7 May 2015

The case for a negative income tax


“Creative destruction” is probably the most accurate and pithy definition of capitalism ever. The expression was coined by Joseph Schumpeter when he taught Economics at Harvard. Without destroying obsolete activities, no progress can occur. One could see that in the former Soviet Union, where no factories were ever shut down. “Destruction” however, bears a cost: managers lose their job, shareholders their savings, workers turn unemployed and sometimes desperate. “Destruction” is a major reason why so many are hostile to capitalism: destruction is visible, when what is created may be invisible, scattered and elsewhere.

Pro-market economists tend not to share the worries of terminated workers: new and better jobs will replace those which need to be discarded. This answer, however true, applies at the global level. Economists like to talk globally, like any social scientist. Yet what is global and may be verified in the long run, is no consolation for those whose lives are suddenly disrupted. The common answer to those anxieties and actual threat has been the Welfare State. In a free-market economy, its basic principle should be preserved but its architecture needs to be revised.

The Welfare State is commonly criticised by pro-market pundits for its skyrocketing cost, which weighs heavily on the private sector. This may be not its major flaw. The Welfare State, as we know it throughout the Western world, is unethical: it transfers all responsibility from the individual to the State. Government and bureaucrats allocate welfare resources, not based on the individual needs, but on what government and bureaucrats consider good for the individuals. This top-down public subsidies system tends to deprive us all from our freedom to choose.

Could the Welfare State be preserved but rebuilt along different principles? Yes, if only we were to rally a solution initially proposed by Milton Friedman some sixty years ago: the Negative income Tax (NIT). The NIT is simple to understand: every citizen would declare its annual income and would pay to the State part of this income, or receive a cash grant. It would belong to our democratic institutions to draw the line between positive and negative income tax. The grant should guarantee to all citizens a decent life, clearing out poverty and the fear of poverty.

More important, the NIT would replace all – or most – existing social programs and agencies which run them. This would make the new system economically viable. There is the rub: many accept the concept of NIT and in some countries, the State does add a cash grant to low wages like the Earned Income Tax Credit in the United States. This EITC, regretfully, does not replace social programs managed by the State: it adds up. The true NIT supposes that the individuals receiving a public income will be responsible enough to manage it to their best interest like feeding their children instead of gambling.

The current Welfare State, on the contrary, is based on the assumption that the poor are not to be trusted, that they will do drugs or gamble if money were given to them. The NIT is based on trusting the individual: if 1% of those who receive the NIT choose gambling, this will be their choice to be compared with the built-in paternalism of the current Welfare State. Another benefit of the NIT would be to get rid of the huge bureaucracy which now lords over the social programs in the name of the beneficiaries of these programs. Welfare dependency would be massively reduced.

Wouldn’t the NIT – a government-guaranteed income – be a disincentive to work? “Any State intervention, any income redistribution, creates disincentives and distortions”, admitted Friedman. “But, if society decides that a certain level of redistribution must take place, the NIT is the best, the most minimally distorting solution ever devised.” To limit the disincentive, the NIT should be progressive.

Say the government drew the income line at $10,000 for a family of four and the NIT was 50 percent, as most economists recommend. If the family had no income at all, it would receive $5,000 – that is 50 percent of the amount by which its income fell short of $10,000. If the family earned $2,000, it would get $4,000 from the government – again, 50 percent of its income shortfall – for a total post-tax income of $6,000. Bring in $4,000, and it would receive $3,000, for a total of $7,000. So as the family’s earnings rise, its post-tax income rises, too, preserving the work incentive. This is very different from many social welfare programs, in which a household either receives all of a benefit or, if it ceases to qualify, nothing at all. The all-or-nothing model encourages what social scientists call “poverty traps”, tempting the poor not to improve their situations.

Another NIT advantage is a free labour market. No minimum wage would be necessary, since a minimum income would be guaranteed. This would boost employment: a legal minimum wage tends to increase joblessness by discouraging employers from recruiting unskilled labour. The NIT would reduce illegal immigration, too. Managed by the Tax Administration, it would apply only to citizens and legal residents, and since it would eliminate welfare programs, aliens would have less incentive to cross the border illegally for government benefits. From an economist’s perspective, the negative income tax is the perfect design. The only reason an economist would oppose it would be from a strict libertarian perspective – opposition to any kind of government-managed welfare.

In the same spirit, other alternatives to the Welfare State have been proposed. The American social theorist Charles Murray, author of a famous mid-eighties book on the pathologies of welfare, Losing Ground, devised an even simpler and more egalitarian substitute for welfare than Friedman’s. All existing government transfer payments, Murray argued, should be replaced with an annual tax-free cash grant to everyone over 21 of $10,000 – roughly where the poverty line is for an individual – with the stipulation that $3,000 of that money go toward health insurance and a strong suggestion that another chunk of it be invested in a retirement account.

Murray’s plan draws not only on Friedman but on another creative economist, Irwin Garfinkel at Columbia University. Garfinkel has suggested a “demogrant”: upon reaching the age of 20, every citizen would get a sizable lump of cash from the government, but no welfare support would be available after that point. The Left tends to reject Garfinkel’s plan, just as they reject Friedman’s and Murray’s, as too libertarian. Conservatives worries that it would discourage work.

The potentially negative aspects of these proposals require research, but we should always compare them with the existing welfare system. All of the above aren’t perfect solutions, but they try to be less imperfect than what we already have in place. What we have in place, paradoxically, pushes many of the beneficiaries against capitalism. If more were treated as adults, able to manage their own destiny, the basic principles of capitalism may be better understood and shared.

What are the chances of the NIT becoming part of a political party platform? Modest indeed because politicians are better at piling on benefits than at re-engineering the State. Maybe the NIT is only one of the “alternative utopias” (Hayek’s word) we should keep in mind to refocus the political debate on bold ideas.

Guy Sorman is an economist at the University of Paris and author of many books on classical liberalism including: The American Heart, In Praise of Giving, 2014. He is also publisher of France Amerique and founder of Action against Hunger.