Negative income tax
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In economics, a negative income tax (abbreviated NIT) is a method of tax reform that has been discussed among economists but never fully implemented. It was developed by Juliet Rhys-Williams in the 1940s and later by United States economist Milton Friedman in 1962 in Capitalism and Freedom. Negative income taxes can implement a basic income or supplement a guaranteed minimum income system.
A negative income tax would consist of a flat tax and a fixed government payment. It would replace current tax systems such as the progressive income tax. Consider for example a flat tax 25% and a government payment of $10,000. A person earning only $4000 per year would pay $1000 in taxes for a net income of $13,000.
$10,000 + ($4000 - $1000) = $13,000 net income (Overall, they would receive a net gain of $9,000 from the government.)
A person making $40,000 would be at the break-even point, essentially paying no taxes.
$10,000 + ($40,000 - $10,000) = $40,000 net income
A person making $1,000,000 per year would pay close to the full 25% tax.
$10,000 + ($1,000,000 - $250,000) = $760,000 net income.
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[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 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. Milton 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.[1]
[edit] Proponents
The proponents of negative income tax believe that its implementation would solve several problems with current systems.
It would eliminate the welfare trap which occurs where effective taxation rates may exceed 100% because of the loss of benefits. In this situation a person who earns more money ends up with less money. In this situation, people have no incentive to work because they cannot improve their situation. Under a negative income tax people always pay the same tax rate because it has no income-dependent benefits.
The need for a minimum wage is eliminated because people would receive protection from the fixed government payment.
A negative income tax would reduce administrative overhead, since the large bureaucracies responsible for administering taxation and welfare systems could be eliminated. The resources saved by eliminating these bureaucracies can then be spent on more productive activities.
A negative income tax is also expected to have a positive influence on the cycle of economic "boom and bust".
[edit] Critics
The main drawback cited by critics is one commonly found in almost any income-based tax system: it requires considerable reporting and supervision in order to avoid fraud. Another concern is that 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 equal to the government payment in the absence of employment.
[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 exemption independent of the amount of the actual income.
[edit] Basic income
A negative income tax can constitute, but is not necessarily, a basic income guarantee. A basic income 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. Basic income is also entirely unconditional, which is not by definition the case for a NIT. A negative income tax is, however, often suggested as a way to implement a basic income guarantee.
[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 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 though Congress. At first Friedman lobbied hard for it, but when the NIT proposal was going to be in addition to the current system, instead of in place of it, Friedman ended up fighting it.
- From 1968 to 1979, the most massive Negative Income Tax social experiment in the US was undertaken The four experiments were in:
- Urban areas in New Jersey and Pennsylvania from 1968-1972 (1300 families).
- Rural areas in Iowa and North Carolina from 1969-1973 (800 families).
- Gary, Indiana from 1971-1974 (1800 families).
- Seattle and Denver, from 1970-1978 (4800 families).
[edit] See also
[edit] External links
- Criticism of the NIT
- Support for the NIT specifically for Australia
