The Negative Income Tax
These and other problems have contributed to the “welfare mess” and have led to frequent calls to scrap the whole system. Reformers seek a simple structure that would get income into the hands of the poor without destroying the incentive to work. The solution suggested most frequently by economists is the so-called negative income tax (NIT).
A particular NIT plan is defined by picking two numbers: a minimum income level below which no family is allowed to fall (the “guarantee”), and a rate at which benefits are “taxed away” as income rises. The table considers a plan with a $6000 guaranteed income (for a family of four) and a 50 percent tax rate. Thus, a family with no earnings (top row) would receive a $6000 payment (a “negative tax”) from the government. A family earning $2000 (second row) would have the basic benefit reduced by 50 percent of its earnings. Thus, since half its earnings is $1000, it would receive $5000 from the government plus the $2000 earned income for a total income of $7000.
Notice in Table 37-4 that, with a 50 percent tax rate, the increase in total income as earnings rise is always half of the increase in earnings. Thus, there is always some incentive to work. Notice also that there is a level of income at which benefits cease-$12,000 in this example. This “break-even” level of income is not a third number that policymakers can select in the way they select the guarantee and the tax rate. Rather, it is dictated by the other two choices. In our example, $6000 is the maximum possible benefit, and benefits are reduced by 50 cents for each $1 of earnings. Hence benefits will be reduced to zero when 50 percent of earnings is equal to $6000-which occurs when earnings are $12,000. The general relation is:
Guarantee = Tax rate x Break-even level.
The fact that the break-even level is completely determined by the guarantee and the tax rate creates a vexing problem. To make a real dent in the poverty problem, the guarantee will have to come fairly close to the poverty line. But then, any moderate tax rate will push the break-even level way above the poverty line. This means that families who are not considered “poor” (though they are certainly not rich) will also receive benefits. For example, a low tax rate of 333 percent means that some benefits are paid to families whose income is as high as three times the guarantee level.
But if we raise the tax rate to bring the guarantee and the break-even level closer together, the incentive to work shrinks, and with it the principal rationale for the NIT in the first place. So the NIT is no magic cure-all. Difficult choices must still be made.
