Negative Income Tax

… a core term used in Economic Analysis and Atlas102

Definition

Jodie Allen, writing in The Concise Encylopedia of Economics (reference below) describes the Negative Income Tax (NIT) as a mirror image of the regular tax system whereby tax filers would receive government payments (“negative taxes”) based on how far their incomes fell below a tax threshold.

Allen goes on to say:

“The idea of a negative income tax (NIT) is commonly thought to have originated with economist Milton Friedman, who advocated it in his 1962 book, Capitalism and Freedom. Others, notably the late Joseph Pechman, long-time tax dean of the Brookings Institution, credited the University of Wisconsin’s Robert Lampman with at least simultaneous discovery and with bringing the concept to the attention of government policy planners in 1965.

“In its purest form a NIT promised a revolution in American social policy. Gone would be the intrusive and costly welfare bureaucracy, the pernicious distinctions between “worthy” and “unworthy” recipients, the perverse disincentives for work effort and family formation. The needy would, like everyone else, simply file annual – or perhaps quarterly – income returns with the Internal Revenue Service. But unlike other filers who would make payments to the IRS, based on the amount by which their incomes exceeded the threshold for tax liability, NIT beneficiaries would receive payments (“negative taxes”) from the IRS, based on how far their incomes fell below the tax threshold.

“The NIT would thus be a mirror image of the regular tax system. Instead of tax liabilities varying positively with income according to a tax rate schedule, benefits would vary inversely with income according to a negative tax rate (or benefit-reduction) schedule. If, for example, the threshold for positive tax liability for a family of four was, say, $10,000, a family with only $8,000 of annual income would, given a negative tax rate of 25 percent, receive a check from the Treasury worth $500 (25 percent of the $2,000 difference between its $8,000 income and the $10,000 threshold). A family with zero income would receive $2,500.”

“Very neat. So attractive that researchers in the Office of Economic Opportunity, the brain trust for Lyndon Johnson’s Great Society in the midsixties, began planning a large-scale field experiment of the idea. Several sites in New Jersey were ultimately selected for the test, which was launched in 1968 with the University of Wisconsin’s Institute for Research on Poverty in charge of the research and a Princeton-based firm, Mathematica Inc., in charge of field operations and data collection.

“The primary purpose of the experiment was to address the concerns of labor-supply theorists. These labor economists worried that providing the working poor with a basic income guarantee if they quit work, and then reducing that guarantee at a fairly steep rate as income from work increased would damage work incentives and ultimately swell NIT costs. They feared that NIT would reduce work effort in two ways. First, by giving a family with no outside income a guaranteed minimum income, NIT might, at the extreme, discourage family members from working at all. And even if workers didn’t quit entirely, they might work less since they could satisfy their basic needs with less work effort. Economists call this an income effect. Second, by reducing benefits some fraction of a dollar for every dollar earned, NIT would, along with payroll and state and local income taxes, reduce the net value of wages and induce recipients to “substitute” leisure for work. Economists call this a substitution effect.”

[To find out what happened, read the rest of the article referenced below!]

Source

Jodie T. Allen, Negative Income Tax, The Concise Encylopedia of Economics, at http://www.econlib.org/library/Enc1/NegativeIncomeTax.html, 11 May 2016.

Atlas topic and subject

Labour Markets, Transfer Payments, and Personal Taxes (core topic) in Economic Analysis and Atlas102.

Page created by: Ian Clark, last modified on 11 May 2016.