Tax credits and the Negative Income Tax: a house cat is not a Bengal tiger

In a radio debate with Mark Littlewood, Adrian Sinfield, Professor Emeritus of Social Policy at the University of Edinburgh, was critical of IEA proposals to replace the present benefit system with a combination of a Negative Income Tax (NIT) and localised workfare. He argued that a proposal for a quasi-NIT had already been evaluated in 1972, and was found so deficient that ultimately, it was only introduced on a minimal scale.    

Prof Sinfield probably refers to the “Family Income Supplement”, an indirect predecessor of the present tax credit system. This was a means-tested transfer for people on low incomes, which was gradually withdrawn with earnings. Thus, like today’s tax credit system, it did indeed contain elements of a NIT.

But comparing the UK’s tax credit system, whether the embryonic one of the 1970s or today’s £30bn juggernaut, to a NIT, is like comparing a plump house cat with a Bengal tiger. Remember, when Milton Friedman first explained the NIT in Capitalism and Freedom, he emphasised, even insisted, that a NIT mustreplace the entire existing jungle of transfer instruments, or at least the bulk of it. Under no circumstances must it become just another palm tree within that jungle. If a NIT merely added to the existing welfare bureaucracy, then, according to Milton Friedman, it would be better not to introduce it at all.

Right from the start, the UK’s tax credit system threw Friedman’s warning to the winds. The Family Income Supplement came on top of the of transfer tools already in place, and so do, of course, today’s tax credits. Unfortunately, tax credits and other benefits do not just coexist peacefully. They get in each other’s way, creating the steep, combined withdrawal rates and uncertainties which even IDS’s Universal Credit will only partially address.   

Also, unlike under a NIT, there was never a separation of benefit entitlement and tax liability. Almost all in-work recipients of tax credits in the UK are also income-tax payers and national insurance contributors. A typical working-age household in the third income decile receives £900 in tax credits per year, but also pays more than £1,500 in income tax. Would it not be simpler to just leave them with more of what they earn?

So it is a strange point to make that a quasi-NIT has “failed” in the past. If you buy an electric appliance which comes with a warning message about how not to use it, printed all over in big, bold red letters, and you still ignore that advice, then don’t be surprised if it does not work.

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).

1 thought on “Tax credits and the Negative Income Tax: a house cat is not a Bengal tiger”

  1. Posted 17/11/2010 at 14:48 | Permalink

    Re-reading Friedman on a negative income tax, I came across his reference to Dicey wondering whether recipients of a state old age pension for the poor should continue to be entitled to vote.

    Surely this has now become a major question, not only in the United Kingdom, whether people who, on balance, are net ‘tax receivers’ over a significant period of their lives should have the same voting rights as tax payers?

    The current government’s deficit reduction plan is showing, what nobody doubted, how very difficult it can be to withdraw tax-financed ‘benefits’ from voters. If it can be achieved, which is by no means certain, we must take care not to get into the same position again.

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