The Adam Smith Institute and a Negative Income Tax

The Adam Smith Institute has contributed to the current debate on income maintenance by publishing Free Market Welfare: The case for a negative income tax. The Institute summarises the report:

  • Lower trade barriers, automation and cheaper transport have brought millions of extra low- and un-skilled workers onto the world market. While this has raised living standards and productivity overall, it has also created a group of people whose relative position has weakened considerably: lower skilled workers in developed countries. Globalisation has lowered the market value of many workers’ skills to the point that the clearing price for some labour cannot provide a growing proportion of the UK population with an income that meets the popular definition of minimum living standards – even though it has also contributed to cheaper consumption bundles.
  • This has been partially masked by government welfare policies but the current stopgap solutions to this are costly, ineffective and overly complex leaving many people stuck in poverty traps and financial insecurity. Recent proposed changes to the tax credit and minimum wage systems will only exacerbate the problems facing low-productivity workers.
  • This paper will make the case that if any type of poverty spending is necessary, it should be the one which can provide the simplest, clearest system which places an emphasis on incentives, freedom and choice: A Negative Income Tax.

A negative income tax (NIT) could deliver the same relationship between disposable income and earned income as a Citizen’s Income, so the Institute’s initiative is to be welcomed. However, the report says that any replacement for the current benefits system should be ‘administratively simple’, but in the report the detail of the administration of a NIT is not discussed.

A NIT could be administered by the Government or by the employer. If the Government administers the NIT, then the employer must provide regular and accurate earnings information to the Government, as with the current Universal Credit. If the employer administers the NIT then if someone moves between employers their NIT administration has to be transferred between employers; if they have a period of unemployment then administration of the NIT has to be handed to the Government and then on to the new employer; if someone has two employments then the employers have to decide which of them will administer the NIT; and if someone has occasional other earnings then their employer needs to be informed so that either some of their NIT can be withdrawn or additional tax can be charged.

If every working age adult receives the same rate of NIT both above and below the break-even point (the point in the earnings range at which neither tax is deducted nor negative income tax paid out) then neither their employer or the Government needs to know any personal details. If people in different circumstances receive different NIT rates or have different break-even points then their employer and the Government will need to know individuals’ circumstances in order to allocate administer the NIT correctly.

Our current income tax system is cumulative. An certain amount of income is not taxed each year: so each week, or each month, the employer has to calculate how much tax to deduct so that by the end of the year the correct amount of tax has been deducted. With NIT, the tax system would be non-cumulative. Each week, or each month, NIT would be paid out or tax would be deducted. A non-cumulative system requires a single tax rate, so anyone paying higher rate tax would need to pay additional Income Tax at the end of the tax year.

The administration of a Negative Income Tax would be complicated. The administration of a Citizen’s Income could not be simpler. Given that both NIT and Citizen’s Income would have the same effect on disposable incomes, a Citizen’s Income should be preferred.

It is a pleasure to see the Adam Smith Institute sponsoring research and engaging in this debate. We hope that a further research project will evaluate details of the administration of both NIT and Citizen’s Income and that the Adam Smith Institute will then issue a further report.