Negative income tax
In economics, a negative income tax is a system which reverses the direction in which tax is paid for incomes below a certain level; in other words, earners above that level pay money to the state while earners below it receive money. NIT was proposed by British writer and politician Juliet Rhys-Williams while working on the Beveridge Report in the early 1940s and popularized by American economist Milton Friedman in the 1960s as a system in which the state makes payments to poor people when their income falls below a threshold, while taxing them on income above that threshold.
Together with Friedman, supporters of NIT also included James Tobin, Joseph A. Pechman, Jim Gray and even then-President Richard Nixon, who suggested implementation of modified NIT in his Family Assistance Plan. After the increase in popularity of NIT, an experiment sponsored by the US government was conducted between 1968 and 1982 on effects of NIT on labour supply, income, and substitution effects.
Generic negative income tax
The view that the state should supplement the income of the poor has a long history. Such payments are called benefits if they are limited to those who lack other income, or are conditional on specific needs, but are called negative taxes if they continue to be received as a supplement by workers who have income from other sources. The withdrawal of benefits when the recipient ceases to satisfy a firm eligibility criterion is often seen as giving rise to the welfare trap.The level of support provided to the poor by a negative tax is thought of as parametrically adjustable according to the opposing claims of economic efficiency and distributional justice. Friedman's NIT lacks this adjustability owing to the constraint that other benefits would be largely discontinued; hence a wage subsidy is more representative of generic negative income tax than is Friedman's specific Negative Income Tax.
In 1975 the United States implemented a negative income tax for the working poor through the earned income tax credit. A 1995 survey found that 78% of American economists supported the incorporation of a negative income tax into the welfare system.
Theoretical development
Theoretical discussion of negative taxation began with Vilfredo Pareto, who first made a formal distinction between allocative efficiency and distributive justice. He sought to show that market economies allocated resources optimally within the income distributions they give rise to, but accepted that there was nothing optimal about these distributions themselves. He concluded that if society wished to maximise wellbeing, it should let market forces govern production and exchange and then correct the result by 'a second distribution... performed in conformity with the workings of free competition'. His argument was that a direct transfer obtained a given redistributive effect with the least possible reduction of economic efficiency, and was preferable to government interference in the market which damages efficiency by introducing distortions.Abram Bergson and Paul Samuelson gave a formal statement to Pareto's claims. They showed that the optimum of efficiency associated with market competition fell short of maximum wellbeing as reflected by a social welfare function only through distributional effects, and that a true optimum could be obtained if the state were to transfer income through 'lump sum taxes or bounties', where 'bounties' are negative taxes and 'lump sum' is Samuelson's term for a hypothetical redistribution with no distortionary consequences.
Optimal taxation theory
It follows from the Bergson/Samuelson analysis that any proposed measure can be assessed according to the balance it achieves between three factors: the improvement in overall wellbeing from a more equitable distribution; the loss in economic efficiency due to the distortions introduced; and the administrative costs. The first of these cannot easily be equated to a sum of money; the last is unlikely to be a dominant factor. Hence redistribution should be pursued up to the point at which any further benefits from a more equal distribution would be offset by the resulting monetary loss of economic efficiency.The Bergson/Samuelson theory was developed in a broadly utilitarian framework. A fourth factor could be added in the form of a moral claim derived from present ownership or legitimate earning. Considerable weight was placed on this during the Enlightenment but Hume and the Utilitarians rejected it. It is seldom mentioned nowadays but cannot be dismissed a priori as a relevant consideration.
The theoretical study of the trade-off between equity and efficiency was initiated by James Mirrlees in 1971. Eytan Sheshinski summarised:
In various examples calculated by Mirrlees, the optimal income-tax schedule appears to be approximately linear with a negative tax at low incomes.
Friedman's NIT
"Negative Income Tax" became prominent in the United States as a result of advocacy by Milton and Rose Friedman, who first put forward a concrete proposal in 1962 in a brief section of their book Capitalism and Freedom. Their system is equivalent in its operation to most forms of universal basic income.In the aforementioned work, Friedman provides five benefits of the negative income tax. Firstly, Friedman argues that it provides cash which the individual sees as the best possible way of support. Secondly, it targets poverty directly through income rather than through general old-age benefits or farm programs. Thirdly, negative income tax could in his opinion replace all supporting programs present at that time and provide one universal program. Fourthly, in theory the cost of negative income tax can be lower than the cost of existing programs mainly due to lower administrative costs. Lastly, the program should not distort the market in the way minimum wage laws or tariffs do.
Friedman envisioned the NIT followingly in an interview in 1968: Considering family A of four with income $4000 and Family B of four with income $2000. If the break-even income would be $3000, after filing the tax report, family A would pay the tax on $1000 while family B would be entitled to receive, assuming the 50% NIT rate, $500. Meaning half of the difference between what they earn and the break-even income. Therefore, a family with $0 income would be entitled to receive $1500 in subsidy. Friedman argued NIT would not destroy the incentive to work, as compared to guaranteed income programmes with 100% effective marginal tax rate, i.e. with the GIP workers lose $1 of subsidy for each $1 increase in wage.
In his 1966 "View from the Right" paper Milton Friedman remarked that his proposal...
has been greeted with considerable enthusiasm on the left and with considerable hostility on the right. Yet, in my opinion, the negative income tax is more compatible with the philosophy and aims of the proponents of limited government and maximum individual freedom than with the philosophy and aims of the proponents of the welfare state and greater government control of the economy.Friedman also elaborated and provided two reasons for the hostility from the right. Firstly, he mentions that the right is frightened due to the introduction of a guaranteed minimum income the poor would have a disincentive to improve their well-being. Secondly, the right is not certain about the political outcomes of the NIT, as there exist threats that there will be an upward pressure on the break-even incomes among politicians.
The Friedmans together promoted the idea to a wider audience in 1980 in their book and television series Free to Choose. It has often been discussed by economists but never fully implemented. Advantages claimed for it include:
- Alleviating poverty
- Eliminating the "welfare trap"
- Streamlining the benefits system.
The Friedmans' writings were influential for a period with the American political right, and in 1969 President Richard Nixon proposed a Family Assistance Program which had points in common with UBI. Milton Friedman originally supported Nixon's proposal but eventually testified against it on account of its perverse labor incentive effects. Friedman was mainly opposed to the idea that Nixon's program would be combined with existing programs at that time, rather than replacing the existing programs as Friedman originally proposed.
Meanwhile, support for negative income tax was increasing among the political left. Paul Samuelson argued in Newsweek that it was an idea whose time had come, and more than 1,200 academic economists signed a petition in support of it. Friedman withheld his signature, possibly on the grounds that the petition did not explicitly describe the new measure as a replacement rather than a supplement to existing programs.
As civic disorder diminished in the US, support for negative income tax waned among the American right. Instead the doctrine came to be particularly associated with the political left, generally under the name "basic income" or derivatives. It received further impetus in Europe with the founding of the Basic Income Earth Network in 1986. Asked in 2000 how he viewed a basic income "compared to the alternative of a negative income tax", Friedman replied that the measures were not alternatives and that basic income was "simply another way to introduce a negative income tax", giving a numerical example of their equivalence.