The Negative Income Tax (NIT) and the welfare state, an effective association?

Talks on the Universal Basic Income (UBI) have been around for decades. While it has never been implemented nationwide in any country, calls for UBI remain strong and, over the past year, notably due to the COVID-19 pandemic, the support on the proposal has notably increased.

The COVID-19 pandemic has had severe economic repercussions worldwide. Source: Getty Images

In the United States, for example, apart from the well-known Alaskan Permanent Fund (which amounted to a single payment of almost $1,000 per person), there has been an increasing support of the proposal by politicians and businessmen. In Europe, as a response to the economic crisis caused by the pandemic, Spain announced a basic monthly income of between 462€ and 1,015€ for the most impoverished households of the country.

Over the decades, the support for a basic income has been embraced by different ideologies. Although it is mostly attributed to being a progressive and social-democratic proposal, several other figures have also expressed their support for the implementation of a UBI or similar programs. One of the most well-known examples is economist Milton Friedman, a fierce advocate of free market and small government. His proposal is known as the “Negative Income Tax” (NIT).

What does the NIT consist of? The NIT is a proposal in which people below a certain income level receive money (negative tax) that is contributed by people above such income level (positive tax, or simply, “tax”). That is, there is a certain level in which in the amount of income is exempted from the income tax (“exemption”). For example, if the exemption amounted to 600€, this would mean that people earning below 600€ would be exempted from paying an income tax, and they would receive money from people earning over 600€. If the negative income tax rate were, for example, 50%, a person earning 500€ per month would receive an extra 50€, since this person’s income would be 100€ below the exemption and 50€ is 50% of 100€.

New monthly income with a rate of 50% and an exemption of 600. The new income of workers earning above 600 (orange) is approximate.

Contrary to the UBI, which would provide an extra income to everybody, the NIT, as specified, would only benefit people earning below a certain amount. So, why do Milton Friedman and other people support the NIT over other types of basic incomes or welfare programs? Friedman provides two reasons for it:

                1.- Since the goal is to reduce poverty, the proposal should be focused on such objective.

                2.- The proposal should avoid distorting the market as much as possible.

Concerning the first reason, Friedman tries to explain that UBI and welfare programs (farm programs, pensions, etc.), although intended to alleviate poverty, they do not necessarily help poor people. As Friedman says: “There is every reason to help the poor man who happens to be a farmer, not because he is a farmer but because he is poor” (Milton Friedman, Capitalism and Freedom, page 191). In other words, Friedman protests against the fact that an important amount of the money intended for poor people ends up in the pockets of people that do not need it as much as others. The second reason is aimed towards welfare programs. Friedman argues that such programs distort the market. This is a classic libertarian view of the welfare state and this article, due to its limited scope and due to the complexity of such claims, does not intend to analyze whether this is true or not. The first reason given by Friedman, on the other side, seems to provide an important point that must be examined.

Milton Friedman was one of the most influential and controversial economists of the 20th century. Source: George Rose (Getty Images).

The European welfare states are at risk. The increasing costs of welfare programs, such as pensions, are undermining the chances of the long-term durability of the welfare states in Europe. Friedman seems to provide a possible solution to the mentioned problem. The increasingly expensive welfare state is theoretically focused towards improving the conditions of all citizens, but it is indispensable for some citizens while it is not for citizens that have enough resources to subsist without the benefits given by the welfare state. The NIT can provide a solution to the problem. Contrary to the UBI or welfare programs, the NIT would help only the members of society that need it the most, thus reducing the government expenditure.

Milton Friedman’s NIT would be enacted as a substitute of the welfare state, whose measures’ he deems as being “wasteful” (Capitalism and Freedom, page 193). However, could the NIT be considered as a complement to the welfare state? Although such claim can be disputed, Friedman seems to have a point when he states that some beneficiaries of the welfare state do not actually need the advantages that it provides. The government could save significant amounts of money while being extremely helpful to the poor. Even though Friedman would surely dislike it, it seems that one of his proposals could help save the welfare state.

Welfare systems have given millions of people access to affordable healthcare. Source: Flavio Lo Scalzo (Reuters, CNS).

We are aware that the welfare state is crucial for the well-being and security of millions of people worldwide. Friedman was a fierce critic of the welfare state. We tried to show that, although the goal of Friedman was different, the Negative Income Tax could be an important addition to the system, even despite the current situation.

This article also seeks to contribute to the discussion regarding the renewed calls for the UBI. The UBI, the NIT and their relationship with the welfare state is extremely complex is many fields, not only economically, but also politically (Capitalism and Freedom, page 194) and ethically since, while all citizens benefit from the welfare state and UBI, only a minority would benefit from the NIT. However, Friedman’s proposition is extremely interesting, and more research should be carried out in this direction.

Sources:

Andrew Kitchenman, Alaska Public Media. For the first time since 2013, the Alaska Permanent Fund dividend will be less than $1,000: https://www.alaskapublic.org/2020/06/12/for-the-first-time-since-2013-the-alaska-permanent-fund-dividend-will-be-less-than-1000/

La Moncloa (Spanish Government). El Gobierno aprueba el Ingreso Mínimo Vital: https://www.lamoncloa.gob.es/consejodeministros/resumenes/Paginas/2020/290520-cministros.aspx

Milton Friedman. Capitalism and Freedom. 2002 (first edition in 1962), The University of Chicago Press, Chicago and London. Notably: “Chapter XVII: The Alleviation of Poverty”.

Eurostat:

Rafael Muñoz de Bustillo Llorente, European Commission. Key challenges for the European Welfare States: https://ec.europa.eu/jrc/sites/jrcsh/files/jrc117351.pdf