Introduction

I am a proponent of Negative Income Tax (NIT). I am because it can deliver social security via a basic income, because it is simple and cheap to administer, and because it is libertarian.

In this piece, I try to set out why implementing NIT in Britain does not require any radical surgery to the existing income tax system. I also point out that the disincentive effects of NIT are comparatively low. I suggest that the sanctions regime currently in vogue would be inappropriate under a fully developed NIT. I also briefly explain why the cost of implementing NIT, at least at first, is likely to be close to zero.

What is NIT?

It’s a very simple idea. For those individuals whose incomes fall below the personal allowance, the tax authority, instead of charging income tax, makes a reverse payment to top up the individual’s income. One of its original architects, Milton Friedman, thought the payment should be universal, unconditional and be made without moral judgement. His idea was to replace complex and judgemental social security systems. The logic of income tax automatically and progressively claws back negative income tax payments when an individual’s income exceeds their personal allowance.

How would IDS and his followers view NIT?

Despite the libertarian origins of NIT, the IDS school of thought would seek to bring NIT, were it to be implemented in Britain, within the currently fashionable sanctions regime. IDS has already expressed his intention to bring in-work benefits within the sanctions regime. It is hence reasonable to suppose that IDS would wish a NIT system to be conditional and to include it in his beloved sanctions regime too. It is pretty clear from the high level of coercion embodied in Universal Credit that IDS does not share the libertarian values of NIT.

How would a negative income tax look in Britain?

Surprisingly perhaps, it would look similar to the current income tax system in Britain – most people would notice no change to their income tax charge and to their net pay. Income tax, whether through deductions at source or through end of year self-assessment would operate as now, without change to method or amount. Only individuals with incomes below the personal allowance would notice any difference.

Only a comparatively simple tweak to HMRC’s software would be needed to implement NIT. NIT would be simple, cheap and low risk to implement. Because radical surgery to the existing system would not be needed, a government should not find practical objections to NIT implementation.

So how would NIT differ from the current income tax system?

At the moment, the first £10,600 of an individual’s annual income is tax free – individuals pay income tax only on their annual income in excess of £10,600. The starting rate of tax for incomes above the £10,600 threshold is 20%. For the purpose of this explanation it is not necessary to consider the higher income tax rates (40% and 45%) as these are unaffected by NIT. In fact, NIT will make no difference to the income tax charge for anyone whose income exceeds £10,600, whether their marginal income tax rate is 20%, 40%, or 45%. Only those whose income is below £10,600 will be affected by NIT.

Example:

Freda’s annual income is £8,000.

Her tax charge under the current system is 20% x (£8,000 – £10,600) = – £520, which, because it is negative, means HMRC will not seek to collect income tax from Freda. So Freda pays no income tax and her post-tax income is £8,000.

In contrast, under NIT the negative result of -£520 produced by her tax computation would trigger a payment to Freda of £520 from HMRC. Her post tax income would hence be £8,520 (£8,000 + £520). In effect, Freda’s wage is being topped up by the state through the tax system.

NB. 20% x (£8,000 – £10,600) can be written as 20% x £8,000 – 20% x £10,600

So why not stick to tax credits currently operated by HMRC?

The NIT calculation is very simple and should logically be preferred to the complex strictures and administrative expense of the tax credit schemes currently operated by HMRC. A further point is that IDS’s intention is to bring in-work tax credits into the benefits sanction regime via Universal Credit. This will add further complication to an already over-complicated system.. An NIT could ease the burden on Universal Credit, which is already creaking under the weight of its own complexity. The implementation proposed here is modest and cautious. Over time, increasing confidence would hopefully impel a government to implement NIT comprehensively, perhaps with a view of complete replacement of other social security benefits.

Would a negative income tax have disincentive effects?

IDS et al hold that low income earners are discouraged from increasing their earned incomes because they are in receipt of tax credits and other means tested benefits. Increased use of sanctions (the withdrawal of benefits) has been IDS’s chosen method of countering these putative disincentive effects. NIT would be perceived by IDS to have disincentive effects given the evidence. IDS et al would thus argue that receipt of NIT should be conditional and subject to sanctions should a recipient be perceived as “free-riding” on the revered tax-payer. IDS is not a libertarian.

The withdrawal rate, (the amount by which the state top-up is reduced for each additional £ of income) is equal to the 20% starting rate of tax. This is far lower than the 65% withdrawal rate aimed for by Universal Credit. The NIT implementation proposed here thus compares favourably to IDS’s Universal Credit.. This suggests that sanctions should not be necessary to “motivate” NIT recipients to increase their incomes

How much would NIT cost?

Confining NIT (at least to start with) to recipients of market incomes and to pensioners then the answer is not much. This is because their benefits and tax credits would be reduced by the amount equal to the NIT payments received by them. NIT would be payable only where market incomes and pensions fall below £10,600, so many people would not be NIT recipients, The total social security bill and tax take would be identical as between the current arrangements and NIT.

So why implement NIT then?

A modest and cautious implementation has been recommended here so that the costs and risks of failure are low. Over time, more benefits of NIT can be captured. These benefits include

reduced administration costs; better incentives; increased flexibility; a basic income; simplicity; reduced benefit costs; a more constructive role for DWP; and less state coercion