Kreps, Juanita M.

English

Research Papers in Economics

NEGATIVE OUTLOOK FOR THE
NEGATIVE  INCOME TAX
Juanita M.  Kreps
Professor of Economics
Duke  University
We are convinced  that rising productivity  has brought this country
to  the  point  at  last  when  all  citizens  may have  a  decent  standard  of
living at  a  cost  in  resources  the economy  can easily  bear. We  believe
that nearly all should,  and wish to, earn  their own support, for the dig-
nity  and  self-respect  that  comes  from  earning  one's  own  living  can
hardly  be achieved  otherwise....  But the war on poverty  has made  it
abundantly  clear  that the  road to  satisfying  life  through  work  is  not
open to everyone:  not to families without  breadwinners,  not to those
whose productivity  is reduced by physical  or mental  incapacity,  not to
people too old to work....
The Commission  recommends  that Congress  go  beyond  a  reform
of the  present  structure  and  examine  wholly  new  approaches  to  the
problem  of income  maintenance.  In particular,  we  suggest  that Con-
gress give serious study to a "minimum income  allowance"  or "negative
income  tax"  program.  Such  a  program,  if found  feasible,  would  be
designed  to  approach  by  stages  the  goal  of eliminating  the  need  for
means test public assistance programs  by providing a floor of adequate
minimum incomes.'
In today's  review  of possible  schemes  for  maintaining  incomes,
the  negative income  tax is but one possible method,  and perhaps  not
the  best.  Yet  it  does  call  attention  to  the  shortcomings  of present
programs.  And it  does attempt  to provide  the one short-run medica-
tion-money-for  the disease  that  we have  come  to diagnose,  with-
out  consultation,  as  poverty.  All  variations  on  the  income  theme
suffer some  disadvantage  in addition  to the common one  of cost.
THE THEME, WITH VARIATIONS
It  is  generally  recognized  that the present  public  assistance  pro-
gram  fails  to  meet  the  needs  of the  thirty-five  million  poor  in  the
United  States.  Not only  are  coverage  and  benefits  restricted,  but ad-
ministration  of the program  leads  to interference  in  the  lives  of the
recipients.  Out of this situation and the concept of the social  dividend
plan-a plan for  the redistribution  of the wealth  of society  based on
the  theory that  everyone  is  entitled  by  right  to a  minimum  share  in
'Technology and the  American Economy,  Report  of the  National Commission  on
Technology,  Automation, and Economic  Progress, Washington,  D.C.,  1966, p.  38.
103the  goods  produced  by  society-has  come  the  idea  of the  negative
income  tax.  This  is  a scheme  for transferring  by  taxation  the money
necessary  to guarantee some  minimum  annual  income.  Its  advocates
argue  that the  concept  of a guaranteed  income  is  already inherent  in
the  public  assistance  program  and that  the tax  system now  transfers
income  from  one segment  of the  population  to  another  by  allowing
deductions to families with children.
The  negative  income  tax  shares  with  other  guaranteed  minimum
income  plans  an  essential  characteristic:  it  is  a  direct  transfer  of
money  to the poor,  and  is thus  an  attempt to provide sufficient  funds
to  maintain  an  adequate  level  of living  now.  It  is  not  intended  to
supplant efforts to increase the factor income of the poor, but is based
on  the idea that these  efforts  are  at best  long run,  and  at  worst,  in-
effective  in reaching  certain groups of persons.
In  effect,  the negative income  tax  involves  a symmetrizing  of the
present positive  tax  system.  Administration  would be  by the Internal
Revenue  Service,  payments  being  made  automatically  upon  receipt
of  a  statement  of  income  similar  to  (but  simpler  than)  an  ordinary
tax form.  It is non-categorical  in approach.  Eligibility  (in most plans,
based on  the family  as a unit)  would be determined  solely  by income
and  family  size;  consequently,  the  difficulties  of determining  eligi-
bility in exclusionary  categories would  be virtually  eliminated.
Although  many  variations  have  been  suggested,  they  all  require
decisions  on the  base  to which  the rate  is to  be  applied,  the  tax  rate,
the  effective  minimum,  and  a  break-even  point.  Two  possible  bases
have  been  under  consideration:  (1)  the  unused  exemptions  and
minimum  standard  deductions  of  a  family  with  no  taxable  income
and  (2)  the poverty-income  gap,  which  is  the difference  between  an
officially  established  poverty  line for  a particular size family  and that
family's  money  income.  Although  the  two  bases  differ  substantially
only  for  very  small  or  very  large  families,  the  poverty-income  gap
is  considered  a better  indicator  of need.  It  has the  additional  advan-
tage  of eliminating  payments  to  families  with  low  taxable  incomes,
but who are not poor in terms  of total money income.
As  to  tax  rate,  one  observes  that  the  present  public  assistance
system  operates under what amounts to  a  100 percent tax-for every
dollar  earned,  the  public  assistance  allotment  is  reduced  by  $1.00.
This provides a disincentive  to work. The negative income tax attempts
to provide  some  work  incentive  by  allowing  the  poor  to keep a  per-
centage  of their  earnings  in addition  to the  payment.  This  means  a
tax rate  considerably  lower  than  100  percent.  Not  only  does  a  100
percent  rate  eliminate  the  monetary  incentive  to  work;  it  could  re-
104suit in  a much greater cost to the economy.  The poverty-income  gap
is  presently  estimated  at  $11  billion.  Although  it  is  impossible  to
measure  the  extent  of the  disincentive  effect produced  by filling  the
gap at one fell swoop, guesses of the probable cost range to $24 billion.
The  effective  minimum  income  can  be  either  a  stated  floor  or
simply  the  amount  paid on  a particular  scale  to  a family  with  zero
income.  The  break-even point is  that point  at  which  a  family's  tax
liability equals its guaranteed income, and thus the payment becomes
zero.
A look at some of the plans  which have been  suggested  indicates
the different  combinations  of these  variables.  One  of the earlier pro-
ponents  of the  negative  income  tax  was  Milton  Friedman,  who  in
Capitalism and Freedom proposed  a  simple  negative  income  tax
plan  to replace the present  proliferation  of public assistance  and  gov-
ernment  welfare  programs.  Friedman's  plan  would  apply  a tax  rate
of,  say,  50  percent  to  a  family's  unused  exemptions  and  minimum
standard  deductions.  If the  exemptions  and minimum  standard  de-
ductions  of a family  of  five  were  $3,700,  and  their income  $2,000,
unused  exemptions  and  deductions  would  be  $1,700.  Fifty percent
of this would  be $850,  so  the total income for  this family would be
$2,850.  The  unstated  but  effective  minimum  income  in  this  case
would be the maximum payment of $1,850  to a family  with no other
income.  Friedman  hopes  to eliminate  all other  forms of government
intervention  in the economy,  including such welfare services as public
clinics, in order to maximize  freedom of consumer choice.2
Most other plans  use the poverty-income  gap, rather than unused
exemptions  and deductions  as their  base;  otherwise,  they  operate  in
much  the  same  manner  as  that  proposed  by Friedman.  To  use  the
same  example,  if the poverty  line  for this family were  $3,500,  their
poverty-income  gap would be $1,500,  and payment  (at a  50 percent
rate),  $750.
Robert  Lampman  has  suggested  several  more  elaborate  plans,
which  demonstrate  some  of the variations  possible.3 All of his plans
are based  on the poverty-income  gap  and restrict payments  to those
whose  incomes  are below the poverty  line. The break-even  point for
a family of four would be their poverty  line of $3,000. For this family,
one plan calls for an effective  minimum of $1,500,  and then a varying
2Christopher  Green,  "Negative  Income  Taxes,  Improved  Public  Assistance  and
Poverty,"  paper delivered at Conference  on Welfare  Problems and Public Policy, Clark
College, Atlanta,  Georgia,  April  19-21,  1966, p. 3;  and Sar A. Levitan, "The Pitfalls of
Guaranteed  Income,"  The Reporter, 36, No.  10 (May  18,  1967),  p.  13.
3Robert  J.  Lampman,  "Negative  Rates  Income  Taxation,"  paper prepared  tor the
Office of Economic Opportunity,  August  1965.
105tax rate with high marginal rates for the lower  income brackets. If the
family's  income  is  $500,  their  poverty-income  gap  is  then  $2,500,
and payment at 45 percent of the poverty-income  gap would be $1,125,
bringing  their total income  up to $1,625.  For a family  with  a $2,000
income,  payment  at  25  percent  of the poverty-income  gap would  be
$250.  This plan  concentrates  its  benefits  on the poorest  of the poor,
but  like  all  negative  income  tax  plans,  would reach  many  of those
people  who  are  working  and  not  on  relief,  yet  whose  incomes  are
considered  insufficient by today's  standards.
Another  of Lampman's  plans  would  provide  a  $750  allowance
for  families with  incomes  from  $0 to  $1,500,  with  a reduction  of 50
percent  in the allowance  for any  income  over $1,500. Here,  more  of
the  benefits  are  concentrated  on  those  who have  some  income,  and
who  are  probably  not  on  relief.  It  also  provides  a  work  incentive,
especially  for  those  with  incomes  below  $1,500.  Since  the  benefits
are  clearly  inadequate  for  those  with  the  lowest  incomes,  the  plan
relies on public assistance  to supplement the allowance.
James  Tobin  would  have  an  income  guarantee  high  enough  to
raise  those  families  with  no  other  income out  of poverty,  and  a tax
rate  low enough  to  provide  incentives  for  those  who  can  work.  For
example,  if the  guarantee  were  to equal  the  $3,000  poverty  line  for
a  family  of four,  and  the  tax  rate  were  set  at  50  percent,  a  family
with  an income of $2,000  would receive  $2,000  ($3,000 less  50 per-
cent  of their  previous  income),  making  their  total  income  $4,000.
He points out that if the income guarantee  is to be sufficient to support
a  family,  and  yet  provide  an  incentive  to  work,  it  is  impossible  to
avoid  making  payments  to families  who  are  above  the poverty  line.
(In  the example  given  above,  the break-even  point  would  be  an  in-
come of $6,000.) 4
This can  be avoided  in  any plan which  provides  a reasonable  in-
come  floor  and  less than  a  100 percent  rate,  but  only  at the cost  of
producing  what  has  been  called  the  "notch"  effect.  If  a  minimum
of  $3,000,  for  instance,  is  specified,  with  a  tax rate  of 50  percent,
and  families  with  incomes  over  $3,000  are  excluded,  a family  with
a  $2,000  income  would  receive  $2,000  ($3,000  less  50  percent  of
$2,000),  making  their  total  income  $4,000.  This  would  be  more
than that of  a family  whose  own  earnings of $3,500 prohibited them
from receiving  any assistance.  The logical thing for the second family
4James  Tobin,  "It Can  Be  Done:  Conquering  Poverty  in  the  U.S.  by  1976,"  New
Republic,  156,  No. 22  (June  3,  1967),  pp.  14-18; also  "Negative  Income Tax,"  excerpt
from  an  article  entitled  "Improving  the  Economic  Status  of the  Negro,"  Daedalus,
Fall  1965,  pp.  891-93.
106to  do would  be to  curtail  its  earnings  until  they dropped  below  the
$3,000 level.
PROBLEMS AND  ALTERNATIVES
Of the  many  problems  involved  in the negative  income  tax per-
haps the most important is  avoiding payments to the non-poor,  if the
guarantees  are to be adequate  and the public assistance  characteristic
of  100  percent  disincentive  is  to  be  avoided.  Moreover,  any of the
plans  would  be  very  costly,  even  if restricted  to  those  below  the
poverty line.  Although calculations of cost must take into account the
amount  of reduction  in public  assistance  expenditures,  it  is  difficult
to see how public assistance  can be eliminated entirely,  without leav-
ing some families worse off than they are  at present.
There would  also  be  difficulties  in  the  administration  of such  a
program.  If payment were made  at the end  of a year  on the basis of
a statement  of that year's income,  the money would not be available
when it was needed.  Payment  on the basis of estimated income would
likely  require  adjustment  at  the  end  of  the  year,  and  it  might  be
almost  impossible  for  a  poor  family  to  return  overpayments.  This
difficulty could be eased somewhat by quarterly or monthly statements.
Objections have been raised to having such a program administered
entirely  by  the  federal  government,  not  only  by  opponents  of  "big
government,"  but by those who feel that local workers can do a better
job. It is  argued  that the need  is  to individualize  benefits,  not nation-
alize them,  and that the Internal Revenue  Service cannot be expected
to  be  more  sympathetic  to  the  problems  of the  poor  than  present
welfare officials.
Finally,  criticisms  of  guaranteed  income  plans  in  general  are
relevant  to  the negative  income  tax.  There  are questions  of whether
a  guaranteed  income  might  lower  the  already  low  mobility  of  the
poor,  making it even less  likely that they will move to sections of the
country  where  jobs  are  more  readily  available.  Congressman
Thomas B. Curtis has suggested that any guaranteed income will lower
the  incentive  to  save,  raise  the  propensity  to  consume,  and  thus
threaten investment.5
Several  alternatives  to  the  negative  income  tax  have  been  pro-
posed;  revision  of  the  public  assistance  system  is  one  suggestion.
Benefits  and coverage  should be expanded,  additional public services
provided,  and  the  means  test  simplified.  The  poor  are  not  a homo-
5"Income  Guarantees:  A  Spectrum  of Opinion,"  Monthly Labor Review,  90 (Feb-
ruary  1967), pp.  III-IV.
107geneous  group,  the argument  runs,  and  a  single program  cannot  be
expected  to meet the needs of all.  Interestingly  enough,  the Advisory
Council  on  Public  Welfare  has  suggested  a  revision  of the  public
assistance  system  which  would  turn it into  a form  of guaranteed  in-
come  plan.  The  federal  government  would  establish  an  income
floor  and  provide  the  states  with  all  the necessary  funds.  Eligibility
would  be  determined  entirely  by  need.  This  plan  carries  the  same
disadvantage  as  the  present  public  assistance  system  or  a  negative
income  tax  with  a  100  percent  rate:  it  eliminates  the  monetary  in-
centive to work.  Lowering the rate would lead to payments to families
above  the  floor;  excluding  these  families  would  result  in  the  notch
effect.
Daniel  Moynihan  has  suggested  a  monthly  family  allotment  of
$10 per child, regardless  of income;  60 percent  of all poor  families,
he points  out,  have children.  However,  the objections  are raised  that
this  amount  is  not  adequate  for  the poor,  and  it  also helps  families
who are not poor and who have 75 percent of the children.6
Some  economists  such  as  Leon  Keyserling  feel  that  while  some
forms  of assistance  are  necessary  and  should  be expanded  for those
who  are  unable  or  should  not  work,  the emphasis  on  a guaranteed
income  is  in itself defeatist.  They would  recommend  instead guaran-
teed  full  employment,  with  the government  as  the "employer  of last
resort."  Keyserling  points out that  there are more than enough  unmet
needs  in  the  public  sector  to  avoid  the  inference  of "made  work."7
In  rebuttal,  proponents  of the  negative  income  tax  argue  that it
would  be  an  effective  way  of filling  the poverty-income  gap without
discouraging  the  incentive  to work.  It  would help  the working poor
-there  are  17.2  million poor persons in families  with  a breadwinner
-a  group  largely  neglected  by present  assistance  systems.  It  would
eliminate  the  need  for  a  huge  welfare  apparatus.  It  would  provide
a national  assistance  minimum,  and the present  wide  state variations
in  welfare  payments  would  be  eliminated.  And  finally,  it  would  be
impersonally  and  impartially  administered,  with  income  and  family
size being the only criteria.
In  conclusion,  it  should  be  made  perfectly  clear  that  proposals
for  guaranteeing  income  are  not  a  substitute  for  longer-range  pro-
grams  designed  to increase labor  productivity.  As Christopher  Green
has noted in his excellent  analysis of the various  income  maintenance
proposals:
6Green, op. cit.; Lampman, op. cit.; and Levitan,  op. cit.
7Leon  H.  Keyserling,  "Guaranteed  Annual  Incomes,"  The  New  Republic,  156
(March  18,  1967), pp. 20-23.
108The transfer-by-taxation  proposals contrast-but  are certainly  not
incompatible  with-the  antipoverty  programs.  ..  . The  programs
under  the  Economic  Opportunity  Act  are  aimed  at  making  the poor
more  productive  future  earners;  the  transfer-by-taxation  proposals
would  give  dollars  directly  to the  poor.  ...  It  is  not inconsistent  to
provide  money  income for the poor and  at  the  same  time  make  gov-
ernment expeditures  for raising the productivity  of the poor.
8
Only in this dual  approach  can  a long-run solution to poverty be
found. But both the long-run goal of higher productivity  and the short-
run  guarantee  of  money  income  are  of  course  constrained  by  our
current obligations,  and by the price pressures  generated in a partwar
economy.
8Christopher  Green,  Negative  Taxes and the Poverty  Problem, Studies of Govern-
ment Finance,  Brookings Institution, Washington,  D.C.,  1967,  pp. 8-9.
109

NEGATIVE OUTLOOK FOR THE NEGATIVE INCOME TAX

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