Negative income tax

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In economics, a negative income tax (abbreviated NIT) is a method of tax reform that is discussed among economists but has never been fully implemented. It was developed by Juliet Rhys-Williams in the 1940s and later by United States economist Milton Friedman in 1962. Negative income taxes can implement or supplement a guaranteed minimum income system.

A negative income tax would replace the current progressive income tax system used throughout most of the Western world. This would be replaced by a flat tax of, say, 25%, but each taxpayer would also be given $10,000 by the government. Thus a person earning only $4000 per year would pay $1000 in taxes, but overall would receive a net gain of $9,000 from the government. A person making $40,000 would be at the break-even point and would neither pay taxes nor receive any benefits. A person making $1,000,000 per year would pay close to the full 25% tax, as the $10,000 would count little towards relieving the tax burden.

1 Specific models
2 Guaranteed minimum income
3 Implementation
4 External links

[edit] Specific models

Milton Friedman proposed a model in which 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 high subsidy rates 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, the negative income tax must gradually replace all other welfare and assistance programs. 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. Source: Free to Choose.

[edit] Proponents

The proponents of negative income tax believe that its implementation would solve several problems with current systems. For example, they believe it would eliminate the welfare trap and the minimum wage. Furthermore, they believe it would reduce administrative overhead, since the large bureaucracies responsible for the current hodge-podge of support services could be eliminated. Since the administrative overhead would be reduced, proponents claim, the payout to recipients could be increased, without increasing taxes. Also a positive influence on the economic "boom and bust" scenario might be expected.

[edit] Critics

Its main drawback is the same as in almost any income-based tax system: it requires considerable reporting and supervision in order to avoid fraud. In fact, 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. Critics claim that the added expense of policing fraud would more than offset the reduction in administration resulting from the cancellation of current welfare services.

Another criticism is that the NIT might reduce the incentive to work, since recipients of the NIT would receive a guaranteed minimum wage in the absence of employment. Nevertheless, there is no evidence that this might be true in a significant way.

[edit] Flat Tax with Negative Income Tax

The effort for reporting and supervision can be very significantly reduced. A flat rate income taxation with tax exemption implements a negative income tax as well as it maintains 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 exeeds 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 exception independent of the amount of the actual income.

[edit] Guaranteed minimum income

A negative income tax can be, but is not necessarily, a guaranteed minimum income (GMI; also known as a basic income). A GMI has to provide enough money to survive on; a NIT could be as low as few hundred dollars and a 2% tax rate implemented by a city government. GMI systems also often have other major reforms, such as the elimination of the minimum wage and the ending of most current social welfare programs.

[edit] 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 codes: 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.