Guest Post: Negative Income Tax II – Advantages and Disadvantages

By Ulrich Andree

Note: This is the second of three articles. For the extended original article see LinkedIn. The previous post focused on redistribution and the concept of an NIT. The final article will focus on the implementation of an NIT in Mongolia.

Economic Advantages and Disadvantages of NIT

The NIT concept in its pure form is an instrument that aims at the abolition of all social trans­fers in the long-term including public pensions, health and unemployment insurance and similar. Even if a complete abolition of these payments, may be difficult, the discussion of (dis)advantages below is based on an idealtypical implementation of NIT.

Advantages of NIT

The NIT could reduce observed deficiencies within the state redistribution system and maybe eliminate them in the ideal case because it would lead to a better coordination and later on integration of direct taxes and social transfers.

Higher Target Accuracy in the Granting of State and/or General Public Support

As generally known “absurd hikes” in the marginal rates can be observed due to the uncoor­dinated tax and transfer basis and schedules in the most existing welfare systems, especially because of uncoordinated income brackets and the sudden abolishment of transfers. If additional transfers to households with a different social status are taken into consideration, one can observe notable marginal rates which in certain cases can be higher than 100 percent. But by means of the correct design of NIT these excesses and misallocations could largely be remedied. The prerequisite for this, however, is the existence of an efficient tax admini­stration which is aware of all facts relevant to taxes and social transfers of each taxable/ needy citizen affected.

More Redistributive Justice

The amount for redistributive purposes in welfare states is so large that serious disincentives via progressive taxes and high social security contributions are unavoidable. What is urgently needed in Mongolia is an inventory of all redistributive measures, especially those which favour groups who do not belong to the “working” and “non-working poor”. The abolishment of those transfers connected with the concentration of redistribution to the „real poor“ could reduce redistributive activities, thus giving room to lower taxes and contributions. A rationally planned NIT could have pride of place with respect to the abolishment of the contrast between efficiency and justice.

Delay or Closure of “Rural Depopulation”

If all Mongolians would be guaranteed the same minimum income even in the most remote regions of the country, they hardly have any existenial reasons to go to the metropolitan are­as, especially to Ulaanbaatar. This migration leads to major problems including the slump into greater poverty due to lack of sufficient paid job opportunities or due to environmental pollution caused by the massive accumulation of yurts on the outskirts of the metropolitan areas.

In addition, many Mongolians must abandon their former place as herders, workers, traders, craftsmen etc. and leave their beloved families, relatives and friends in the countryside to earn livelihood in a completely strange environment. This is a disaster from the “human point of view” because it stresses or destroys the most personal relationships and/or forces their families to participate in the “vabanque game” – whether they remain in their native land or whether they take the risky step to go in unknown regions too.

Saving Social Bureaucracy Costs and Improving Tax and Social Transfers Transparency

The costs of social bureaucracy in Mongolia are enormous, and according to “Murray’s Law of Unintended Rewards” they have a tendency to expand even further. To that Murray re­marks: “„Any social transfer increases the net value of being in the condition that prompted the transfer.” (Murray, Charles, Losing Ground: American Social Policy, 1950-1980, Basis Books, New York 1984, p. 212 – 213)

That is why the abolishment of social transfers could reduce the cost for social bureaucracy and raise tax-related transparency considerably. The Government would no longer need the sprawling multiple agencies necessary to distribute food stamps, public housing, medical aid, cash welfare, etc. and a big number of community development programs. Nor would they need to pay the salaries and future pensions of public employees who run all these social programs.

Increase of Labour Incentives and Preservation of Free Labour Marktes

If NIT would be developed progressively, incentives to work would be retained for the trans­fer recipients, which might be stronger or weaker depending on the tax rate and the level of the minimum income. Concrete tax parameters are  a political decision and depends on facts.

Yet another NIT advantage is the liberalization of the labour market. No minimum wage would be necessary, since a minimum income now would be guaranteed. This would boost employment: as economists recognize, a legal minimum wage tends to increase joblessness by discouraging employers from recruiting unskilled labour. Therefore NIT, as a by-result, could subsidize unskilled jobs in decreasing the effective wages for the employers via a decline of the wage costs.

This proposal is connected with the perception that there is no general shortage of labour, but a shortage of „payable labour“, with the consequence of a high “pedestal unemployment”. And in Mongolia the current average wages are relatively low with the corresponding conse­quences for payable work.

Disadvantages of NIT

Some opponents of NIT fear following disadvantages which mainly concern the practical im­plementation:

Difficulties in Recording the Correct Tax Base

In practice there are a lot of obstacles which hamper the introduction of NIT. In order to be able to determine the number of people in need and the amount of NIT tax refunds accurate­ly, it is imperative to provide the appropriate statistical data which must be as detailed as possible concerning the individual situation of taxable/needy persons and taking into account their very personal circumstances and their associated tax-related burdens or social transfer claims, resulting from all of this.

To prevent individual tax cuts, tax evasion or social transfer fraud, the establishment of a highly qualified tax administration is indispensable. In this regard in Mongolia is still a lot of catching up to be done so that the introduction of a NIT is very closely linked to the creation of an efficient, country covering tax administration.

Difficulties in the Definition of the Beneficiaries and the Amount of the Subsistence Minimum

This problem is primarily connected to the question of the most suitable attribution units and the determination of the available redistribution amounts. Should incomes be determined at the individual, family, household level or something else?

Another problem is the determination of the total amount of the existence minimum which can be redistributed. The volume depends on many factors that are difficult to quantify “ex ante” and which are also related to overall economic development.

High Cost of Setting Up an Efficient Tax Administration

This objection can be unmasked as “pseudo-argument” because in Mongolia there already is a social transfer bureaucracy that is not very effective and efficient and which still has deve­loped a “life of its own”. It fuels Murray’s Law of Unintended Rewards because this bureau­cracy has a great interest in expanding its own scope by influencing politicians as well as trying to exercise power over the highest possible number of citizens. And politicians volunta­rily and involuntarily play the “useful idiots” who need a political platform to distribute benefits among the citizens.

This will give political interventionists the opportunities for further influence to support newly defined group interests with the aim of maximizing their votes. It is therefore essential to compare the high costs at present with the costs of creating and developing an efficient tax administration.

At the same time, one should also take into account the fact that an efficient tax adminis­tration is the indispensable basis for the functioning of a modern state which can not be dis­pensed with. The cost of a well-developed tax administration would certainly be much lower than that of a separate social bureaucracy.

Resistance by Powerful Stakeholders

This point leads to the “public choice theory”. Politically responsible persons and influental interest groups initially have their individual benefits in mind, and only consider the common good after that. The personal utility of a politician is vote maximizing and his/her prestige from a public office. In order to achieve this he/she will subordinate all political actions to the objective of a re-election, and will prefer interest groups that can support this goal. Since only well-organized groups are helpful, their interests are satisfied first.

But apart from this “disastrous alliance”, there is another interest group that probably would oppose the introduction of a NIT: the trade unions. However, their tasks generally are far more comprehensive than the negotiation of minimum wages and include, for example, regulations on working time, accident prevention, occupational safety, holiday arrangements, etc. Therefore, the tax-related concerns about about diminishing influence are largely un­founded.

And finally, there would remain the social transfer recipients themselves who, for psychologi­cal reasons, would estimate personal financial contributions and in-kind benefits higher than deductions from tax burdens. The latter are less noticeable and the politicians know this very well. From that it can be assumed that the abolition of the social transfer bureaucracy only can be enforced against the bitter resistance of these powerful stakeholders and its “stir­rups”, the politicians.

Decrease of Labour Incentives

The results concerning taking up a job are ambigious and are highly dependent on the speci­fic structure of NIT, both regarding the tax rate and the consideration of tax- and/or social-relevant facts. In the case of high reimbursement rates, the “underground economy” also comes into play, with the consequence that “non-working poor” can earn higher incomes than “working poor” or even regular employees. But usually the productivity of unskilled workers is often less than their total wage costs – one important reason why especially unskilled workers are the dominating group within the long-term unemployed.

And therefore, as Jamie Dimon, CEO of the Morgan Chase, has said on the occasion of the World Economic Forum in Davos, Switzerland: “I think negative income tax is a big solution for the low-skilled, to give people a living wage and the dignity of a job.” (http://markets.busi­nessinsider.com/news/stocks/how-negative-income-tax-earned-income-tax-credit-works-2017-1-1001702980). And this is especially true of the Mongolian labor market.

Non-Economic Reasons

Besides the economic reasons there are weighty non-economical considerations which plead for the implementation of NIT. The Mongolians are people who love their freedom, their inde­pendence and their self-resonsibility above all. They are proud of their great culture and no­madic heritage which dates back to the time of Chinggis Khaan and earlier. Therefore, in the souls of Mongolians, it is the greatest misfortune when they have to apply for state aid as “petitioners”. Or as one says in many countries of Asia: With this attitude they would “lose their faces” and would be “stigmatized”.

With the implementation of NIT this “social humiliation” would cease because all compulsory taxpayers/needy persons are already recorded in tax or transfer lists, regardless of the amount of their current income. The prerequisite for this, however, is that there would be a well equipped and well functioning tax administration whicht is still not the case to this day.

About Ullrich Andree

Dr. Ulrich F. H. Andree is a Visiting Professor at National University of Mongolia NUM
and public sector consultant.

This entry was posted in Demography, Development, Economics, Health, Inequality, Policy, Public Policy, Public Service, Social Change, Social Issues, Taxes, Ullrich Andree. Bookmark the permalink.

Leave a Reply

Your email address will not be published.