21 June 2016 - DrSunshine.org - by Dr Jwalk, a friend of Dr Sunshine
Everywhere in the news lately is the pros and cons of a guaranteed minimum income (GMI). Switzerland voted down a referendum to give all adults $2500 a month, which got a lot of press. Finland plans to experiment with a limited $1100 a month minimum, a Dutch city is experimenting with a $1000 a month minimum. There are other examples of areas flirting with a GMI, including an experiment in Manitoba that was discontinued by political conservatives despite having been a grand success. The rationale for such proposals is the prospect of automation (including robots) displacing large numbers of workers. The GMI is intended to prevent massive social unrest as a result of displaced workers.
While significant displacement of workers is probably not imminent in the US, social welfare programs are a sprawling mess: there are over 80 ad hoc, largely uncoordinated federal social welfare programs that consume about 15% of the revenue generated by the income tax. (This does not include Social Security, Medicare, and Medicaid, which have their own separate funding sources.) A GMI could replace most of those programs and provide a more coherent and flexible way to address evolving social welfare needs.
This note proposes an approach that could be phased in gradually and seamlessly, as needed, within the current income tax structure. It could evolve all the way to a substantial GMI, on the order of $1000 a month or more for each adult.
While it is not usually described this way, the current US earned income tax credit is a crude example of a negative income tax. A negative tax means payment received from the government, rather than taxes paid to the government.
The key concept with the negative income tax is that if an individual's (or household's) income falls below a certain amount, herein called the deduction, a portion of the difference between the deduction and the income is paid to the individual (or household); if the income is more than the deduction then the individual (or household) pays in taxes a portion of the difference between the income and the deduction. These two portions need not be the same percentage and neither need be a single percentage; indeed, the current US tax structure does not use a single percentage ("bracket"). However, for the analysis below an idealized "flat tax" is used, with a single tax rate for all types and levels of income, to make the computations simpler and the concepts clearer. The same results can be achieved in a more complex income tax structure.
In the examples below the income is designated as Inc, the deduction as Ded, the (flat) tax rate as Rate, and the resulting tax as Tax. The basic computation for each individual (or household) is: Tax = ( Inc - Ded ) × Rate. (Note that Tax is negative if Inc is less than Ded.)
If this computation is made for each household in the US for Ded = $50,000 and Rate = 20%, the results come close to what really happened in 2010 according to US census data. First, the actual overall net income tax rate (total tax revenue divided by total income) in 2010 was just under 20%. Second the total amount of positive taxes computed is very close to the total income tax revenue received in 2010. Third the total amount of negative taxes computed (those funds paid to households with incomes less than $50,000) is very close to the total amount paid out by the various social welfare programs in 2010. Fourth about half of the households have negative taxes, which compares nicely with the actual 2010 data. And note that those having the least income would get the biggest payments, which would be expected of normal social welfare programs. This represents the overall 2010 picture with surprising accuracy for such a simple model.
For those with zero income the negative tax is $10,000 per year ($50,000 × 0.2), and could be considered the effective 2010 GMI. This is probably close to what lowest income households could expect to receive from current social welfare programs (exclusive of Social Security, Medicare, and Medicaid); therefore it might well justify replacing that plethora of programs with a simple negative income tax.
If welfare needs increase in the future, including effects of worker displacement, adjustments of Ded and Rate could provide the required amounts of support. Of course more social support would require higher tax rates. For example, making Ded $60,000 and Rate 30% would raise the GMI to $18,000 a year per household. This would address increasing social welfare needs while keeping tax revenue available for non-social-welfare needs approximately the same ("revenue-neutral") with 2010 levels.
A Ded of $65,000 and a Rate of 40% would generate a GMI of $26,000 a year per household and be roughly revenue-neutral with 2010 values for non-social-welfare programs. $26,000 is getting close to poverty level support for typical households. And 40% is essentially the top tax bracket in the current US income tax structure. (Of course a household with $65,000 income would pay zero tax, one with a $100,000 income would pay a net 14% tax - (($100,000 - $65,000) × 0.4) / $100,000 - so the actual net tax rate is quite progressive with the top being the current 40%.) The reason this level of GMI works with a top tax at current levels is that this negative income tax model assumes that all forms of income are treated the same. Should this condition be met, it would be practical to provide this level of GMI now within the current US tax structure and thereby solve a whole host of problems. (That one condition could also allow the current complex tax computation process to be replaced by something much simpler, such as the above.)
Obviously further increases in Ded and/or Rate could provide more generous GMI values, while having enough revenue for non-social-welfare programs. And indeed at some point these may well need to increase. But there are three limitations to this approach. First, realistic values do not generate adequate GMI in severe cases of worker displacement - the 40% example above generates only half of what the Swiss had proposed. Second at the 40% rate the middle class is beginning to be squeezed too much tax wise. And third, the very rich are not squeezed enough. Ideally one would consider three tax rates: one for those incomes over Ded, one for incomes under Ded, and a third for those incomes over some "rich level". For example, consider three tax rates of 20%, 40%, and 60%, respectively for these catergories, a Ded level of $50,000, and a "rich level" placing a higher tax on the portion of income exceeding a million dollars a year; this would be revenue neutral, generate a GMI of $20,000 per household per year, lighten the middle class tax load, and more fairly distribute to taxes to to those with very high incomes. Such a three-tiered approach provides more flexibility in providing the needed GMI, eliminating the plethora of social welfare programs, and somewhat addressing the problems of income inequality.
The proposed approach to providing a GMI can be easily incorporated into the current tax system, evolve within that system, and eliminate a loosely-connected conglomeration of social welfare programs. Despite the simplicity of the approach, setting the rate at 20% and the deduction at $50,000 closely mimics current tax revenue, so overall taxation need not increase. It eliminates categories of income (such as capital gains and carried interest), and the tax breaks currently associated with them, which is key to making it revenue neutral at low tax rates and fair across income levels. It provides a general strategy for dealing with worker displacement if that becomes a serious structural problem in the future, and as a side effect shows how to greatly simplify the US tax system.
(sometimes going against the grain)
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