The negative income tax

The Government of India recently announced direct cash transfer schemes to deliver welfare benefits to millions of poor citizens. In my opinion, this is a wonderful step in the right direction towards providing any kind of social welfare, subject to clean and effective implementation. India’s public distribution system (PDS) for long has been a source of massive leakages, opacity and corruption, and providing cash directly in the hands of beneficiaries is a welcome step towards tackling many of these problems. Goes without saying, this will be deemed effective only if it REPLACES and doesn’t ADD to the existing set of subsidies being delivered, failure to meet which will add substantial additional burden to the exchequer. Clearly, this will not be a cakewalk and smooth implementation would require tackling many hurdles currently present.

This led me to read about the benefits of a cash-subsidy vis-à-vis an in-kind-subsidy, where I stumbled upon the theory of the Negative Income Tax (NIT). Simply put, a negative income tax (in effect, a cash subsidy) is a progressive income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. Thereby, people earning a certain income level would owe no taxes; those earning more than that would pay a proportion of their income above that level; and those below that level would receive a payment of a proportion of their shortfall, being the amount by which their income falls below the “desired” level.

For simplicity of calculations, assume that the minimum level of “desirable income” were set at 100 per “consumer unit”, and suppose that the NIT were a flat rate of 50% (the percentage that was originally proposed by Milton Friedman and later advocated by many economists). Then every consumer unit whose income fell below 100 would be paid a subsidy of 50% of the difference (= poverty line minus income). If its earned income were 50, for example, it would receive 25 (50% of 100 minus 50); if its earned income were 20 it would receive 40 (50% of 100 minus 20); if its earned income were zero it would receive 50 (50% of 100 minus zero).

There have been many proponents and opponents of the NIT theory, and tons of challenges (which I won’t call insurmountable) in its practical implementation. However, the multitude of benefits that I see from India’s perspective are:

(a) Giving power back to the people, in the form of cash: the current central government-run program of subsidies hands immense power to a few people at the top to decide on various lifestyle choices of the million beneficiaries of these programs. The key question that comes to my mind here is how can a few people decide, to so much level of intricate detail, the choices that are best suited for the entire population. If the government wants to play a part in the system of providing social insurance, might as well give cash to the beneficiaries, allowing them the freedom to use it the way they deem fit.

(b) Shutting down India’s inefficient benefits-in-kind public distribution system: I’ll be optimistic here and use the word “shutting down” instead of “minimising”, because the NIT applied in its purest sense will eliminate many middlemen, and put a stop to all possible leakages from the long PDS supply chain in India.

(c) Eliminating corruption and a large portion of India’s inefficient bureaucracy: this flows from the previous point. Corruption is plaguing our system, and the scams we read about, almost on a daily basis, run into lakhs of crores and so on. Again, the NIT applied in its purest sense, will help in cleaning up the system and introducing the much-needed transparency.

The 1.3 billion odd population in India always seems to be a big challenge to address, and a convenient political excuse for inertia in reforms. However, an NIT system like the above surely merits testing in the form of small pilot projects, likes of which were conducted in the United States in the 1960-70 period (results of which I will discuss later).

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