Some Negative Thoughts on Tax Reform

I gave a short talk today to a CEDA Tax Policy Directions Forum in Canberra. My title was “Yet Another Economist Advocating Negative Income Taxes”. My slides are here.

(In discussion, I also mentioned that I couldn’t see any economic arguments against following the Alesina-Ichino proposal, and only delivering the proposed tax cuts to women. This would cost about $12 billion rather than $31 billion, and deliver almost the same labour supply impact. I’m pretty sure I failed to convince a soul.)

Update: This piece in the Age by Nassim Khadem neatly sums up the forum, including Nicholas Gruen’s audacious proposal to scrap dividend imputation and cut the company tax rate.

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8 Responses to Some Negative Thoughts on Tax Reform

  1. Sinclair Davidson says:

    I’m pretty sure I failed to convince a soul.

    Married couples in Australia are taxed as individuals and not as a family unit, so the very high marginal rates of taxation on a second income don’t apply here as they do in the US. So I’m not convinced on the labour supply argument, but it would ‘cost’ a whole lot less than $31 billion. Now to the extent that the beast should be starved more tax cuts are better – but Andrew wouldn’t agree with that point.

  2. Kevin Cox says:

    Negative income tax is a step in the right direction but why overload the poor old income tax system with yet another social welfare function.

    Why not give everyone an untaxed social wage and tax all other income from any other source.

    This is simple, fair, removes many social security payments, is easy to administer and cheap.

  3. Peter Whiteford says:

    Andrew
    A few comments:

    While the current Australian system isn’t a negative income tax, it is closer to being a NIT than any other country, including the US system when Friedman first advocated one. Remember most other developed countries have a combination of insurance payments and much more tightly targeted social assistance payments (except NZ).

    Have a look at
    http://www.oecd.org/document/33/0,3343,en_2649_34637_39619553_1_1_1_1,00.html
    and if you want more details go to the country tables at
    http://www.oecd.org/document/29/0,3343,en_2649_34637_39618653_1_1_1_1,00.html

    The current Australian system allows people to continue to receive payments while in part-time work, and indeed the OECD publication shows that EMTRS for the transition from complete reliance on benefits to part-time work are lower than in any other OECD country, except ones where social assistance benefits for those out of work are much lower (the US, Spain) or practically nonexistent (Greece, Italy).

    However, EMTRs are higher than average when moving from part-time to full-time work. This reflects the fact that social assistance payments in most other countries have 100% withdrawal rates, i.e. the disincentives are concentrated on the lowest paid or those with the lowest hours, but then disappear, while in Australia withdrawal rates are lower but more widely spread. Also in my view precisely because we have no social insurance system, take-up of assistance benefits is higher than take up of assistance benefits in other countries, meaning that EMTRS “bite” more.

    While what Sinclair says about Australia’ s individual income tax system is correct, what offsets this for the low paid is the fact that we have joint income-testing for unemployment payments (even if more relaxed than pre-1995) and for pensions. Unemployment insurance generally doesn’t involve joint income-testing, so is better for incentives for second earners. (In passing, however, even if unemployment insurance isn’t income-tested it is not necessarily better for incentives to work for the recipient, since the categorical nature of insurance means there are usually high implicit marginal tax rates for the recipient – take a part-time job and you lose all your payment.)

    I am actually in sympathy with the argument that Australia should consider how to improve incentives for full-time work rather than part-time work and also improve incentives for second earners. However, I think this needs to go a long way beyond advocating a NIT in a generic sense. What are needed are specific proposals that identify an in-work payment that can be properly integrated with the existing tax and transfer systems and that improves incentives for second erner and for full-time work or substantial part-time work.

  4. Andrew Leigh says:

    Peter, in terms of actual plans, I was merely hitching my wagon to the five economists’ proposal, which I’m pretty sure they wrote up in some detail (maybe in the Australian Economic Review?) in 1998. The family payment system has changed somewhat since then, but not so much that 5 Ec wouldn’t still be a useful starting point.

    Of course, what was crucial about 5 Ec was that it found a way to make low-skill workers more employable (reducing the minimum wage) without hurting those workers (because the EITCs made up for the lower wage).

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  6. derrida derider says:

    I have a NITpick (sorry). The NIT can be found in JS Mill’s scribblings, and was widely debated in Britain during WWII (at the prompting of Lady Rhys-Williams) as an alternative to the Beveridge proposals that moulded the postwar welfare state. Only USAnians would believe Milton Friedman thought of it first.

    On the 5 Ec, the vulnerable part of their proposal was the assumption that restraining award wages (not just FMW) would restrain actual wages paid. It wasn’t true then and it is even more untrue now.

  7. Bruce Bradbury says:

    Andrew, are you implying that a NIT (negative income tax) and an EITC (earned income tax credit) are the same thing? If so, this is misleading. The ‘negative’ in NIT refers to a negative average tax rate (ie a net payment). The EITC may also have a negative average rate, but its key feature is that it can produce negative marginal rates.

    I think it is better to describe the EITC as a particular type of NIT – one that produces negative (or at least very low) marginal tax rates in the lower parts of the income distribution. [It’s been a few years since I looked at it, but my recollection is that it doesn’t (or at lest didn’t) actually lead to negative marginal tax rates, as the negative rates in the EITC were offset by state taxes and social insurance contributions. ]

    As Peter Whiteford says, the current Australian system is quite close to a NIT (particularly for families with children). I can see a case for an EITC, but there are trade-offs. In particular, it lessens incentives to increase income past the peak EITC level.

    As for the Ramsey-rule type arguments for taxing women at a lower rate, I’m not yet convinced. Why do women have more elastic labour supply? The usual explanation is that they are more productive at home than men (given current cultural norms!). I recall there is a paper by Piggott and Whaley arguing that if you take this productivity difference into account then joint taxation of spouses is optimal (joint taxation amounts to having the same marginal rate on both spouses).

    There is an additional equity argument for not having joint taxation based on the idea of taxing using those variables most strongly correlated with full rather than actual income (Apps discusses this in some of her papers). I find this more convincing.

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