For and Against Negative Income Taxes

The arguments for the Negative Income Tax

The attractiveness of a NIT depends both upon your political viewpoint and the system it is designed to replace.

The main argument which Milton Friedman put forward when originally arguing for a NIT were that it concentrates public funds on the poor, thereby costing taxpayers less money, and it creates positive work incentives for people on low incomes compared to the welfare programmes it is replacing.

A NIT focuses funds on those living on a low income. The comparison with a Basic Income, where payments are universal, is stark.

Milton Friedman argued that the NIT would replace existing welfare schemes where often the effective marginal rate of tax for someone of welfare was 100% - destroying work incentives. By contrast his version of the NIT would have a marginal withdrawal rate of 50%.

In fact, an NIT introduces two processes which have differing effects upon work incentives. The first, the income effect, is that, with a guaranteed income, people may satisfy their basic needs with less work ? thus an NIT could reduce work incentives. This may particularly effect second earners in a household. Second, the substitution effect, as people earn more their NIT is withdrawn ? reducing the net value of wages and dulling work incentives. The magnitude of these effects will depend upon the system which the NIT is replacing.

Many of the US experiments found that there were work disincentive effects among the participants of the pilot schemes. The participants in the Canadian Mincome pilot programme also experienced a small dulling of work incentives (see here for more details).

Other arguments which have been put forward in favour of a NIT are that compared to other labour market interventions such as a minimum wage it is a efficient wage subsidy and should encourage the creation of (low wage) jobs.

Others have argued that some variants of NIT are preferable to Basic Income schemes as they are still conditional on labour market activity or demonstrating that unemployment is due to an unavoidable disadvantage.

The integration of the tax and benefit systems is seen as an advantage by many ? bringing together a patchwork of systems which fit awkwardly together into a coherent whole. And it is possible that this process may reduce the gulf between tax-payers and benefit recipients ? looking at chart 1 everybody is on the same slope even if they are at a different level.

One of the key worries is that NIT schemes may encourage marital break-up. Those households which were previously held together by financial necessity would dissolve. Moreover if a household splits up then each new household is eligible for the NIT ? creating a financial incentive to divorce or split up. And this is indeed what seemed to occur in the American and Canadian pilot programmes (see here for more details).

The most fundamental objection to a NIT comes from those who are against any form of means testing. The advantages of social insurance and basic income schemes are that there is no intrusive means testing ? with all its detrimental effect upon work incentives (though as noted above the actual effect will depend upon the system which the NIT is replacing). Moreover compared with schemes such as social insurance (where benefits are earned through contributions) and basic income (where payment is received as a right), a NIT may still suffer from the stigma attached to many means tested systems ? with consequent effects for take-up rates.

NIT proposals generally are focused upon households rather than individuals. To those who favour independent taxation as a means of promoting independence between men and women, and to those who worry about targeting family poverty (research generally finds that payments to mothers are a more effective way of ensuring money is spent ion the children) this is a mistake.

Finally a NIT is paid after a calculation of the difference between earnings and the NIT scheme?s stipulated income. This is different from other schemes where benefits or social insurance payments are paid automatically. Unless designed carefully therefore, NIT schemes can introduce an element of uncertainty into household income, which is absent in Basic Income, social insurance and other entitlement based welfare programmes.

Further Reading