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Replace Welfare With a Negative Income Tax

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Replace Welfare With a Negative Income Tax

October 8, 2015

Amid years of perpetual congressional gridlock and partisan rivalry, the notion that both Republicans and Democrats could come together in support of sweeping welfare reform seems laughable. Yet, if it were to happen, the likeliest candidate for such a reformative policy might be the negative income tax (NIT). Versions of the NIT have been touted by Milton Friedman, Richard Nixon, and even the Green Party.  Even Martin Luther King, in his last book, Where Do We Go from Here: Chaos or Community?, wrote, “the solution to poverty is to abolish it directly by a now widely discussed measure: the guaranteed income.” Each version more or less entails the same basic structure.

A progressive income tax is one that taxes individuals at a rate which increases as income increases. This is the norm in most developed countries. For example, the United States levies a personal income top tax rate of 39.6 percent on individual taxable incomes over $413,201, and a bottom rate of 10 percent on taxable income under $9,225.

Under the most basic form of the NIT, people still see increased tax rates as their income levels grow. But when incomes decline past a certain threshold, the government credits taxpayers a percentage of their income that decreases as their income approaches the threshold such that for whatever income a taxpayer earns below the threshold, he is credited with the difference between his income and the threshold. For example, if the threshold were $1,000 and Ambrose only had an income of $700, the government would credit him $300 after. If Ambrose instead earned above $1,000, he would be taxed at increasing rates corresponding to his level of income. Slightly more nuanced versions of the NIT, such as the one famously proposed by Friedman, credit applicable individuals at flat rates such as 50 or 25 percent of their earned income below the threshold. In all cases the government acts to “guarantee” a certain level of income.  

Often the NIT is implemented in a diluted form. The United States uses a version of the NIT (the Earned Income Tax Credit, which also enjoys bipartisan support). In Israel, a very limited NIT is employed for individuals in low income brackets who meet a range of criteria. 

The NIT has two big selling points. Its efficiency gains support from fiscal conservatives while its implications for social fairness garner support from progressives. 

Currently, the American welfare system consists of many agencies staffed by a multitude of employees at an enormous cost to American taxpayers.  Under a NIT, the government could effectively “cut out the middleman,” and transfer funds directly from taxpayers to welfare recipients at a substantially lower cost to taxpayers. Furthermore, unlike other forms of welfare which subsidize specific products and services (thereby driving up their respective market prices) the NIT would create fewer market distortions.  

From the enlightenment onward, philosophers have stressed the importance of creating “fair” societies. They believe that even the worst off should have lives that any constituent member would consider to be within the material bounds necessary to sustain human dignity. While welfare brings society closer to reaching this point, a NIT would almost instantaneously empower people with a small safety net which could afford them access to fundamental goods and services which help people to preserve and protect their basic dignity.

If a NIT would efficiently reduce poverty and bureaucratic overhead, and is supported by leaders across the political spectrum, why have the United States and most other advanced countries held off from instituting one? There are at least four answers which might collectively explain why policymakers avoid NITs.

A major welfare reform that reduces the necessity for bureaucracy eliminates the need for government agencies and employees. Politically, that is not a popular change. In theory, getting rid of overlapping, inefficient welfare agencies in a way that improves outcomes is something few would disagree with. But when a NIT results in civil servants and political appointees losing their jobs, the program becomes prospectively difficult sell to constituents and interest groups.

Currently, the bulk of welfare payments come in the form of subsidies for particular fundamental goods and services such as housing and healthcare. Under a NIT, recipients could use their payments for goods and services which do nothing to alleviate the adverse conditions that characterize the lives of the poor.  For this reason, when policymakers actually put a NIT into practice, the type they implement is usually a highly regulated variation designed to address this very problem. Generally, these variations include extra measures such as means tests, varying negative tax brackets, and criteria tests. 

A NIT involves the setting of a minimum threshold below which no taxes are paid. Because of the inherent simplicity of any NIT proposal, this threshold would constantly be susceptible to political pressures. If a NIT were implemented, the initial threshold might be reasonable, but it would be tantalizing low-hanging fruit for newly-elected, pro-welfare legislators. For example, the somewhat similar EITC program which exists alongside a host of other welfare programs was significantly expanded and increased by new legislation in 1990, 1993, 2001, and 2009.

A NIT might create disincentives to work in ways that traditional welfare does not. Because the NIT guarantees a basic income that disappears as taxpayers earn more money, it provides an incentive for people not to go to work. Why work for $5,000 when one can get the same for just loafing around? According to an analysis of a series of experiments conducted on New Jersey households during the 1960s, when a NIT was simulated by researchers, it reduced hours worked by husbands, and especially hours worked by wives. Even more problematic, but not unlike some other forms of welfare, families allotted the NIT were less likely to be stable than other families in a control group.              

Even in light of the NITs detractions, it would be a vast improvement over the inefficiencies of the American welfare system. Given the policy’s ideological bilateral support and its clear benefits, legislators on both sides of the aisle might profit by reexamining all that a NIT has to offer. 


Michael Shindler is a contributor to Economics21. Follow him on Twitter here.

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