Negative Income Tax
I'm back in Munich after a wild week in Chicago (wild in that it was a whirlwind of cleaning and repairing and renting my apartment). The United States was warm and sunny, just as confident and optimistic as always, and seems to be getting along just fine without me.
Before I left Robin and I were watching a very interesting series of videos about economics. They were released by Milton Friedman in the early 80's as a PBS series called "Free to Choose". There is also a published book version available on Amazon. Now when it comes to social issues, as my friends know, I'm rather liberal, but I find myself becoming more and more of what might be called an economic conservative. Surprisingly, this doesn't seem that contradictory at all.
One of the interesting concepts Mr. Friedman presents in his videos is that of the negative income tax. It works as follows.
Currently, in the US, when you pay taxes, you can take certain "deductions". Roughly, this means that you don't have to pay income tax on money expended for certain purposes (for example, mortgage interest). Even if you don't have any expenses which show up on the list of "accepted deductions", you can still take a "standard deduction". Basically, this is because we believe that everyone needs a certain amount of money to live, and so we shouldn't have to pay taxes on that amount of money. Currently the standard deduction is, for example, $5150 for a single taxpayer, and $10,300 for a married couple filing jointly (I wonder how many places in the US you can live on that....).
Meanwhile, for similar reasons, we also have a minimum wage - for the last 8 years, this has been $5.15/hour. At 40 working hours/week and 50 working weeks/year, this comes out to $10,300. In other words, at the moment, if you work a full-time job, paying minimum wage, with two weeks of unpaid vacation (or sick days), and support a non-working spouse, you will earn $10,300 and not pay any taxes.
But what if you get pneumonia and are sick three weeks instead of two? Or what if you can't find a full-time job, and have to take a job making 30 hours/week? You'd just have to survive on less. And if you lost your job and couldn't find another one, you'd get unemployment for 6 months, but then you'd be out of luck. If you have children, you could get on welfare, but otherwise you'd just just have to survive on savings, if you had any, and otherwise charity. The US has no General Assistance.
The Negative Income Tax is a way of dealing with this problem. Let's imagine that as a society, we could make the decision that a single needs at least $10,000/year to live. Let's imagine that we made the additional decision that every dependent in the household costs an additional $5,000/year to live. (NOTE: these numbers are completely arbitrary. I'm not saying that $10,000 a year is actually enough to live on.) So, for starters, we'd make this the standard deduction. So if I'm a single parent with two children, making $50,000 a year, my deduction would be $20,000, and so I'd only pay taxes on the remaining $30,000.
So far this is basically similar to the current deduction system. But let's say I lose my job, and can't find another. After 6 months, I'm making $0. Now what? Under the current system, I would be able to apply for welfare (limited by a number of restrictions and requirements). But the Negative Income Tax would deal with this more simply. It would say, while I'm not making any money, I should pay a Negative Income Tax - that is, the government would pay ME the amount of money that it costs to live - by our deduction calculations, $20,000.
The really nice thing about this system is that means we could do away with a number of other systems - the welfare system, the minimum wage, and others, all very expensive to administer and police. Instead, the administration of the Negative Income Tax would be a relatively simple extension of the current tax procedures. It would just be a slight change in the way the IRS calculates the taxes, plus the ability to send out monthly checks (the IRS already sends out many adjustment checks each year, after the tax returns are in), and a form to fill out at the local post office if you have no income at all. There is a certain amount of policing to be done, but it all falls under the heading of tax fraud, which the IRS already handles in great quantity every year.
A system like this would be simple, but wouldn't it discourage people from working? This is a valid concern. In fact, any tax system like this needs to address three basic principles:
1) The system should help people who are not making enough to live.
2) The system should always encourage people to take work.
3) The more money you make, the less the system should help you.
I did some playing with numbers and came up with a surprisingly simple formula which fulfills these goals: a simple standard deduction and a flat tax rate. For example, let's say that the standard deduction is $10,000 and the tax rate is 50%. So, if I'm a single person making $0, the state will give me $10,000. If next year I get a part-time job making $5000, the state will still be helping me out, but not as much - it will give me $7500, so my total income will be $1250. If I get a full-time job making $20,000, I come out even - the state doesn't take anything, or give me anything. Here's how it looks:
Job Pays --> I Receive:
$0 --> $10,000
$5000 --> $12,500
$20,000 --> $20,000
$30,000 --> $25,000
$50,000 --> $35,000
$100,000 --> $60,000
$200,000 --> $110,000
$500,000 --> $260,000
$1,000,000 --> $510,000
Visually:
And here's a chart of effective tax rate, based on salary:
The system is crude, but it works out surprisingly well - especially considering that I made up the original $10k out of my head (although I just checked, and it is very close to the official 2006 federal poverty threshold for the contiguous 48 states - $9,800).
OK, that's enough math for one post. I still want to consider this more; some questions which come to mind are:
- How to deal with married couples and dependents?
- How to deal with working minors?
- What about geographical variations in cost of living?
- How much money would this actually make the Federal Government?
I have some possible answers for these, but I'll deal with them in another post.
P.S. Feel free to comment on why I'm a complete idiot and this won't work at all....
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