rate...
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
Welfare state
A welfare state is a "concept of government in which the state plays a key role in the protection and promotion of the economic and social well-being of its citizens. It is based on the principles of equality of opportunity, equitable distribution of wealth, and public responsibility for those...
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
Laissez-faire
In economics, laissez-faire describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies....
society where all welfare is privately administered. The negative income tax has come up in one form or another in Congress
United States Congress
The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....
, 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 taxationFlat tax
A flat tax is a tax system with a constant marginal tax rate. Typically the term flat tax is applied in the context of an individual or corporate income that will be taxed at one marginal rate...
with tax exemption
Tax exemption
Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Tax exemption may also refer to a personal allowance or specific monetary exemption which may be claimed by an individual to reduce taxable income under some...
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
Tax credit
A tax credit is a sum deducted from the total amount a taxpayer owes to the state. A tax credit may be granted for various types of taxes, such as an income tax, property tax, or VAT. It may be granted in recognition of taxes already paid, as a subsidy, or to encourage investment or other behaviors...
, 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.
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 creditTax credit
A tax credit is a sum deducted from the total amount a taxpayer owes to the state. A tax credit may be granted for various types of taxes, such as an income tax, property tax, or VAT. It may be granted in recognition of taxes already paid, as a subsidy, or to encourage investment or other behaviors...
s which can be paid even when there is no tax liability to be offset, such as the Earned Income Tax Credit
Earned income tax credit
The United States federal earned income tax credit or earned income credit is a refundable tax credit primarily for individuals and families who have low to moderate earned income. Greater tax credit is given to those who also have qualifying children...
in the United States and working tax credit
Working tax credit
The Working Tax Credit is a state benefit in the United Kingdom made to people who work on a low income. It is a part of the current system of refundable tax credits introduced in April 2003 and is a means-tested social security benefit...
in the UK. Under President Richard Nixon
Richard Nixon
Richard Milhous Nixon was the 37th President of the United States, serving from 1969 to 1974. The only president to resign the office, Nixon had previously served as a US representative and senator from California and as the 36th Vice President of the United States from 1953 to 1961 under...
, 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.
A negative income tax has been implemented for a certain bracket of low incomes in Israel
Israel
The State of Israel is a parliamentary republic located in the Middle East, along the eastern shore of the Mediterranean Sea...
.
Advocates
In Australia, a negative income tax is advocated by the Liberal Democratic PartyLiberal Democratic Party (Australia)
The Liberal Democratic Party is a classical liberal Australian political party founded in 2001.-Party name:In 2007 the party tried to register federally under the name "Liberal Democratic Party" but this was opposed the by the Liberal Party, so the party chose to register as the "Liberty and...
as part of their tax policy.
See also
- Basic incomeBasic incomeA basic income guarantee is a proposed system of social security, that regularly provides each citizen with a sum of money. In contrast to income redistribution between nations themselves, the phrase basic income defines payments to individuals rather than households, groups, or nations, in order...
- Citizen's dividendCitizen's dividendCitizen's dividend or citizen's income is a proposed state policy based upon the principle that the natural world is the common property of all persons . It is proposed that all citizens receive regular payments from revenue raised by the state through leasing or selling natural resources for...
- Earned Income Tax CreditEarned income tax creditThe United States federal earned income tax credit or earned income credit is a refundable tax credit primarily for individuals and families who have low to moderate earned income. Greater tax credit is given to those who also have qualifying children...
- FairTaxFairTaxThe FairTax is a tax reform proposal for the federal government of the United States that would replace all federal taxes on personal and corporate income with a single broad national consumption tax on retail sales. The Fair Tax Act would apply a tax once at the point of purchase on all new goods...
- Flat taxFlat taxA flat tax is a tax system with a constant marginal tax rate. Typically the term flat tax is applied in the context of an individual or corporate income that will be taxed at one marginal rate...
- Poverty in the United StatesPoverty in the United StatesPoverty is defined as the state of one who lacks a usual or socially acceptable amount of money or material possessions. According to the U.S. Census Bureau data released Tuesday September 13th, 2011, the nation's poverty rate rose to 15.1% in 2010, up from 14.3% in 2009 and to its highest level...
External links
- Criticism of the NIT
- Support for the NIT specifically for Australia