Fallacies of the Negative Income Tax

Is it unwise to let the perfect be the enemy of the good? Sure. But many seemingly free-market reforms are in fact worse than original problem.

Take the negative income tax (NIT) for example. The NIT is supposed to make the welfare state more “efficient” (but why should libertarians help the government do evil more efficiently?) and rebut objections of the ideological Left by providing a guaranteed safety net. John Humphreys has come up with the 30/30 plan in a monograph published by the Centre for Independent Studies.

Many credit Friedman as being the originator of the idea, but they are wrong. Well before Milton Friedman received credit for the NIT, Austrian School economist Henry Hazlitt had already thought of the idea. However, Hazlitt later discarded it as unworkable. The objections of the Austrian School have been ignored by most Australian commentators, but now is a good time to understand their arguments. Let Hazlitt make the case:

[K]nowing what we do of political pressures, and of the past history of relief, “social insurance,” and other “antipoverty” measures, we are forced to conclude that once the principle of either the NIT or the straight guaranteed income were accepted, it would be made an addition to and not a substitute for the present conglomeration of relief and “antipoverty” programs. And even alone it would drastically reduce the productive incentives of those earning less than the guaranteed amount and seriously reduce the incentives of those earning more, because of the oppressive taxation it would necessarily involve. Its overall effect would be to level real incomes down, not up.

Murray Rothbard raises other objections:

The one element that saves the present welfare system from being an utter disaster is precisely the red tape and the stigma involved in going on welfare. The welfare recipient still bears a psychic stigma, even though weakened in recent years, and he still has to face a typically inefficient, impersonal, and tangled bureaucracy. But the guaranteed annual income, precisely by making the dole efficient, easy, and automatic, will remove the major obstacles, the major disincentives, to the “supply function” for welfare, and will lead to a massive flocking to the guaranteed dole. Moreover, everyone will now consider the new dole as an automatic “right” rather than as a privilege or gift, and all stigma will be removed.

The NIT is innovative only in an administrative sense. As Robert Murphy puts it, the NIT is “a welfare program that is novel only in the method by which the amounts of the checks are calculated”. It changes how cheques are sent out to dole recipients, but it’s hardly the type of radical reform that will end the culture of dependency fostered by the welfare state.

Unfortunately, there’s no easy-fix for the welfare state. We must argue for its complete abolition, not tinker with cures like the NIT that are worse than the original disease.

7 thoughts on “Fallacies of the Negative Income Tax

  1. 1. Hazlitt is wrong, because of circumstance. We already have welfare so the dynamic effect is already exhausted save for those the NIT benefits.

    2. Rothbard is wrong. Because of circumstance again. Generational poverty is far worse a problem than the few bludgers who will genuinely get the dole so they don’t have to work.

    3. The 30/30 is probably unworkable because of a change in circumstance. The tax scales are far different to what they were 10 years ago.

    4. The LDP wanted to change the policy last time I turned up for a meeting or discussed it with the officials or other economists. We were looking at something like the basic income and a consumption tax, with conditional welfare for people who are bloody hopeless. So you might have two tiers, no income tax, a basic income with it’s benefits, tapering off of benefits so there is less churn than the NIT and in kind transfers for some.

    5. Mass privatisation is a way to fund the “buying out” of welfare, superannuation and pensions. The public can be given shares in public corporations which can be traded on paper before they are given away for cash on their issue, and land etc would be auctioned off and distributed as cash. Per capita private wealth would rise in such a way there would be permanent effects on income and no real case for welfare.

    6. Kevin Rudd basically tried to destroy any remaining philanthropy Australia had. You ought to look into this as to why winding back welfare requires a lot of research and legislative reform.

  2. I agree with .’s response and would add that the NIT could be paid only through an employer. Basically a direct subsidy to negative marginal productivity workers; you have to work to get it. I see it more as a social program to break dependancy. I think NIT will inevitably reduce wages across the board by eliminating the prop of the minimum wage. That’s not a bad thing either. I’m not sure if there aren’t any WTO implications, but by then the LDP would have cut all tarrifs and ‘opened the free trade floodgates’ anyway.

  3. I actually think the NIT being paid through an employer is really quite a bad idea.

    “I think NIT will inevitably reduce wages across the board by eliminating the prop of the minimum wage.”

    The minimum wage doesn’t prop up wages. It keeps people out of work. In the long run it probably suppresses wages as hundreds of thousands remain unskilled.

  4. The one element that saves the present welfare system from being an utter disaster is precisely the red tape and the stigma involved in going on welfare. The welfare recipient still bears a psychic stigma, even though weakened in recent years, and he still has to face a typically inefficient, impersonal, and tangled bureaucracy.

    This is kind of like saying the good thing about hitting yourself on the head is that it hurts a lot so you might stop doing it. Which is why we should keep hitting ourselves on the head. Doh!

  5. Job Network is the hidden enabler of welfare in Australia.

    If you’re not on welfare, you will not be part of the job network system.

    A few years back, a HR firm would get $800 from the Commonwealth for every job network “client” they found work for. End the bloody thing right now.

  6. Hazlitt’s argument seems to be a Slippery Slope argument; i.e. that the proposal itself will get screwed over by the political process and turned into an “NIT as a new program” rather than an “NIT as a replacement for those programs.” This doesn’t necessarily discredit the actual NIT proposal (which in all cases is NIT-as-a-replacement).

    Rothbard’s argument seems to be far too into humiliating welfare recipients. The fact is that ‘dole bludgers’ are relatively rare.

    I think the argument that the NIT is worse than the current welfare state is false. The NIT (as replacement, not supplement) abolishes tons of bureaucracy and thus removes plenty of rent-seeking interest groups. It also isn’t useful for social engineering in the way that “targeted” welfare systems are; thus it disempowers central planners. It would lower the cost of government significantly.

    Yes, it is technically immoral. But unfortunately, its a necessary political compromise and even I doubt that a libertarian society could be sustained over the long term without either an NIT or a Randian Philosophical Revolution. The former is probably easier to implement than the latter.

  7. This may be a good place to remind readers of the Negative Payroll Tax approach of Professor Kim Swales of the University of Strathclyde and his colleagues (in the UK – see here), and of Nobel winner Professor Edmund S. Phelps, McVickar Professor of Political Economy at Columbia University (in the USA – see here, or his book “Rewarding Work”). I myself have done a game theoretic analysis of aspects of these proposals (in Australia – see here and following. I have also covered it as part of a Henry Tax Review submission posted on this very blog.

    A Negative Payroll Tax already addresses Forester’s point about going through employers to get a gain, and also bypasses Hazlitt’s objections about tax rate disincentives on workers by using a different carrying tax from income tax (it is convenient to use a GST for this carrying tax, though it is not the only or even the most efficient possibility, mainly because of its disincentives on employers’ investment and economic activity generally). Furthermore, Professor Swales’s work shows that it would actually boost GDP, by about half the improvement in unemployment in percentage terms; this is also the sort of thing my own work shows would happen, from it working like a Pigovian subsidy offsetting the spillover costs of funding unemployment benefits. In the long run, either a Negative Income Tax or a Basic Income would also do that – all three, and also Distributism, are long run equivalent, with the last one being a Coasian approach. However, a Negative Payroll Tax is not a true subsidy, i.e. requiring funding outflows, so there would be no churning with associated costs as with a Negative Income Tax or a Basic Income. Nor would there be transitional costs as with a Negative Income Tax or a Basic Income, as it does not involve a delay while real wages fall enough to price people into work – their gains are folded into wages paid over (that makes it faster acting, too).

    The only outstanding issues relate to effects on saving to build investment and interactions with other economies under other systems, as jobs could still be exported if savings, capital and/or industrial activity were. I am working on those separately, e.g. in Appendix C of my Henry Tax Review submission.

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