Against the Negative Income Tax
The Manhattan Institute’s City Journal is a reliably excellent magazine, and the current issue is no exception. I found myself disagreeing, however, with Guy Sorman’s article arguing for a Negative Income Tax (NIT).
The NIT, in plain English, is a government-guaranteed minimum level of income. Sorman makes the classic argument that the biggest advantage of the NIT is that it would eliminate almost the entire welfare bureaucracy, and the tangle of often counter-productive programs that go with it. He dismisses the obvious common-sense objection – that the prospect of a lifetime income for doing nothing might discourage people from slapping the top of the alarm clock every weekday morning at 6AM and going to work – with the argument that the NIT could be made progressive in a way that would theoretically encourage work as compared to the current welfare system:
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.
Sorman goes on to reference the famous (among nerds) series of randomized experiments in the 1960s and 70s that tested the effects of the NIT on labor force participation. He says that the results of these experiments were “fuzzy,” but that the first of the experiments showed that the unemployed people who received the NIT grant were “likelier to try to get back to work.”
Sorman is wise to look to these tests of the theory. The power of randomized experiments is that they provide the scientific gold standard method for cutting through the tangle of correlations inherent to these kinds of social questions to create a definitive answer to the question of the causal effects of a tested program on a measured outcome. But I believe his interpretation of the NIT experiments is incomplete, in ways that are fundamental to his argument.
There were four large NIT experiments conducted in the U.S. between 1968 and 1980. These tested a wide variety of program variants among the urban and rural poor, in better and worse macroeconomic periods, and in geographies from New Jersey to Seattle. There was, and is, a lot of scholarly debate about many of the experimental results, and their potential application to policy-making. But there are two consistent findings across this body of experiments.
First, the tested NIT programs reduce number of hours worked versus the existing welfare system. Directly contrary to how I understand Sorman’s claim that the the New Jersey – Pennsylvania experiment showed that the NIT made recipients “likelier to try to get back to work,” this reduction in labor hours was primarily caused by workers remaining non-employed longer if and when they became non-employed.
Second, the tested levels of progressivity of implicit tax rates did not get around this problem by encouraging work, as Sorman’s theoretical argument asserts they should. See for example, Robert A. Moffitt (the subject matter expert cited by Sorman), who has written extensively about why the NIT experiments showed that “lowered tax rates had essentially no effect on labor supply.” Moffitt has, in fact, written a series of papers trying to show why even the theoretical argument that implicit tax progressivity would encourage work was incorrect.
While generalizing from experiments to broad policy is always complicated in social science, true randomized experiments confirm common sense: when it has been put to the test, the NIT reduced work effort.
There was a further series of about thirty welfare experiments done around the time of the welfare debates of the early 1990s. These tested many ideas for improving welfare. What emerged from them was a clear picture: work requirements, and only work requirements, could be shown experimentally to get people off welfare and into jobs in a humane fashion. (I’ll have a lot more about this in the upcoming book.) These experiments were an important input into the central tenet of welfare reform -work requirements – which was one of the greatest conservative domestic policy successes of the past twenty years. It moved us in exactly the opposite direction of the permanent, lifetime dole of the NIT.
But what about the argument that there is an important benefit – namely, the elimination of the welfare bureaucracy and the dog’s breakfast of “food stamps, public housing, Medicaid, cash welfare, and a myriad of community development programs” that according to Sorman’s article accounts for $522 billion of annual federal spending? This is extremely unlikely.
By analogy, the debate in global warming circles sometimes pits a “simple, efficient carbon tax” against the politicized mess of the cap-and-trade bill that emerged from Congress. But in that case, the real difference is not that between a theoretical carbon tax and a theoretical cap-and-trade system; it is the difference between an academic idea that has not yet been subjected to lobbying and legislation, on one hand, and real laws that are the product of a democratic process, on the other. In the same way, there is nothing inherent about an NIT that will prevent Congress from creating thousands of pages of special rules, exemptions, tax expenditures and so on, that are collectively just as convoluted as the current welfare system. After all, “tax each person a given fraction of income” is a pretty simple idea too, but look at the 2011 federal income tax code.
And the likely maintenance or reemergence of the functional equivalents of many of these programs isn’t just the result of cynicism, but of healthy intuitions of natural justice that are essential to maintaining a well-functioning political order. As one example, do we really think it’s a good idea to further disconnect work and income? As another, if part of the motivation for giving adults income is that they spend it supporting their children, would we really allow parents receiving taxpayer money to spend it any way they want with no requirements for child welfare beyond child abuse laws? And as another, a huge portion of the costs of the list of programs Sorman provides is healthcare. Suppose we gave every adult in America an annual grant of $10,000, and some person who did not buy health insurance with it got sick with an acute, easily-treatable condition. Would we really bar them from any urgent medical care and just say “tough luck, but it’s time to die”? Even if you think this would be a desirable public policy, it’s not plausible that the existence of an NIT would somehow change the political calculus enough to make it substantially more of a reality than it is today.
Inevitably, and justifiably, the taxpayers who will have to work more overtime, take shorter vacations and eat out less in order to come up with the taxes to pay for an NIT or any other welfare system, will demand some degree of accountability from the recipients; which will, in turn, require monitoring, enforcement, adjudication, and the other manifestations of a welfare bureaucracy. As I put this in a recent article in National Review:
This basic idea arose again and again during the 1960s and 70s. Examples of such proposals advanced by the political right and left included Milton Friedman’s negative income tax (1962), Robert Theobald’s guaranteed income (1965), James Tobin’s guaranteed income plan (1965), R.J. Lampman’s subsidy plan (1967), Edward Schwartz’s guaranteed income, the negative income tax plan of President Johnson’s Income Maintenance Commission (1969), President Nixon’s Family Assistance Plan (1969), George McGovern’s $1,00-a-year plan (1972), and HEW’s Income Supplementation Plan (1974). This idea constantly arises even today in academic discussions, and is being pursued seriously by the current coalition government in the U.K. The key reason we haven’t implemented such a scheme in the U.S. is that we are afraid that many of the recipients will not work, and then blow the money on Cheetos, beer and big-screen TVs. In more academic language, the moral legitimization of the welfare system requires that the recipients earn and then use this money in support of a way of living that comports in some rough sense with the idea of the good life held by taxpayers who provide the funds.
The NIT is a fascinating and useful thought experiment, but it’s not a practical public policy.
(Cross-posted at The Corner)
You really are on a roll, Jim.
I was a huge supporter of work requirements for welfare, precisely for the reasons you’ve articulated, and yet I’ve also flirted with support for a Guaranteed Minimum Income, in part because of the serious plight of the working poor, and in part because I don’t think we can afford to offer as generous entitlements as we currently do to the middle-class elderly, and so need to rethink more generally how “social insurance” works.
I think the appeal of “just give money” isn’t just that it reduces bureaucracy, but that it reduces the likelihood of policy-capture by service providers. Social Security just writes people checks. So it’s a really efficient program, operationally, but it also can’t be captured by any constituency. Compare to Medicare, which offers a service – insurance. This is a much more expensive program to administer (though arguably with less overhead than private insurance) – but, as well, there is the pervasive problem of the program being “captured” by service providers, who lobby to have their services covered and/or organize their services more around coverage rules than around medical necessity or efficacy. Some have used this as an argument for “voucherizing” Medicare, but to some extent this just pushes the problem of capture on to whatever body is responsible for regulating the insurance that you are allowed to purchase with the voucher. Your point about how politics inevitably leads to some degree of capture is well-taken, but programs can nonetheless be designed to be more or less vulnerable to capture of this sort. Unfortunately, I think there is a necessary trade-off between paternalism and the risk of capture, so to the degree that you believe some degree of paternalism is necessary for a program to achieve its goals, you just have to live with this tension.
It would be interesting to try to calculate which imposes more of a drag on the economy as a whole: providing a guaranteed minimum income, which would discourage work at the margins, or providing welfare with a work requirement, with all the management costs associated with making that program work. In other words: would the additional work done by welfare recipients under the second scheme add enough economic value to pay for the additional costs of administration. I doubt it would. Of course, this isn’t the only consideration by a long shot – the welfare of the recipients ought to be the primary consideration. But it’s still a point worth pondering.
Another idea that gets floated in these discussions is wage subsidies. This would presumably encourage rather than discourage work, and would specifically help the working poor. Trouble is, it’s also plausible that it wouldn’t help them much, because most of the subsidy would be captured by employers, who could get away with offering lower wages because of the subsidy.
— Noah Millman · Feb 15, 04:54 PM · #
Jim, I’m kind of astounded to find no mention here of the Earned Income Tax Credit — which is essentially a negative income tax with a work requirement.
I don’t think I have to tell you how its efficacy and efficiency answer (almost?) all of the objections your raise here.
I also think its important to point out the EITC’s dual incidence: it both encourages employees to work, and employers to hire (because they can get a higher-quality, higher-ticket employee for less).
Aside from expanding it significantly, I would also suggest a significant education campaign teaching workers that they can receive their EITC on their weekly paychecks. (Only about 1% of recipients do.) This would greatly increase its “salience,” hence it incentive effect on workers.
I actually think of the EITC as equivalent to a turbocharger on a car — recycling hot, volatile waste gases (think: money profits from credit-financed financial arbitrage) back into the carburetor of the real economy, putting circulation of those moneys in the hands of the crowds — so their collective wisdom can do its magic.
— Steve Roth · Feb 15, 04:59 PM · #
Noah’s point again suggests the merits of the EITC, which is much more like Social Security than Medicare. It just cuts checks to workers based on a fairly simple income-based formula. Those flows are not easily captured — or at least they haven’t been so far.
— Steve Roth · Feb 15, 05:08 PM · #
Steve: do you know of any studies that address my last question, the question of whether wage subsidies are effectively captured by employers?
I’m an employer. I can retain a workforce of a certain caliber by offering $8/hour, and at that rate I can run a profitable business, and compete effectively with other businesses in the same position.
Now the government passes a law subsidizing my $8/hour rate by $2/hour for employees who are below the poverty line. This should make the job more attractive to more people.
But what does that mean to me or my competitors? The subsidy allows me either to upgrade the skill-level of my workforce, since I can now offer the equivalent of $10/hour (net of the subsidy), or to cut the wages I offer to increase my profit (since I was able to attract workers before for $8/hour, presumably I could still do so for the same net cost).
What you’d expect to happen is that I do the latter, and that my competitors do the latter as well. With higher profits, we can afford to cut prices to increase market share, and so we all do that as well, until we reach a new equilibrium where our profits are back where they were, wages net of the subsidy are also back where they were, and the subsidy winds up in the pockets of consumers.
Obviously the world isn’t as neat as all that – but it’s a strong theoretical argument, I think, that wage subsidies (such as the EITC) can’t help the working poor as much as people would like to think.
You can put a floor under the whole scheme by having a minimum wage at a sufficiently high level. In that case, I might not be able to cut my offered wages. But a high enough minimum wage also makes some jobs uncompetitive – or, rather, pushes them into the underground economy.
To use my prior example, suppose I have a competitor who provides higher wages – $10/hour – and offers a superior service at a higher price. Our market is segmented – I’ve got the customers who are satisfied with a lower level of service at a lower price, and he’s got the customers who will pay a slightly higher price for a higher quality of service. Assume, further, that the minimum wage is $8/hour.
Now the wage subsidy goes into effect. Assume both my employees and my competitor’s are eligible for the subsidy. Net of the subsidy, my employees now earn $10/hour. My competitor’s earn, let’s say, $12/hour.
Now assume my competitor lowers his wages to $9/hour before the subsidy.
He’s still offering more than I am – so he’s still retaining a higher quality of employee. But he’s paying less out of his own pocket than he was, so he can lower his prices and capture market share.
How do I compete?
Well, I could lower my wages – except that my employees are making the minimum wage, so I can’t. So I start to lose market share, as my marginal customer moves up to the higher-quality service that is now closer in price to my own offering.
At some point, I’m going to do one of the following things:
I could get out of the business. In that case, my competitor will capture all the market share, and will offer a higher-quality service for the price I used to offer and the wages I used to offer (which, net of the subsidy, are the wages he used to offer). My ex-employees, who were not productive enough to provide that quality of service, now have to find work in another sector, assuming such work is available. The wage subsidy has been captured by consumers in the form of an improvement in the quality of service.
Or I could try to get around the minimum wage, which might mean employing some people illegally off the books, or legally moving operations to other jurisdictions where wages were lower, or what-have-you. Whatever I do, at least some of my old workforce is laid off because I cannot continue to pay them the wage I paid them before due to competition, but the market remains segmented and both I and my competitor offer our old services at lower prices. The wage subsidy has again been captured by consumers, in this case in the form of lower prices.
I’ve gone on too long, but the point is that, in general, subsidies for one or another activity change the prices of a variety of goods and services, and thus don’t necessarily end up subsidizing what you’d think is being subsidized.
— Noah Millman · Feb 15, 05:31 PM · #
Noah, thanks for your long note. Sorry I don’t have time for an equally lengthy reply, only a few thoughts.
No, I don’t know any research that’s answered your question. Will explore.
Yes, of course your basic theory makes basic sense, and yes of course the world isn’t that neat.
Employers are to some extent competing with each other for workers (at least in certain locales, geographic and temporal), limiting their ability to cut wages.
Especially apt bringing up minimum wages, because they remove that option for low-wage employers who aren’t willing to cheat.
I have followed the research on that subject, and I’m pretty convinced at this point that at the minimum-wage levels we’ve seen over past decades, the earnings effect is significant (i.e. important), while the employment effect, at least in the aggregate, is small to nonexistent. Here’s the most recent I’ve looked at, which strikes me as being especially well-executed, comparing adjacent counties across state borders, over decades.
http://www.irle.berkeley.edu/workingpapers/157-07.pdf
IOW the demand for labor among low-wage employers is quite inelastic — again, at least within the range of minimum wages we’ve seen over the decades.
Combine a $7 minimum wage with a $2 spiff…
— Steve Roth · Feb 16, 03:30 AM · #
I find it interesting that Jm Manzi should mention carbon taxes in connection with the negative income tax, because I believe a guaranteed income has major benefits for the environment. Obviously, human labour produces or at least delivers many of the goods and services we buy, but equally, the natural world provides inputs to those goods and services as well. If the natural world has limits, and a portion of all the goods we consume takes some value, either temporarily or permanently, from natural world, then our consumption needs to have limits. It follows that the current paradigm of working harder in order to consume more will not work indefinitely; I would argue that we have already hit several critical limits. Maybe we need to reward people for figuring out ways of producing goods and services while using less in the way of resources, but I would argue that we also need to find a way to reward people for simply consuming less, and it seems to me that the negative income tax offers a good step in that direction.
So let us say that Bill and three friends decide to take off and live in a shack on the beach, collecting their negative income tax and seeking out the perfect wave. I would argue that in a world of environmental limits, people who do not consider they have something important to contribute and who will agree to curtail their consumption actually perform a valuable, and indeed essential service. It only makes sense to provide at least a basic reward for this choice.
— John Spragge · Feb 16, 07:42 AM · #
“In the same way, there is nothing inherent about an NIT that will prevent Congress from creating thousands of pages of special rules, exemptions, tax expenditures and so on, that are collectively just as convoluted as the current welfare system. After all, ‘tax each person a given fraction of income’ is a pretty simple idea too, but look at the 2011 federal income tax code.”
Let’s see it.
EITHER the structure of your tax system has relevance in terms of ease of political machination, or it doesn’t. It seems self-evident that certain tax structures are harder to abuse then others. The simplicity of understanding the concept of our tax system has nothing to do with its ease of manipulation.
You touched on the important issue with the mandate. I overlooked issue is that because of economy of scales, a household is usually better off adding an additional person than more labor. Which would result in some very weird outcomes.
One thing to note is that the larger government gets, the lower the minimum income level can be, so both problems can be solved with a massive state backed by large taxes. Rather then shrinking the size of government, such a program would likely ratchet it up! For systems with inherent minimalism such as Sea Steading, Charter Cities, and especially something like a space colony, it could work. Transitioning to a NIT in the US though would require a massive change in the relationship of the people to the government. Both a reduction in size of government services, and change in how we solve our life’s problems at the individual level. NIT is an outcome you would expect after massive Voucherization, not just of Education, but of Health and Roads and many other Government Services. It is, in essence, a voucher for simply BEING a citizen, with the expectation that you will spend it wisely based on your ‘needs’. A NIT is Socialism as a result of an increasingly Libertarian state: As the social net becomes more individualized it becomes even larger and more encompassing.
I’m not too sure what I think of that.
— Patrick L · Feb 19, 12:45 PM · #
Just to address Noah Millman’s comment: I suggest looking at the function of a negative income tax a little differently. Consider that all government wealth transfer programs exist to try to resolve an economic contradiction: human skill and effort plays an important part in all economic processes, but humans have an inherent dignity that transcends economic performance. Thus, the joint stock company protects entrepreneurs from the traditional consequences of bankruptcy, such as loss of home and, in ancient times, loss of freedom. Social welfare programs do the same thing for workers. However efficient or inefficient a negative income tax proves at transferring wealth, it will transfer power.
Right now, the negative effects of the welfare system mean that low wage workers have very little to bargain with, and managers of these workers, or the owners of the businesses where they work, have a license to behave quite badly. The system provides strong incentives for people in need, not only to get up and go to work, but also to compromise their dignity for a pay cheque. With a negative income tax, a badly behaved employer has much less power. Workers can put up with a very low pay rate from an employer who will treat them with dignity and teach them something; people work for poverty level wages, and in some cases pay to work, for things they believe in. A negative income tax will make it easier for a low wage employer willing to instruct employees and help them move to better jobs, and correspondingly harder for employers who have only dead end jobs on offer.
— John Spragge · Feb 22, 04:56 AM · #