Tax Alternatives: The Negative Income Tax

The current tax system in the United States is an unmitigated disaster. Nobody really denies this fact, one of the few issues that seem to unite republicans and democrats in our country. The tax code is so big, nobody has a grasp of it and that includes the IRS. While you and I may groan once a year when it is time to file our personal tax returns, larger corporations don't have it much better. One well known corporation reported that they file the equivalent of one tax document with the IRS every 3 minutes! While the may or may not pay their share, the pure burden of filing taxes for them and us is crazy.

Given the nature of the mess, one would think we would do something. The age old question, however, has been what functional alternative is there to the current mess? One proposal that has been around for some time is the negative income tax method.

The negative income tax was originally proposed in the 1960s by Milton Friedman, a fairly famous economist. His idea was not to just address the collection of taxes, but to create a system that would do away with welfare, food stamps and all types of government entitlement programs.

The basic idea at the core of the negative income tax rate system was a flat tax with a twist. The twist gets a bit complicated, but it involves tax deductions and negative income. A flat tax rate of say twenty five percent would be established on all income earned. You would then be able to take certain deductions against the tax for things like dependents [kids]. If your deductions totaled more than the total income you earned during the year, the government would then owe you all the taxes you paid in during the year and a percentage of your ?negative income?. At this point, an example will probably help.

To make things simple, let's assume we have a family of five with total earnings being $30,000. Further assume the total deductions that can be claimed equate to $40,000. The head of household has negative $10,000 under our system. The government would then owe the family all the money they paid in during the year in taxes from paychecks and a percentage of the $10,000 of negative income. Not bad, eh?

The negative income tax rate approach never really caught on with advocates. The system is ripe for attack because taxpayers have a major temptation to tweak their financial numbers to show negative income. Frankly, the criticisms were probably justified, but that should not distract us from the idea that the current tax mess can be dealt with. There is an answer to the mess, but it will require thinking outside of the box as Milton Friedman tried to do.