What Is Negative Income Tax?
Negative income tax (NIT) is a concept that is widely believed to have originated from an economist Milton Friedman from his book Capitalism and Freedom in 1962. It was an alternative to the welfare system in the United States. It was meant to provide money to people who earned below a specified level by giving money back to them.
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Milton Friedman’s Negative Income Tax
The goal of having a negative income tax was to ensure no one would make less than half of the NIT income threshold. This concept was to motivate people to work, reduce the government cost of managing welfare, and ensure low-income earners to have a guaranteed income each year. The tax basis would give money back to those workers through their paychecks versus giving out benefits to them through welfare programs.
The challenge of implementing the NIC in a progressive tax system is the tax system is already complicated. The United States income tax brackets and percentages are subject to change depending on the political administration, creating other challenges related to management. If NIT were to be implemented today in our progressive tax system, there would be cases of some individuals or families receiving money back through their own paychecks. Unemployed people would have to file an income estimate similar to how a contractor or self-employed workers and potentially the reduction or phase-out of social security disability and other welfare programs. Without adequate case studies, it would be difficult to know ahead of the real impact of those who would lose government benefits.
If we had NIT in place today, for example (using basic arithmetic), the threshold is set at $25,000 (anyone who earns $25,000 or less would be entitled to 50% of the difference in their income and the limit). Family A had an adjusted gross income of $25,001, Family B had an adjusted income of $20,000, and Family C had zero income. All families are two parents married and filing jointly with two children.
Family A: $25,001 has a NIT of $0.00. Under the NIT plan, it would entitle this family to $0.00 in NIT and pays income taxes on the difference. $25,001 threshold minus $25,000 = $1.00
Family B: $20,000 has a NIT of $5,000. Under the NIT plan, it would entitle this family to $2,500 (50% of the NIT). For a total adjusted income of $22,500.
Family C: $0.00 has a NIT of $25,000. Under the NIT plan, it would entitle this family to $12,500 (50% of the NIT). For a total adjusted income of $12,500.
NIT Theories and Experiments
There has been a lot of debate on the negative income tax theory. Some theorize workers may experience less motivation to work and would collect 50% of the difference of the NIT. There are also questions around treatment depending on conditions. Should a single pregnant mother be treated the same as an unemployed single worker? More factors such as the conditions within each city or county, minimum wages, and childcare.
Supporters suggest that even with the reduction in other benefits that low-income earners would still come out ahead. The extra income would put power in the hands of those receiving it to spend the money on what they need, versus the government allocating where benefits are used. More theories are the extra money paid back might recirculate within the economy.
There is a lot of speculation around NIT, and we have only attempted the system through studies and trials, but never a formal law passed resulting in tax reform. There were social experiments conducted, and the results were inconclusive from too many moving parts that complicated the research and analysis. Instead of promoting family stability, it actually resulted in more family breakups and fewer percentages of those working. Later when the effects were examined, it was reported that there was a high rate of misreported income.
Negative Income Tax and Universal Basic Income
UBI and NIT put money back in the hands of people with the distinction that NIT only focuses on low-income earners. UBI does not have a focus or limit on earnings to qualify. However, UBI requires more moving and transferring of funds and taxes than the negative income tax. With universal basic income, the worker earns their paycheck, pays income taxes but receives a credit back. It poses more of a tax upfront but a larger refund later.
The administrative cost may be more expensive compared to the NIT in terms of the additional overhead that may be needed to process taxes and the payouts to everyone. Despite the argument, UBI is becoming more popular for some individuals by the standards of how people are treated. A universal basic income may be more attractive because everyone is treated equally and the program leaves some welfare assistance in force. Either way, depending on the current economic status and politics, implementing either policy into a progressive tax system would have additional costs to administer.
Negative Income Tax Versus the EIC
President Ford authorized the earned Income Credit (EIC). This program initially was for families that had children. Couples married and filing jointly are granted a specified dollar amount as long as they are earning money by working. There is a phase-out that determines how much a family can receive based on their income.
The United States does not have a negative income tax in place. However, the earned income credit (EIC) is a close model. The EIC acts as a hybrid between the welfare system we have in place and the concept of a negative income tax. The distinction is that people must be income earners and file a tax return. This counters the negative income tax that unemployed individuals would receive funds back as long as they filed a tax estimation or tax return.
Negative Income Tax Versus Welfare
Welfare and negative income tax also differ in that welfare typically comes in the form of benefits. For example, welfare can include food stamps, Medicaid, and temporary assistance programs. Some benefits may have an expiration date (meaning the recipient must work so many hours or have a job within a specific time frame). Welfare benefits also may come with a determination of assets; an individual is limited to how many assets they own to receive the benefit compared to negative income tax that does not impose any asset restrictions.
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This post was updated November 7, 2019. It was originally published November 7, 2019.