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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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  1. Mark Kuster says:

    Lordy, Lordy, where to start . . .

    Understanding folks who publish without knowing their subject challenges all logic. See this article in a publication calling itself “conservative” shocks me. I do not wish to personally attack the author, but the sheer number of falsehoods in these articles leads me to ask if the author did not read the bill at all, did not understand what he read, thinks the FairTax threatens him, or has some hidden anti-FairTax agenda. Under the FairTax, lobbyists and the politicians who cater to them have the most to lose, though both, as well as IRS employees and tax accountants, will surely find more productive employment.

    Let us examine the false statements, beginning at Part 1.

    1) Depositing money into an account does not incur a tax; no consumption has taken place, only a transfer. If the bank charges a fee to an end-consumer for a service, then that “service” might incur a tax.

    2) The FairTax taxes nothing twice. Interest on financed purchases adds separately to a purchase price. The FairTax may tax the total only once, but neither twice.

    3) The FairTax prebate obviates complicated tax structures designed to exempt “necessities”.

    4) The FairTax does not regressively tax the populace. Due to the prebate, the effective rate (as a portion of spending) only reaches the full 23 % for the highest spenders. Those below the poverty line pay no FairTax at all, sharply in contrast to what they pay now in hidden income tax priced into products and the ultimately regressive payroll tax.

    5) Again, the FairTax does not target the poor. Wake up. Everyone pays retail tax. All citizens receive a prebate. Therefore, the effective consumption tax rate rises from 0 % to 23 % with increasing spending.

    6) Potential black markets under the FairTax pale next to uncollected income tax–tax evaders, criminals, illegal aliens, etc. Nation-wide chains handle a very high portion of retail sales; for example, Walmart would not operate in the black market. For those small retailers who might do so, the policing retail businesses requires far fewer enforcers than an income tax system that attempts to police every individual and business in the country.

    7) The FairTax taxes only retail sales, not business purchases.

    8) Doh! One does not deduct expenses from the FairTax; that complication belongs to income taxes and their brethren (VATs). FairTax–simple! VAT–complicated! Income tax–complicated! The author completely misses this feature and all his paragraphs about businesses trying to deduct expenses, favoring large businesses, keeping the poor poor, stagnation, et. al. apply to income taxes and VATS, not to the FairTax. Wasted words.

    Part 2

    9) The FairTax hides nothingl it will appear clear as day on each receipt. Income tax costs hide in your receipts.

    10) Inclusive 23 %, exclusive 30 %, yadda, yadda, yadda. The existing income tax rates INCLUSIVELY tax spending.

    11) Summing rotten melons and foul turnips (FIT and FICA tax on wages) doesn’t yield strawberries (tax on retail consumption). The author should consult a reputable economist to understand how the FairTax replaces existing revenues rather than babbling nonsense.

    12) The author attempts scare tactics about increasing prices but neglects to consider the hidden income tax costs removed from prices in every production step and the increased take-home pay available for spending. The grocery example falls flat for not considering the decreased grocery costs to the grocer and the decreased employee FICA costs, not to mention the accounting and tax compliance costs.

    13) The FairTax does NOT tax employee wages. Wages represent untaxed business inputs. The FairTax taxes only “retail” services; e.g., an end consumer delivery charge. The author again blatantly misrepresents it.

    14) State and local taxes will not increase any more than the price of goods as mentioned above.

    15) The IRS does go away. Additional personnel at the SSA, et. al will not begin to compare to the IRS staff size.

    16) Almost all states already collect sales tax; adding to the amount causes no burden relative to the portion states will receive in exchange. States that do not currently collect sales tax may defer to another state for service. The states will lose no freedom or incur any burden from the federal government.

    17) The states have repealed amendments before. Congress has ammended the Constitution before–no show stopper, even if deemed appropriate.

    18) The FairTax gives Congress no power to manipulate the economy. When no taxes on citizens hide as corporate income tax and appear in plain view on every receipt, citizens will not easily allow Congress to monkey with the tax structure.

    19) The SSA already tracks every citizen and issues checks to those eligible. Sending out prebate checks amounts to nothing more than changing a computer program. Bingo, no more IRS.

    20) The author invents problems to moan about that do not exist. The FairTax does not means test the prebate.

    Part 3

    21) The present income tax began as a tax flatter than that proposed by Forbes and anyone else. Resetting it sounds great but only restarts the lobbying cycle. The FairTax lets people keep what they earn, not an income tax. The income tax requires complicated assessment of income, if not for citizens, then for businesses, which pass the cost to consumers.

    22) Indeed, the FairTax achieves all the supposed benefits the author lists for a flat income tax much more effectively–simplicity, corruption, tax elimination, economic stimulation, complicated deductions.

    23) Predictability indeed. Economists know that consumption tax bases remain much more stable through economic fluctuations than income tax bases. People who lose their income still spend money–whether from government benefits, charity, borrowing, savings, or whatever. The income tax rules change every year and businesses constantly expend money and effort in compliance and tax planning. The FairTax obviates all that nonsense.

    Part 4

    24) The author rambles off topic on welfare, but suffice it to say that a negative income tax credit would not nearly encourage work like the FairTax, which imposes no penalty whatsoever to earning wages. Under the FairTax, what you earn over the level of basic consumption remains completely in your pocket.

    Mark Kuster