A negative income tax is a form of wealth transfer which is designed to combine the redistribution of wealth currently performed by two systems, the progressive tax system (which calls on those with greater ability to pay to pay a higher proportion of their income to the government as taxes), and the traditional welfare system for the poor. Instead, a negative income tax would see people earning less than a certain income receive a large tax “refund” from the government rather than owing taxes to the government. It is somewhat similar to, though a different system from, other proposals for legislated minimum income.
There are two ways to implement a negative income tax system. The first is essentially similar to today’s tax system, but with a key difference. Today, the net tax owing to the government starts at zero, and then increases as income increases. (In progressive tax systems, like the American and Canadian federal income tax, the proportion of tax charged also increases as income increases.) However, the starting point for tax could be a negative number instead – say, $10,000. Someone earning no income would receive $10,000 from the government. As income increased, people would essentially work off this subsidy until they reached the cut-off point, where no new refund would be made (in a system with 25% tax, this point would come at income of $40,000 per year). They would then start paying into the tax system.
The above system is a relatively simple modification of the current one, although it does introduce the risk of people deciding on alternative income strategies to maximize their tax refund. The alternative is to switch to a flat tax model, supplemented by a $10,000 tax payment from the government to every citizen, every year. Advocates say this system is most equitable, since everybody qualifies for the same payment, regardless of their economic activity. However, a person with no income would receive $10,000 and pay no taxes, whereas a person with $40,000 income (and a tax of 25%, as in the above example), would receive $10,000 from the government and pay $10,000 in taxes, essentially breaking even. Once again, everybody earning above the cut-off point would be paying into the system.
Advocates of the negative income tax system, led by extreme free-market advocates like Milton Friedman, argue that it could eliminate the need for a wide variety of more complicated welfare provisions, including food stamps and even the minimum wage, which would be subsumed within the $10,000 annual payment to every citizen. At the same time, sympathetic conservatives point out, it would eliminate the supposed dependency which results from welfare payments: people on welfare may lack an incentive to work and go off welfare, but people receiving their negative income tax refund have no disincentive to work because they will be receiving the refund anyways. The increased number of tax administrators would probably be more than counterbalanced by layoffs of social workers and welfare administrators.
Critics of the negative income tax system include those who simply dismiss the conservative arguments above about the threat of the welfare trap, or Friedman’s own objections to large government sustained by income taxes (Friedman himself preferred the total abolition of income tax, but considered negative income tax an acceptable alternative). Moreover, setting the fixed refund level from the government is problematic and reintroduces some of the problems that the negative income tax scheme attempts to avoid. If $10,000 is enough to live on with only a minimum amount of productive work added on, then it creates a welfare trap of its own for those people willing to subsist on a minimal income thanks to the vastly increased leisure time it would afford them. However, if $10,000 is not enough to live on with only minimal extra work, then at least some people would still be left without the means to survive, and some sort of private or public welfare system would presumably end up remaining in place to assist those people.
Today, no major government has ever introduced a negative income tax scheme except in the form of limited, small-scale social experiments.