Yawning Bread. 28 December 2009

Negative income tax


    

 

 

I have mentioned 'negative income tax' a number of times before in various articles, yet never got around to explaining the concept. I think it is time to do so -- before I publish Part 2 of Two Oppositions.

The reason is that in Part 2 of Two Oppositions, I will be referring to how our opposition parties rarely present alternative policy ideas... and as I was drafting Part 2, I suddenly stopped and asked myself: Do Singaporeans even know what an alternative policy idea is if they have never encountered such a beast? Would they understand what I mean by that term?

So here is 'negative income tax'. I'm not saying it is such a good idea that it must be adopted -- as noted at the end of this article, there are possible serious difficulties with it -- but merely by laying it out, it helps focus thought and discussion simply because a concrete alternative is being offered. It provokes debate about that is right or wrong about existing tax policies, what can be cured by an alternative policy, what cannot. In other words, to get our teeth into some meat, rather than go on and on berating the government with no alternative ideas to offer. 

I hope by this example to show why it is important for opposition parties to present alternative policy schemes if we are to mature politically.

Concept

Personal income tax is typically levied as a percentage of one's annual income. Typically, also, it is progressive, meaning that there are different bands of income with larger percentages raked off as tax in the higher income bands. The lowest band is often rated at zero percent, effectively putting in place a threshold below which a person is not liable for income tax.

In Singapore currently, the lowest band is $0 - $20,000 annual income. In other words, if you earn less than $20,000 of taxable income in a year (i.e. after various allowable deductions), you don't have to pay any tax.

The other bands can be seen from this table which I got from the website of the Inland Revenue Authority of Singapore.

Here's a graph showing the tax (in orange) payable with rising income (red line). It may not be visible to you that the orange starts from the $20,000 point, because the percentage tax is so small.

 

Negative income tax adds a twist to this concept. Below a certain threshold, instead of you paying tax to the state, the state pays an income supplement to you.

Like income tax bands, the amount paid out to you is rated as a percentage, this time of the shortfall from a threshold figure. This is unlike other kinds of social security payments which often come as lump sums, justified on any number of measures like disability or being laid off.

Just for discussion, let's assume firstly, a threshold figure of S$10,000, and secondly, a supplement rate of 50 percent. The income supplement (or negative income tax) is computed thus:

(Threshold income annual income) x 50% = Income supplement

The next graph is the inset from the above graph, showing the lower income bands, this time with a negative income tax (or income supplement) added in blue.

 
Why might this be a good proposal?

The fact is, Singapore already gives out a variety of income supplements to the needy. The principle of the state doling out money is not alien.

The problem is the variety. There are numerous schemes, each dependent on arcane measures. The public assistance scheme depends on you having to apply and be tested for it. Workfare depends on another set of tests. (There's also something called Workfare Bonus -- how that differs from Workfare escapes me!) Beyond that, we have baby bonuses (only to heterosexually-married women, not single mothers, not same-sex parents) and medical assistance schemes. Since each has its own rules and peculiarities, each therefore has its built-in discriminatory aspects. People continue to fall through the cracks.

Workfare and other measures are also not permanent; they come and go depending on the annual state budget. It offers no peace of mind. 

People either don't know these schemes exist or find the process too complicated, or don't know who to ask. The result is that the effectiveness of such schemes fall short of intent. For example, there were news stories earlier this year of grassroots volunteers having to go door-to-door to enquire about their neighbours' incomes (surely that is a private matter???) and help them sign up for Workfare (or was that Workfare Bonus?) and even then, a subsequent report, which I haven't been able to locate for referencing in this article, said that the take-up rate fell short of target.

The systems are too complicated, and too dependent on individual assessments. It is ripe for patronage and corruption.

Another angle to consider is this. The Goods and Services Tax (GST) introduced in 1994 dramatically reduced the progressivity of taxation in Singapore. The GST is a flat tax. Poor or rich, you pay the same percentage for every dollar you spend. One could in fact argue that it is a regressive tax, in that the poor pay a higher percentage than the rich. This is because poor people tend to spend a larger proportion of their income than the rich; the rich have so much money, they save or invest a big part of it. What they don't spend, they don't pay the GST on it. So, relative to income, the poor end up paying more GST than the rich.

With the introduction of the GST as a source of revenue, the government massively reduced the income tax rates for the higher bands. Today, at only 20 percent, our highest band is in fact one of the lowest top rates in the world.

In return, the government instituted a GST Credit scheme as income supplement for the lower income groups, but this was a temporary scheme. In 1993 - 1994 there was a howl of protest that the rich got permanent tax cuts when the poor had temporary relief.

It should hardly be a surprise then that economic inequality has risen dramatically over the years.

 

 

A negative income tax fixes these issues. It is not discretionary like the many schemes we currently have; it is permanent. It is automatic once your income falls below the threshold, which we have assumed here to be S$10,000 a year. In other words, it has "knowability" and reliability -- a huge advantage offering people some peace of mind, which is surely what social safety nets should be all about.

Adults only or children too?

An interesting question is whether negative income tax should only apply to adults. It is quite possible to extend it to every child who is a citizen, replacing the baby bonus schemes.

In effect, then, every child (and we assume no child works) gets the maximum income supplement of S$5,000 a year, until he starts working.

Immediately of course, other questions arise. To whom should this amount be paid? There is a real risk that some dead-beat mothers just keep producing babies to avail themselves of the income supplements due to their children, and then spend the money on drugs or cigarettes. These concerns can be addressed by paying into escrow accounts, meant for say, education and medical care.

Problems with negative income tax

The concept is not without its problems. The biggest is that the whole idea depends on people declaring their incomes truthfully with a way of verifying them. When people are already earning so little, the cost of compliance and verification may be disproportionate.

On the other hand, the enormous bureaucracy we have gradually built up to manage the multitude of existing discretionary schemes is already a cost.

A contentious issue is whether the income supplement should be extended to non-citizens. One argument is this: Since non-citizens resident here pay income tax, why shouldn't they be eligible for negative income tax too? I honestly think that is a fair case; in any event, the likelihood of a non-citizen staying on in Singapore while unemployed for the long term is remote. The amounts involved may not be significant.

* * * * *

 
As I said above, this is not a panacea for everything. But as an alternative policy proposal, it helps focus a debate about how we have failed to adequately redress the regressivity of the GST.

Sure that debate rumbles on even now, but because opposition parties do not offer an alternative scheme, they can be accused of just grumbling with no "constructive" proposal put forward. Well, here is one, then.

It is also the kind of policy proposal that can be sold with a sound bite: "Income supplement if you earn below $10,000 a year." With maybe an additional soundbite: "From cradle to cremation."

Now that would be real politics.

Yawning Bread 


 

"Welfare discourages work," it is argued

Because a negative income tax is rated as a percentage of income shortfall, it addresses one of the biggest criticisms of lumpsum payouts which is that the latter discourage people from working. With lump sum schemes, when a person takes even a low-paying job, the person may find himself disqualified from the assistance scheme and he ends up being worse-off working than not working.

 

Footnotes

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Addenda

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