DEFINITION of 'Negative Income Tax (NIT)'

Negative income tax (NIT) is an alternative to welfare suggested by, among other proponents, economist Milton Friedman in his 1962 book Capitalism and Freedom. NIT proponents assert that every American without income above the threshold for tax liability should have a basic income guarantee and that negative income tax (NIT) is a means to subsidize the needy at less cost than the welfare system.

BREAKING DOWN 'Negative Income Tax (NIT)'

To get a negative income tax (NIT) subsidy, the needy would, along with other taxpayers, simply file income tax returns. The IRS’ computerized system could then quickly and objectively identify taxpayers with income below the threshold as eligible for help.

NIT proponents envisioned negative income tax (NIT) as a mirror image of the existing tax system where tax liabilities of above-the-threshold taxpayers vary positively with income according to a tax rate schedule; and tax benefits of below-the-threshold taxpayers vary inversely with income according to a negative tax rate (or benefit-reduction) schedule. Taxpayers with income above the threshold would pay taxes in a cash amount equal to the difference (‘positive taxes’) and taxpayers with income below the threshold would receive NIT refundable credits in a cash amount equal to the difference (‘negative taxes’).

NIT opponents applying labor-supply economic theories worried that negative income tax (NIT)’s promise of a threshold income guarantee would cause the working poor to work less or quit entirely to substitute in leisure activities since wages reduce but may not exceed the guarantee, particularly after payroll and state and local income taxes are taken out. If too many of the working poor succumbed to this income effect and this substitution effect, the swelling number of needy with income below the threshold and eligible for NIT refundable credits would make total negative income tax (NIT) costs untenable.
 

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