Negative Income Tax vs. Universal Basic Income

by Andy Braden

Universal basic income (UBI) goes by several names — a guaranteed income, unconditional income, a citizen’s wage. These phrases describe wage transfer systems in which everyone receives the same money regardless of how much extra income a person earns. Most proposals for basic income include measures to “claw back,” or tax away this basic income for those over a certain wage threshold after it is received. The rich receive money but don’t ultimately keep it.

Most proponents of basic income believe in this approach. Why would the CEO of a bank get to keep $10,000 of basic income when they already make over $1,000,000? However, many economists and small-government advocates push back — why give the wealthy basic income payments if it is going to be taxes away? It might be more efficient to not deliver the payment in the first place. More taxation means a larger bureaucracy and a more expensive program. Since basic income already comes with a steep price tag, many economists argue the guaranteed wages should be delivered in a different fashion — the negative income tax.

What is the Negative Income Tax?

The negative income tax (NIT) is an extension of a progressive income tax system. In a standard progressive tax system, the wealthy pay increasingly higher rates of taxes on their income. The NIT continues this trend in the opposite direction — those below some type of poverty threshold pay increasingly negative tax rates on their income.

Wait.

How can you pay a negative tax?

You can’t. But remember that taxes and transfers are opposites of one another. A positive tax is the same thing as a negative transfer (the government is taking income). A negative tax is the same thing as a positive transfer (the government is giving income). So with a NIT, the government provides individuals below a poverty threshold money to raise them to a guaranteed income floor.

The idea had its origins in the 1940s and was popularized in the United States by the famous economist Milton Friedman. This may surprise some as Friedman was famous for his economic policies devoted to free market capitalism set on limiting government intervention; he served as an advisor to President Reagan and British Prime Minister Margaret Thatcher. Like free-market/libertarian proponents of universal basic income, he saw the NIT as a more efficient welfare delivery system. (He ultimately believed the income tax should be abolished and all welfare privatized but for a period he supported a temporary NIT).

So NIT and UBI are just the same thing?

Not exactly. They produce similar outcomes but take different paths to get to that point. The UBI gives money unconditionally but later takes it away for the wealthy. NIT only gives money to the poor, not the wealthy.

Here is an example, compliments of Scott Santens (a UBI writer and advocate):

“A NIT is like giving someone $50 and asking for nothing back, and a UBI is like giving someone $100 and asking for $50 from their next paycheck. Both result in the person getting an extra $50. The question of which is better depends on the details involved and how the person feels about them.”

Ok, so NIT and UBI are basically the same, right?

Many advocates for a guaranteed income don’t like the optics of only the poor receiving a wage checks. Though no conditions come with NIT money, some feel it is stigmatizing.

The two schemes also have potentially different behavioral consequences. Let’s think about how the government taxes money in the NIT and UBI systems. In a NIT arrangement your earnings are taxed — the transfer occurs on income you are going to receive. In a UBI system a benefit is removed — the transfer occurs once you’ve already received the additional earnings. You are either losing some of what you earn before you have it or losing some of what you already have. Assuming you lose the same amount of money in both tax situations, it should not matter how the government transfers the money. But early research shows that the systems have dissimilar effects on people’s behavior.

Silvia Avram of the Institute for Social and Economic Research, ran an experiment to test how people reacted to losing future earnings versus losing part of a benefit they had already received. She asked subjects to complete a boring, tedious task in order to receive money. Subjects were to use computers to move virtual sliders along a continuum to a certain point. If they did this successfully, they would receive money. For the control group, the first 250 sliders completed earned them £0.01 per slider, from that point on they received £0.02 for each slider. They could complete as many sliders as they wished for an hour and could stop whenever they wished.

Both treatment groups received £0.02 for each of the first 250 sliders completed. The first treatment group was told they would be taxed 50% of their earnings for the first 250 sliders. Another treatment group was told they would receive the £0.02 for each slider but have to pay it back upon completing the slider — they perceived the transfer as losing a benefit. The outcome is the same, both groups received £0.01 per slider. However, more of those in the benefit treatment group stopped early then those in the tax treatment group. The effects were greater for those individuals who ranked as loss-averse on a post-treatment test. If you are more loss-averse you weigh avoiding losses more heavily then increasing gains.

(Note, those who rejected fewer then 6 lotteries were more risk averse).

The above table shows more of the risk-averse members of the benefit treatment group stopped early then the control or tax treatment group. A series of regression models were then run to analyze two outcome variables — how long individuals worked and the intensity with which they worked. She ran several models controlling for covariates (including gender, age, and a number of pre-treatment tests of comprehension of the experiment) and they did not impact the findings. An odds ratio was constructed to determine the probability of stopping work before the hour was complete. Those in the benefit control group were much more likely to end the experiment early.

It happens because of something psychologist Daniel Kahneman calls the ‘endowment effect’ — we value things we currently own more than the same thing if we don’t own it. It hurts more to lose money we already have then to earn less money in the future, even if the outcome is the same.

These findings are new and though they provide an interesting lens to consider UBI, they should not be interpreted as conclusive. The author notes an experimental drawback since subjects were in the same room when they completed the tasks. Some of the effects may have been peer-effects — people stopped because they saw other people in the room stop as well.

The behavioral framing of transfers is important in weighing a universal basic income versus a negative income tax. The UBI loss of a benefit for those above a certain income threshold may be more of a disincentive then not giving this benefit — the forfeiture of the UBI wage may influence their decision to work. Scott Santens writes this may nudge people away from pursuing lucrative careers, perhaps impacting income inequality. Some governments may wish to pay everyone the UBI and use these behavioral incentives to drive people to certain actions.

These question beg follow-ups — should a government be attempting to nudge people away from high incomes? Does a $10,000 UBI payment really matter to someone making $350,000? The conversations surrounding UBI and NIT remain robust and contentious. Future research will continue to influence whether either of these options is adopted as a viable future welfare and tax structure.

Works Cited

Avram, Silvia. “Benefit Losses Loom Larger than Taxes: The Effects of Framing and Loss Aversion on Behavioural Responses to Taxes and Benefits.” Institute for Social and Economic Research. 2017. Web. 8 Mar. 2017.

Hammond, Samuel. “”Universal Basic Income” Is Just a Negative Income Tax with a Leaky Bucket.” Niskanen Center. 13 July 2016. Web. 07 Mar. 2017.

Santens, Scott. “Negative Income Tax (NIT) and Unconditional Basic Income (UBI).” Scott Santens. 17 Dec. 2014. Web. 08 Mar. 2017.