A negative income tax beats both the minimum wage and welfare

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Recently, there have been demonstrations by fast food workers and labor unions calling for an increase in the minimum wage from the current $7.25 per hour to a whopping $15 an hour. This comes as recent reports show that more than 35 percent of Americans receive some kind of welfare benefits, whether they be SNAP, Medicaid, TANF, WIC or some other program.

Raising the minimum wage would likely raise unemployment and having more than a third of the population on public assistance is not sustainable. But there is one idea policymakers could use to combat poverty while encouraging work. Devised by Nobel laureate Milton Friedman, the negative income tax would address low-wage employment while simultaneously steering welfare recipients to work, rather than collecting benefits.

Problems with the minimum wage

The biggest problem of the minimum wage is that arbitrarily raising it can destroy jobs. As businesses’ labor costs increase, they erode profit margins. In order to maintain profits, they will have to raise prices or reduce costs, including labor costs.

The minimum wage harms low-skilled workers because it prices their labor out of the market. As the price of labor goes up, employers will seek to streamline or automat processes, and invest payrolls in more skilled workers. This makes it tougher for those entering the workforce, particularly teenagers, and those trying to re-enter the workforce, such as after a stint in prison or in a substance abuse rehabilitation program.

For the most, the minimum wage does not actually help poor families. Economist David Neumark noted in a recent piece that only 17 percent of those who make minimum wage are actually members of poor households. Most are members of families in which their minimum-wage job provides just a small percentage of family income.

Problems with welfare

Studies demonstrate that welfare programs can discourage positive behaviors such as work, marriage and investment in education. Welfare programs tend to be structured with what economists call massive “tax cliffs,” in which benefits phase out as income increases in a way that it becomes more expensive to get off of them by working to improve one’s self. It’s hard to think of a more perverse disincentive to encouraging Americans to become more self-reliant than the current social safety net.

There needs to be a solution that doesn’t discourage work, while at the same time encouraging productive social behaviors such as obtaining an education and getting married. Meanwhile, most citizens believe it is reasonable to provide a basic safety net to prevent Americans from being unable to feed, clothe or shelter themselves for reasons of both compassion and to maintain order in American society. History shows a correlation between people being unable to feed themselves and violent revolution.

Why a negative income tax?

A negative income tax is the best way to eliminate the pitfalls of both the minimum wage and the failed, bureaucratic welfare state. The NIT would function as a basic minimum income that would get cash to the people who need it without the red tape of bureaucracy and benefit rules. Since it is a cash payment that can be spent on anything (rather than a voucher-type system) and it is done through the tax code, there is no need for special welfare fraud enforcement.

The NIT, especially when combined with tax reform that sets a decent-sized gap between the income ceiling to qualify for NIT payments and the income level where income and payroll taxes would apply, can eliminate the perverse incentives in the welfare state against work, education and marriage. Unlike the current welfare state, an NIT can serve both as a safety net and as a springboard to help recipients improve their lives. Since an NIT only covers the gap between between what someone makes and a certain basic income, there is no penalty for getting a raise that puts you over the income threshold.

How would it work? The government would set a basic income amount, perhaps at 130 percent of the poverty threshold as defined by the U.S. Census Bureau. The poverty threshold is essentially the amount of money determined annually to feed, clothe, shelter a person or family in the United States. For a family of four, including 2 children, according to the latest figures available from 2013, the threshold would be $23,624 per year, such that 130 percent of that total is $30,711.20.

The NIT would pay out benefits every month, rather than once a year, as is the case with the current Earned Income Tax Credit. The only paperwork difference would be that W-9s would be submitted monthly instead of annually. For a family of four, basic monthly income would be $2,559.25. If the family earned $2,000, they would receive a check for $559.25. The funds could be deposited directly, like Social Security, without the red tape and restrictions of the current multitude of welfare programs.

The biggest objection that can be articulated is that a NIT still would discourage work by being paid out to the unemployed. Of course, one could retain the unemployment insurance program and count those benefits against the NIT threshold. For those who simply refuse to work, the NIT rate could be adjusted downward, say, for those who report no income for six months straight. If they bring in no income for another three months straight, it could be reduced again.

If crafted correctly, an NIT can replace the welfare bureaucracy and its perverse disincentives and it can actually encourage work and achievement and break a cycle of dependence. Also, by eliminating the minimum wage, an NIT can possibly help increase employment and help low-skilled workers enter the workforce. It’s a public policy solution that policymakers should seriously consider as we consider overhauling the welfare state for the 21st century.

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