Home > Economic policy > Negative income taxes

Negative income taxes

March 15th, 2005

Reader Hans van Leeuwen wrote to ask about the Negative Income Tax which is one of those concepts that always seems to be discussed in favorable terms but never makes it on to the policy agenda. The basic idea, due to (or at least put forward by) Milton Friedman is that the tax system should consist of a flat grant and tax levied at a proportional rate on all incomes. The ‘negative’ part comes from the fact that people on low incomes would get money from the government and would therefore pay negative tax.

I’m sympathetic to the general concept, but I think it’s necessary to take the whole tax-welfare system into account. The implied objective then is to make positive transfers to low-income individuals and families while giving everyone roughly the same effective marginal rate of taxation. From this perspective, as the OECD noted the other week, the big problem is high effective marginal rates of taxation for low-income and middle-income families.

This is a difficult problem because, in general, I would like to make the grant component large for families with children (a view shared by government). It’s difficult to do this, apply a common marginal rate and hold the cost to revenue of the initial grant down to an affordable level.

Categories: Economic policy Tags:
  1. Andrew Reynolds
    March 15th, 2005 at 14:25 | #1

    John,
    The problem of high effective marginal rates of tax is one that is difficult to get around where welfare benefits are withdrawn and income tax added as income rises – it is part and parcel of the system. Do you have any suggestions for getting around it?
    Raising the threshold would be a good start I would have thought, but benefits still need to be withdrawn or they become yet another middle class subsidy.

  2. March 15th, 2005 at 19:49 | #2

    In many countries, the deductible threshold increases if the spouse is not working, or there are children.

    In Australia, some of this is done through Family Tax benefits, and carer rebates. All these rebates and benefits are quite expensive to administer (I had to fill a form for Child care and it is an amazing amount of work! Most of the information is already available to the government in other departments). Imagine how much money the government could save if this was all done as part of income tax returns.

  3. March 15th, 2005 at 23:27 | #3

    I have been over this before, in pointing out how the Kim Swales approach works. I have a lot of material on it here, so I’ll just do some overview stuff now. For one thing, with the different impact you get a Negative Payroll Tax, not a Negative Income Tax, and it can rest on a better tax on producers than Payroll Tax proper.

    By switching the point of impact/point d’appui/Schwerpunkt around, you get a lot of things that just don’t register to methodologies that implicitly assume that incidence is all that matters. (They do show up in things like Games Theory, though.) With “grants” being provided via offsets to GST per employee on a payroll (including owner-operators etc.), you get the same incidence but with these differences:-

    - No outflows from the government, so no churning, no compliance costs, and no need to provide funding through a transition period.

    - Faster transition, since there is no need for sticky wages to adjust in nominal terms to keep providing the same real standards of living.

    - Simpler administration, once the paperwork is reduced to anonymous transferrable vouchers issued on a periodical basis (maybe quarterly).

    That last point deals with JQ’s problem of varying grants by family size; there need be only one wage earner in a household for all members to benefit from their vouchers.

    Clearly, of course, those vouchers would eventually become monetised and there would be economic effects from that – but until then the Swales approach doesn’t have funding difficulties, so there is no transitional funding problem as with Negative Income Tax (if set at levels matching Social Security, that is).

    As it happens, over the long term Negative Income Tax, Negative Payroll Tax, and Guaranteed Incomes all converge to the same sustainable level (ignoring Malthusian limits), but only if the base level is not enough for survival. At those levels, people do price themselves into work, apart from a small number who can be dealt with by safety nets, and best of all by charity (since that is more responsive than bureaucracy, unless it is itself Red Cross style Big Charity).

    Over the very long term such a system would be sustainable without government intervention at all, with the government obligations being commuted for inalienable payments from trusts or the like; in a simpler world, this is precisely what Chesterbellocian Distributism would have delivered, so that would be an updating of the same concept. Unfortunately that could only be delivered by a government that thought of its duty as being to work itself out of a job (instead of which, we have penalties on inactive politicians, rather than rewarding them for reducing the need for such costly cure).

    But I digress. While that is a very long term indeed, it at least serves as a point of reference. We can and should try for a Swales type system just as soon as we have found what else is involved, what catches there might be like effects on foreign trade and implied commitments we already have and the like. I have written letters on all this to the papers before, and I have just written another one to the Australian just on Monday.

    I do not know whether any of this will raise a splash, any more than the last several times, but at least I am not a fanatic touting a magic bullet. I do want these things looked at and tested out as much as can be, then if flaws are found at least we have a fruitful set of guidelines for further work.

    Only, as I remarked elsewhere, here on the internet everybody is talking and nobody is listening.

  4. March 15th, 2005 at 23:34 | #4

    Oh, and I forgot. With the Swales approach, you don’t get the same problem of effective marginal rates since there is no point of impact on people’s individual income tax.

  5. 2dogs
    March 16th, 2005 at 05:43 | #5

    Has there been any analysis done on the effect if done in a revenue neutral fashion, and with a grant component of the size PrQ suggests?

    I suspect there is little or no prospect of a cut in the top marginal rate/general rate under such a scheme, and would likely involve a general rate higher than the current top.

    Now, when the top marginal rate cuts in at $62,500, a single is paying about $16k in tax. Given a single would probably need a $15k grant, keeping the single paying the same amount of tax at this level of income would require a rate of 49.6%, slightly more than what we have now. But we would need to more than break even with the single, to provide the benefits to families. So a rate in excess of 50% is quite likely.

  6. Mark Upcher
    March 16th, 2005 at 15:47 | #6

    My understanding is similar to 2dogs. That is, a negative incom tax with similar redistribution properties to the current system would require a marginal tax rate of around 55% – higher than the top marginal rate at present. This reflects the high level of welfare payments going to middle income earners, which is the most signifcant shift over the last 30 years.

  7. John Quiggin
    March 16th, 2005 at 15:53 | #7

    Oddly, enough I was just discussing this with a colleague and estimated, off the top of my head, that 55 per cent would be about the necessary rate.

  8. March 16th, 2005 at 20:44 | #8

    The current Australian system has the highest marginal tax rates at the bottom of the income distribution (as benefits are withdrawn). On the other hand, the basic optimal tax literature generally suggests that a negative income tax with a roughly constant marginal tax rate will be the best way to address the equity/efficiency trade-offs (taking into account the labour supply effects of taxes).

    This theory, of course, rests on many assumptions. I think two issues are particularly interesting:

    1. Should we be interested in maximising the economic concept of welfare, or are we mainly interested in maximising employment? The optimal tax literature assumes the former, but the latter is more prominent in public debate. They are quite different. To take one example, any sort of ‘workfare’ or ‘mutual obligation’ that forces the unemployed to take up employment that they would not have chosen, will increase employment but has a welfare cost (people are being constrained in their choices).

    2. If we are to focus more on employment, this leaves open the question of whether it is better encourage it by reducing marginal taxes, or by ‘hassling’ people into employment (eg mutual obligation programs). The latter is politically possible for income support recipients, but not for taxpayers (ie we don’t charge people more tax if they fail to apply for a higher-wage job). This means that labour supply can (possibly) be made less elastic at the bottom of the income distribution – which in turn provides a justification for a higher tax rate at the bottom.

  9. derrida derider
    March 16th, 2005 at 21:12 | #9

    55% was the rate the Melbourne Institute calculated some years ago for an unconditional BI with payment at the same rate as the pension. They estimated a 45% rate would be possible with a conditional one, after taking behavioural shifts into account (I think the latter calculaton was wrong, but the technical issues are too hard to go into now).
    The thing about a BI is that it is much more than a technical device to change solve some problems in tax and benefit administration. The pattern of effective marginal tax rates embodies a view of how we want people to live – it is a product of our preferred social welfare function. The key thing to remember is there is no (or anyway not much) free lunch here – given a fixed payment rate, you can only lower one person’s effective tax rate by raising someone else’s (sorry, PM, doung it through consumption rather than income tax doesn’t change this). What the pattern of EMTRs is that gives the best tradeoff between our vision of what’s equitable and what is efficient isn’t obvious – certainly there is no a priori reason to think it best served by a flat rate.

  10. March 17th, 2005 at 01:39 | #10

    DD, yes it does change things – the issue isn’t “consumption tax” v “income tax” at all, but the nature of the carrying tax. If you follow the material at my pages you will see that I deplore GST except as the starting point we’ve got, and recommend other taxes in a package being used to take up the slack.

    By switching the point of impact away from the point of employment decision you get less of an adverse consequence from marginal rates on the person making the decision. If you go all the way to a carrying tax (or tax package) that is based on production capacity rather than actual realised flows, you find the rates drop to near zero for individual payers, from spillover mechanisms throwing the burden on others in the tax base.

    It all shows up under Games Theory.

Comments are closed.