What Is Negative Income Tax?

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This tax system got popularized in the mid-19th century. As a result, people became more active in the tax-filing process. In addition, it played a vital role in closing the poverty bridges. Also, they got a subsidized benefit on their incomes. The government has access to personal tax claims. However, businesses and individuals have created loopholes in the system.

Key Takeaways

  • Negative Income Tax is a welfare program initiated by the United States government to provide a subsidized benefit to lower-income groups.In 1962, American economist Milton Friedman proposed this concept. Later, in 1965, Robert Lampman and other economists contributed their notable works. Finally, U.S. President Richard Nixon implemented this plan in the Family Assistance Plan in 1969.The negative income tax formula is Negative income tax (tr) = t (y – xk)The negative income tax system reduced the poverty gaps within the U.S. and provided financial support to families.

How Does Negative Income Tax Work?

Negative Income Tax, also known as net operation loss (NOL), allows individuals to earn a subsidized amount on taxable earnings. American economist Milton Friedman first proposed this system in 1962. According to the system, only certain income groups can access this income. Individuals qualifying for the negative income tax program will receive the benefit. However, it discouraged people from working.

The idea of this tax is traceable back to the 1960s. In 1962, economist Milton Friedman proposed the concept in the book “Capitalism and Freedom.” Later, in 1965, another economist, Robert Lampman, popularized the idea of a net operation loss rate. Lampman argued that the government should provide welfare benefits to two-parent families and single people.

This theory is a mirror reflection of the existing tax system. For example, Friedman’s negative income tax theory states a few benefits that can influence the global economy. Let us look at them:

  • Provides financial assistance to the individualsTargets low-income groups and minimizes the poverty gapsThis program can replace all other supporting programs.Better than other welfare as the cost involved is relatively lower.

Formula

Let us look at the formula to calculate this tax for a better understanding:

Negative income tax (tr) = t (y – xk)

Where tr = transfer amount by the government to the taxpayer

           y = market income (taxable income)

           t = net operation loss (NOL) rate 

         xk = minimum income limit set by the government 

While y depends on the individual’s income, the government pre-decides the t and xk. However, Friedman suggested that the rate be not more than 50%. And the limit should be around $10,000. Likewise, the formula helped in understanding the negative income tax graph.

Suppose a family has net annual earnings of $8500, and the negative income tax rate is 35%. So, as per the formula, the calculation appears as follows:

Negative income tax = 35% (8500 – 10,000)

                                      = 35% (1500)

                                      = $525

Example

The Friedman negative income tax system was supposed to cut down poverty. During 1968 and 1980, the Federal (U.S.) government devised an experiment on this tax. Economists referred to them as income maintenance, guaranteed income, or net operation loss experiments. The government conducted five experiments within a group of 983-4800 participants.

As a result, areas like New Jersey, Carolina, Seattle, Denver, Gary, and Indiana had a reduced poverty line. However, the NIT system reduced the number of hours worked by married and single people by 20-30%.

Pros & Cons

This tax was a boon for below-poverty-line families. The government, as well as society, benefitted from the program. The former had access to the tax filings of the individuals. As a result, people became reluctant (active) to file their income tax returns. As a result, a net operation loss system costs relatively lower than other welfare programs. However, there were specific cons related to it.

To fall under the low-income group, individuals started dropping their work. As a result, they showed misleading figures in their tax returns. In contrast, some economists felt that the NIT program increased the costs of the government budget. Also, it added no extra value to the pre-existing welfare programs.

Negative Income Tax vs Universal Basic Income

Although net operation loss (NIT) and Universal basic income (UBI) provide welfare, they differ slightly. The former tries to provide financial support to low-income groups. However, the latter aims at the universal radar, providing an amount to everyone.

Moreover, while the former originated in the mid-20th century, the latter prevailed during the 16th century. Lately (2020), American businessman Andrew Yang has focused more on applying the latter.

This article has been a guide to what is Negative Income Tax & its meaning. We explain it with its formula, example, pros & cons, and comparison with universal basic income. You may also find some useful articles here –

No, net operation loss (NOL) existed until the early 1970s because of opposition from Congress. U.S Senator Russell Long and National Welfare Rights Organization (NWRO) opposed the NIT and associated FAP. Thus, in replacement, Earned Income Tax Credit (EITC) came into force.

In business, this tax can result from the low income derived in the fiscal year. Therefore, they can apply NIT liability by debiting (removing) from the account payable and crediting the income tax expense.

The main reason for this tax failure was the reduction in work productivity. As a result, people started hiding their actual income. Also, the cost of handling the program was rising suddenly. Besides, even the Congress leaders opposed the plan.

While the welfare programs consider everyone or most of the population as the beneficiaries, the latter focuses on the lower-income groups. Also, the welfare programs were lacking as they benefited the richer more, increasing the poverty gap.

  • Wealth TaxOther IncomeTax Loss Harvesting