Thursday, December 28, 2006

Negative Income Tax

I have been a long time reader of They have a subscription service which sends out articles daily. They recently had an article on fallacies of negative income tax

The article says

An orthodox relief program would pay the jobless head of a family, say, $60 a week. If he then started to earn something, he would be paid simply the difference between that amount and $60. Under the NIT principle a man who was earning nothing would also receive a relief payment of $60 a week. But if he then earned $30 a week on his own he would still get a $45 payment (reduced by only $1 for every $2 earnings), bringing his total income to $75 a week.

I am not an economist. Infact this was the first post where I ever heard of negative income tax. However, I feel that the numbers in the examples just don't add up.

According to me under the NIT principle if he earned $30 a week on his own he would still get a $15 (half of the difference) payment from the government. So his total income would be $45 and not $75.

So there is no anamoly. Anytime a person earns more than $60 he gets nothing from the government. Anytime he earns less than $60 he would be just that much close to $60. So earning $58 a month would get him $1 from the government for a total salary of $59.


  1. I think you misunderstood Negative Income Tax.

    NIT is a form of Guaranteed Income scheme (GIS) with the following variables

    1. F: The government provided a fixed payment to every individual.
    2. R: A flat tax rate of positive income tax.(In percentage)
    3. I: Income earned other then the fixed government payment.
    4. E: Total take home earning of an Individual

    E= I – R*I/100 + F
    In this case
    E= 30-15+60 = 75.

    The rationale for NIT is, if we take into consideration something called the ‘Welfare Trap’. For that we need to compare the effect of Progressive Income Tax on Low Wage Employment.

    Take the case of a government providing GIS under Progressive Tax System. An unemployed gets a fixed payment of 100.Income tax is 20%.

    Let us also assume that the Minimum prevalent wage (Enforced by Law or otherwise) is also 100. This is a reasonable assumption to make for two reasons
    1. We cannot accept the government to pay less then what the law/society deems as a minimum cost of decent moral living. (This is a welfare system)
    2. We cannot accept the government to pay more than the minimum wage because there is a limit on available resources and funds with it. Also paying more then the minimum prevalent wage would be a sure shot way to give ‘Unemployment Incentive’.

    Let’s analyze an unemployed person who is receiving this payment. If he is offered a job paying 110 Rs. Will he take it?
    No. 110 Rs would invite a tax of 22 Rs.
    Thus his earnings are 110-22=88Rs.
    This is a net loss of 12Rs from what he was getting when he was unemployed.

    Thus we can see that the progressive tax system is a ‘deterrent’ to employment for those who are expected to earn wages near the minimum wage. A ‘Welfare Trap’.
    NIT avoids this situation (Theoretically speaking).In case of NIT he would get 188Rs.

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