Negative income tax
|An aspect of fiscal policy|
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 (and non-earners) receive money, as shown by the blue arrows in the diagram. ‘Negative Income Tax’ (NIT) is the name of both a specific proposal made by Milton Friedman in the 1960s and (without capitals) of the generic system in which the state makes payments to the poor based on their level of income.
“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 (UBI) (qv., particularly the section Fundamental Principles for the equivalence).
In his 1966 “View from the Right” paper Milton Friedman remarked that his proposal...
has been greeted with considerable (though far from unanimous) enthusiasm on the left and with considerable (though again far from unanimous) 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.
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 (and endorsed) by economists but never fully implemented. Advantages claimed for it include:
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 favoured the proposal but eventually testified against it on account of its perverse labor incentive effects.
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 1200 academic economists signed a petition in support of it. Friedman withheld his signature, possibly on the grounds that the petition didn't 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 BIEN 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.
Generic negative income tax
The view that the state should supplement the income of the poor has a long history (see UBI§History). Such payments are seen as benefits if they are limited to those who lack other income, or are conditional on specific needs (such as number of children), but are seen as 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 (with or without provisos) the proposition that ‘the government should restructure the welfare system along the lines of a “negative income tax” ’.
Theoretical discussion of negative taxation began with Vilfredo Pareto, who first made a formal distinction between allocative efficency (ie. the market's ability to give people what they want subject to their incomes) and distributive justice (ie. the question of whether these incomes are fair in the first place). 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 is the market (as happens in modern economies through the minimum wage) which damages efficiency by introducing distortions.
Abram Bergson and Paul Samuelson (drawing on earlier work by Oscar Lange) gave a more 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 (including the proposal to leave things as they are) can be assessed according to the balance it achieves between three factors: (i) the improvement in overall wellbeing from a more equitable distribution; (ii) the loss in economic efficiency due to the distortions introduced; and (iii) 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 (non-monetary) 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.
In various examples calculated by Mirrlees, the optimal income-tax schedule appears to be approximately linear with a negative tax at low incomes.
- M. Friedman assisted by R. Friedman, “Capitalism and Freedom” (1961), pp. 190–195.
- M. Friedman, “The Case for Negative Income Tax: A View from the Right” (1966). Republished several times.
- Alston, Richard M.; Kearl, J.R.; Vaughan, Michael B. (May 1992). "Is There a Consensus Among Economists in the 1990s?" (PDF). The American Economic Review. American Economic Association. 82 (2): 203–09. Retrieved 17 October 2015.
- Suplicy, Eduardo (June 2000). "Eduardo Suplicy's Interview With Milton Friedman". The U.S. Basic Income Guarantee NewsFlash.
- Leland Neuberg, “Emergence and Defeat of Nixon's Family Assistance Plan” (2004) https://usbig.net/papers/066-Neuberg-FAP2.doc.
- Manuale di Economia Politica con una Introduzione alla Scienza Sociale (1906) / Manuel d’Économie Politique (1909), §53 and §55 of Chap. VI.
- O. Lange, “The Foundations of Welfare Economics” (1942).
- P. A. Samuelson, “Foundations of Economic Analysis” (1947), pp. 219–249.
- See Edwin G. West, “Property Rights in the History of Economic Thought: From Locke to J.S. Mill” (2001/2003).
- Sir J. Mirrlees, “An Exploration in the Theory of Optimum Income Taxation” (1971).
- E. Sheshinski, “The Optimal Linear Income Tax” (1972).
- Edmund Phelps (ed.), “Economic Justice”, selected readings (1973), esp. Part Five (mathematical).