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Negative Income Tax Definition
What is the definition of a negative income tax? First, let's go over income tax. Income tax is a tax levied on people's income who make above a certain amount. In other words, the government is taking a portion of people's money who "earn enough" to fund government programs and services.
A negative income tax is a money transfer that the government gives to people that earn below a certain amount. In other words, the government is giving money to people who are in need of financial assistance.
Another way you can think of a negative income tax is as a welfare program to assist low-income individuals and families. Recall that welfare programs aim to assist people who are in need. In fact, there are programs in the United States that serve this very function — The Earned Income Tax Credit.
A negative income tax may be an ancillary effect of a progressive tax system. Recall that in a progressive tax system, people with lower incomes are taxed less, and people with higher incomes are taxed more relative to those with lower incomes. The natural corollary to such a system is that people who earn very little will also be assisted in their income.
Income tax is a tax levied on people's income who make above a certain amount.
Negative income tax is a money transfer that the government gives to people that earn below a certain amount.
Want to learn more about welfare and tax systems? These articles are for you:
- Progressive Tax System;
- Welfare Policy;
- Poverty and Government Policy.
Negative Income Tax Example
What is an example of a negative income tax?
Let's take a look at a brief example to see what a negative income tax may look like!
Mariah is currently struggling because she earns $15,000 a year and lives in an area that is very expensive. Thankfully, Mariah qualifies for a negative income tax since her yearly earnings fall below a certain amount. Therefore, she will receive a direct money transfer from the government to alleviate her financial struggles.
More specifically, the United States has a program that serves the very function of a negative income tax. That program is called the Earned Income Tax Credit program. Let's learn more about this program and how it affects people.
The Earned Income Tax Credit program is means-tested and a money transfer. A means-tested program is one where people have to qualify for it to receive its benefits. An example of this includes earning below a certain amount to qualify for a certain welfare program. A money transfer is more straightforward — this means that the benefit of a welfare program is just a direct money transfer to people.
This still begs the question, how do people qualify for the Earned Income Tax Credit, and how does it work? People need to be currently working and earn below a certain amount of income. The amount needed to qualify is lower if a person is single with no children; the amount needed to qualify is higher for married couples with children. Let's see what this would look like in a table.
| Children or Relatives Claimed | Filing as Single, Head of Household, or Widowed | Filing as Married or Jointly |
| Zero | $16,480 | $22,610 |
| One | $43,492 | $49,622 |
| Two | $49,399 | $55,529 |
| Three | $53,057 | $59,187 |
As you can see from Table 1 above, individuals who are single have to earn less than married couples do to qualify. However, as both groups have more children, the amount needed to qualify for the Earned Income Tax Credit increases. This accounts for increased expenses that people will incur if they have children.
Means-tested programs are those that require people to qualify for them to receive the benefits.
Negative Income Tax vs. Welfare
What is the relationship between negative income tax vs. welfare? First, let's start out by defining welfare. Welfare is the general well-being of people. In addition, a welfare state is a government or polity that is designed with a host of poverty-alleviating programs.
Recall that negative income tax credit is a money transfer to people that earn below a certain level of income. Therefore, it's easy to see the relationship between negative income tax and welfare. A negative income tax aims to help those in need who do not earn enough money to sustain themselves or their family. This underscores the main idea of welfare and would likely be a part of a government that considers itself a welfare state.
However, if welfare programs are strictly viewed as an in-kind benefit or as a specific good or service that the government provides for those in need, then a negative income tax would not satisfy the requirement of a welfare program. Instead, a negative income tax is a direct money transfer from the government to the people who need help.
Welfare state is a government or policy that is designed with a host of poverty-alleviating programs.
Welfare is the general well-being of people.
Negative Income Tax Pros and Cons
What are the pros and cons of a negative income tax? Generally, there is a main "pro" and "con" to any welfare program that is implemented. The main "pro" is that a welfare program assists those in need who cannot sustain themselves on their current income; people are not left to "figure it out" if they need help financially. The main "con" is that welfare programs may disincentivize people to work; why work to earn more if you can remain unemployed and receive benefits from the government? Both of these phenomena are present with the negative income tax. Let's go into further detail to see how and why.
The "pro" of a welfare program is present in the negative income tax. Recall that a negative income tax, as opposed to the traditional income tax, aims to give direct money transfers to those who make under a certain amount in yearly income. In this way, the negative income tax is helping those in need of financial assistance — the main pro of any welfare program. The "con" of a welfare program is also present in the negative income tax. The main "con" of a welfare program is that it could disincentivize people from working. With a negative income tax, this could occur since once people earn above a certain amount, they will be charged income tax instead of receiving money transfers. This may discourage people from getting jobs that earn them an income above this amount.
Given that a negative income tax can have both pros and cons, it's imperative that if a government decides to implement a negative income tax that it does so in a judicious way to exemplify the benefits and minimize the losses that the program may incur in the economy.
Negative Income Tax Graph
How can a graph represent what it looks like to qualify for a negative income tax?
Let's take a look at the Earned Income Tax Credit graph in the United States to further our understanding.
Fig. 2 - Earned Income Tax Credit in the US. Source: IRS1
What does the graph above tell us? It shows us the relationship between the number of children in the household and the income people must earn to qualify for the Earned Income Tax Credit in the United States. As we can see, the more children people have, the more they can earn and still qualify for the Earned Income Tax Credit. Why? The more children people have, the more resources they will need to take care of them. The same also can be said for people who are married. People who are married will earn more than someone who is single; therefore, they can earn more and still qualify for the Earned Income Tax Credit.
Negative Income Tax - Key takeaways
- Income Tax is a tax levied on people's income who make above a certain amount.
- Negative income tax is a money transfer that the government gives to people that earn below a certain amount.
- The pro of a negative income tax is that you are helping people in need.
- The con of a negative income tax is that you may be incentivizing people to work less to receive the transfer payment.
References
- IRS, Earned Income Tax Credit, https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/earned-income-and-earned-income-tax-credit-eitc-tables
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Frequently Asked Questions about Negative Income Tax
How does negative income tax work?
A negative income tax gives a direct money transfer to those who earn under a certain amount.
What does it mean when income is negative?
If income is negative it means that people make below a certain level that the government has established is "too low."
Is negative income tax welfare?
Yes, negative income tax is generally considered welfare.
How to calculate tax if net income is negative?
If income is negative, then people will receive a direct money transfer from the government and won't pay any tax.
Do you pay taxes on negative net income?
No, you do not pay taxes on negative net income.
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