Friday, December 2, 2011

Rejecting FairTax Part Four: The Negative Income Tax Credit

In Part One, I'll cover the dangers of taxing consumption as a major source of government revenue, both to the individual and to the economy.

Part Two will cover the little-known problems in the FairTax proposal- the "fine print" FairTax advocates won't tell you about (or don't know themselves); I'll also refute some of the inconsistencies and rhetoric used by FairTax advocates.

Part Three will introduce the reader to the benefits of flat income taxation- why it's superior to consumption tax, and the economic benefits of flattening the tax code.

Part Four will introduce the reader to the Negative Income Tax Credit- an ideal solution to the the problems of our massive welfare state, which can only be implemented in conjunction with an income tax system.

Part Four: The Negative Income Tax Credit

There is no doubt that our public welfare system is badly broken and in need of serious overhaul. It is far too expensive, far too lax in preventing and detecting fraud, and far too generous.

Before we can begin to address the problems with the system, we must first accurately define the three major problems with the current grant-based welfare system:

1) Those not familiar with the welfare system tend to classify welfare recipients in two groups: Those who "need it", and those who "don't". This overly-simplistic concept ignores one of the major problems with our welfare system: The poverty trap.          

Many government programs intended to assist working persons with insufficient incomes are established with static income limits. If a person's income rises exceeds the limit even slightly, most or all of the assistance is lost. This creates a "welfare trap", where people are forced to remain in a state of underemployment- turning down more work hours, promotion, or another offer of employment at a higher wage- because a small increase in wages would result in a total (or near-total) loss of benefits.

You probably know people in this position, though you may not know they recieve entitlements. Many of them are ashamed to admit it. I know people who, for example, grocery shop late at night to avoid being seen using an EBT card. These people would much rather work their way to prosperity, but can't.

2) The welfare reforms of the 1990s eliminated one major problem with welfare benefits by imposing a work requirement. Unfortunately, it also created an exemption to this work requirement for people who are certified "disabled". The result: A dramatic increase in the percentage of the population certified "disabled". This added bulk of not-really-disabled people drains resources from those who are legitimately handicapped: During the same period that the "disabled" population grew, the amount of spending on programs for people with severe mental and physical impairments decreased. Public money the taxpayers believed was going to assist these people was actually being paid to freeloaders.

In order to undo this situation, we have to scrap the entire concept of "disability" from the law. I recommend a similar, but more precise term: "Helplessness". I don't think any small-government conservative, no matter how hardcore, really has issue with assisting those who are legitimately helpless- those whose physical or mental impairments make them unable to fend for themselves.

3) The size of the welfare bureaucracy is staggering. Approximately 750,000 federal, state, and local public employees work in our welfare system nationwide. To put this number in perspective, that's about the number of medical doctors in the United States. The vast majority of these people work in jobs involving the movement of money and/or paperwork between government entities. It goes without saying that this obscenely large bureaucracy is enormously costly.

So how do we eliminate the poverty trap, reform disability, and shrink the enormous bureaucracy, without eliminating the social safety net?

Enter Milton Friedman, the god of libertarian economics.

Friedman's idea for fixing this problem was to scrap the grant-based system and replace it with a single, uniform negative income tax credit. Under this system, each person would be eligible for a refundable tax credit, which would diminish fractionally for each dollar of income earned.

To illustrate this concept (the actual amounts would likely differ):

Assuming a NIT credit of $10,000 and an amortization rate of 50%:

A person who earned no income would be eligible for the full credit of $10,000;

A person who worked and earned $5,000 would have their credit reduced by 50% of this amount ($2,500), and would have a total income of $12,500 ($5,000 in wages plus $7,500 in credit);

A person who earned $12,000 would have their credit reduced by 50% (or $6,000), and would have a total income of $16,000 ($12,000 in wages plus $4,000 credit);

A person who earned $20,000 would neither pay taxes nor recieve credit, and income above $20,000 would be subject to income tax.

As you can see, this system would eliminate the welfare trap, since any increase in wages would still yield an increase in total income. It would require substantially fewer bureaucrats to administer. And it would allow funds to be targeted specifically toward the helpless- in the form of supplying facilities and equipment, such as group homes and motorized wheelchairs- rather than doling out cash, which is too prone to fraud.

It would also substantially reduce the cost to taxpayers of providing a social safety net.

It must be noted that we do have a NIT credit of sorts in use already- the Earned Income Tax Credit (EITC). Unfortunately, it's currently just another welfare benefit. In order for a NIT system to genuinely replace the welfare grants, we'd have to convince enough well-intentioned but misguided liberal voters that it really is a better, more compassionate system; one which allows us to better serve genuinely handicapped people, and which allows working people to succeed and get off of welfare- and live with greater dignity- rather than being stuck in a system which demeans and dehumanizes them.

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