The thought of the terms “tax theory” and “exciting” being in the same sentence is about as mind boggling as a comprehensive study of quantum physics. I don’t even know what quantum physics is, but I know it’s probably mind boggling, so I’ll go ahead and use that example. However, I do believe that the idea of Universal Basic Income achieved through a reverse income tax is a very, very exciting idea. That may sound like a mouthful, but it’s actually a pretty straightforward idea, and I’ll explain it all very shortly. But before going any further, it is worth stating that it is currently impossible to fully implement the ideas I am about to lay out. This is because we exist in a society that frames every issue into a two year matter. Why two years? Because that’s how often we hold elections in the US (midterm elections). So with that being said, it would be too politically costly for our elected officials in Washington D.C to fully back this type of reform until a disruptive force fundamentally changes the way our society functions- like automated robots gobbling up traditional employment opportunities. But seeing that automation is on the fast track dominating our labor market, now is probably the right time to begin thinking about this concept.
So, what is a reverse income tax?
A reverse income tax (or negative income tax) is a form of tax that guarantees a minimum level of income by subsidizing a portion of your earnings if you are below the poverty line, but the best way to really explain this is by using a simplified example:
Note: The figures used in the following examples are only intended to help facilitate an understanding of the concept, and are not actual proposals for tax levels, those will be made later on.
Say the poverty line for a single individual in Florida is $10,000. With a reverse income tax, if your income fell below that level, the government would help make up some of the difference. More specifically, say your income was $1,000- you would be another $9,000 short of the poverty line. So, under a reverse income tax, the government would take that $9,000 number, and would base your subsidy off a certain percentage of that number. If there was, say, a 50% subsidy, the government would pay you 50% of 9,000 ($4,500), bringing your income to $5,500.
After reading that example, you may ask yourself:
“Why not just pay them the full $9,000”?
In fact, this is a question I first asked myself when I came across this theory a few years ago. However, if you fully subsidize an individual’s income, then you effectively kill their incentive to go out and find work. By partially subsidizing it, you allow them to maintain that incentive while making things a little bit easier on them. Also, this tax is not a replacement of welfare, so lower income Americans can still benefit from existing programs.
To see how this system guarantees a minimum income, consider the following:
Say a single male in Florida had $0 in income. That leaves him $20,000 short of the poverty line. With a 50% subsidy, he would then receive $10,000 from the government. So essentially, in this example scenario, the reverse income tax guarantees an income of $10,000 to anybody, no matter what; and that is how the reverse income tax can be utilized as a nontraditional form of Universal Basic Income.
So now that the basics of the Reverse Income Tax as it relates to UBI are covered, we can venture a little further into the weeds. This means discussing the implications of this tax plans for individuals making over the exemption level.
- What level of income should be exempt from taxes?
This was probably the most interesting question to answer when writing this piece, because in order for this tax plan to be equitable, it would have to keep after tax income equal for roughly everybody. If the exemption is too low, then you’re not doing enough to help working and middle class individuals. If it is too high, your tax revenues will fall short of what is needed. Currently, the tax scale is progressive, with each increased level of income subjected to higher tax rates. So to start, let’s look at how taxes are currently paid at three different income levels for a single filer (somebody who is not married or dependent, most 20 somethings would fall into this category).
- An individual making $25,000 currently pays $3,283.75 in taxes, not accounting for any refunds or deductions.
- An individual making $48,000 currently pays $7,738.74 in taxes, not accounting for any refunds or deductions.
- An individual making $150,000 currently pays $34,981.75 in taxes, not accounting for any refunds or deductions.
So those are the current numbers in our system, and now that we know those, we can move ahead with determining what the reverse income tax should look like. Once again, we want to keep tax levels for everybody roughly equal.
In this system, it appears that an $20,000 exemption balances benefits with revenues quite nicely, that is, benefits are strong enough, and the exemption level (when paired with an adequate tax) doesn’t mess with federal revenues. To see this play out, keep reading.
2) Since we’ve established a $20,000 exemption level, what should the tax rate after that be?
With a $20,000 exemption, we need to find a general tax rate that keeps revenues close to what they are now. After tinkering with different percentages, it became clear that the flat tax range should be between 27 to 29%, depending on how much you earn. In order to keep the tax revenues collected from individuals earning $48,000 equal, a 27.64% rate is most appropriate. As you will see, this rate will create a slight budget deficit, which will need to be made up for.
- An individual making $25,000 would now pay $1,382 in taxes, less than 50% of what they paid before. Net income change from new tax: +$1,901.75
- An individual making $48,000 would now pay $7,739.20 in taxes, almost equal with what they used to pay. Net income change from new tax: -$.46
- An individual making $150,000 would now pay $35,932.75 in taxes, slightly more than what they used to pay. Net income change from new tax: -$951.00
So, with a 27.64% flat tax that applies to everybody making over $20,000, we can see that the tax levels are pretty close to the status quo. However, it is worth noting that with individuals making $25,000 paying less than half of what they pay now, the government would have to find a way to make up the difference. This gives us two options to chose from: mildly raise taxes on top income earners ($300,000 and up) to 29% or so, or make relatively small cuts to the budget. In my opinion, both of these options are very reasonable and practical. In the end, these numbers need to be played with, and that is why it is an almost flat tax, because we would still need a slightly progressive tax scheme to keep tax revenues equal to what they are now.
So, what is the end goal of instituting a policy like this? Well, as I mentioned earlier, automation is truly on the fast track to replacing manual labor, and in order to transition to a society where most everybody is technologically proficient, we need to give those individuals making that transition a more secure safety net, without going bankrupt in the process. In order to do this, many people recommend enacting a policy of Universal Basic Income. However, it doesn’t take a genius to realize that the government indiscriminately giving $10,000 to everybody, no matter what they earn, is extremely wasteful. With a reverse income tax, every American would be guaranteed at least $10,000 in income, and tax subsidies would be scaled based on income, which is far more efficient. What is more, is that the reverse income tax grants every American a much higher tax exemption, and who doesn’t want that? This piece is not meant to act as a “be all end all”, but it is rather just to get people thinking. If we want to prepare ourselves for the future, it is clear that we will need to establish a minimum level of income for everybody, and in my opinion, this is the best way to do it.