UK Accounting Glossary
A negative income tax is a method of tax reform that is popular among economists but has never been fully implemented. It was developed by Juliet Rhys-Williams in the 1940ies and later by United States economist Milton Friedman in 1962. It is commonly used as a method of implementing a guaranteed minimum income system.
A negative income tax would replace the current progressive income tax<tax system used throughout most of the western world. This would be replaced by a flat tax of, say, 25%, but each taxpayer would also be given $10,000 by the government. Thus a person earning only $4000 per year would pay $1000 in taxes but overall would receive a net gain of $9,000 from the government. A person making $40,000 would be at the break-even point and would neither pay taxes nor receive any benefits. A person making $1,000,000 per year would pay close to the full 25% tax, as the $10,000 would count little towards relieving their tax burden.
A negative income tax solves several problems with current systems. According to its proponents, it would eliminate the welfare trap and the minimum wage. Although it is often thought of as a method of implementing a social dividend, it can also be viewed as an employment subsidy with the main effect of reducing wage costs, especially for the lowest-qualified jobs. Seen in this light it can be seen as most beneficial to labour-intensive industries and less so to capital-intensive ones. Some critics of the negative income tax contend that, in effect, such a scheme is a subsidy given to employers of low-qualified jobs so that they do not really have to spend the money to adequately pay their workers.
Its main drawback is the same as any income-based tax system: It requires a good deal of expensive reporting and supervision in order to avoid fraud. In any case, the subsidy effect would probably cause a long-term reduction in unemployment, though it would probably not have a long-term effect on net wages since in the absence of a legal minimum wage, employers would compensate for it by offering a lower gross wage.
A negative income tax can be but is not necessarily a guaranteed minimum income. A GMI has to provide enough money to survive on; a NIT could be as low as a few hundred dollars and a 2% tax rate implemented by a city government. GMI systems also often have other major reforms, such as the elimination of the minimum wage and the ending of most current social welfare programs.
While the notion has long been popular with economists, it has never been politically feasible to be implemented. In part, this is because of the very complex and entrenched nature of the current tax codes in most countries that would have to be rewritten under any NIT system. What has happened in some countries has been the introduction of refundable (or non-wastable) tax credits which can be paid even when there is no tax liability to be offset.
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This glossary post was last updated: 13th February 2020.