Beware the ideas of IDS

Introduction

I am a proponent of Negative Income Tax (NIT). I am because it can deliver social security via a basic income, because it is simple and cheap to administer, and because it is libertarian.

In this piece, I try to set out why implementing NIT in Britain does not require any radical surgery to the existing income tax system. I also point out that the disincentive effects of NIT are comparatively low. I suggest that the sanctions regime currently in vogue would be inappropriate under a fully developed NIT. I also briefly explain why the cost of implementing NIT, at least at first, is likely to be close to zero.

What is NIT?

It’s a very simple idea. For those individuals whose incomes fall below the personal allowance, the tax authority, instead of charging income tax, makes a reverse payment to top up the individual’s income. One of its original architects, Milton Friedman, thought the payment should be universal,  unconditional and be made without moral judgement. His idea was to replace complex and judgemental social security systems. The logic of income tax automatically and progressively claws back negative income tax payments when an individual’s income exceeds their personal allowance.

How would IDS and his followers view NIT?

Despite the libertarian origins of NIT, the IDS school of thought would seek to bring NIT, were it to be implemented in Britain, within the currently fashionable sanctions regime.  IDS  has already expressed his intention to bring in-work benefits within the sanctions regime. It is hence reasonable to suppose that IDS would wish a NIT system to be conditional and to include it in his beloved sanctions regime too. It is pretty clear from the high level of  coercion embodied in Universal Credit that IDS does not share the libertarian values of NIT.

How would a negative income tax look in Britain?

Surprisingly perhaps, it would look similar to the current income tax system in Britain – most people would notice no change to their income tax charge and to their net pay. Income tax, whether through deductions at source or through end of year self-assessment would operate as now,  without change to method or amount. Only individuals with incomes below the personal allowance would notice any difference.

Only a comparatively simple tweak to HMRC’s software would be needed to implement NIT. NIT would be simple, cheap and low risk to implement. Because radical surgery to the existing system would not be needed, a government should not find practical objections to NIT implementation.

So how would NIT differ from the current income tax system?

At the moment, the first £10,600 of an individual’s annual income is tax free – individuals pay income tax only on their annual income in excess of £10,600. The starting rate of tax for incomes above the £10,600 threshold is 20%. For the purpose of this explanation it is not necessary to consider the higher income tax rates (40% and 45%) as these are unaffected by NIT. In fact, NIT will make no difference to the income tax charge for anyone whose income exceeds £10,600, whether their marginal income tax rate is 20%, 40%, or 45%. Only those whose income is below £10,600 will be affected by NIT.

Example:

Freda’s annual income is £8,000.

Her tax charge under the current system is 20% x (£8,000 – £10,600) = – £520, which, because it is negative, means HMRC will not seek to collect income tax from Freda. So Freda pays no income tax and her post-tax income is £8,000.

In contrast, under NIT the negative result of -£520 produced by her tax computation  would trigger a payment to Freda of £520 from HMRC. Her post tax income would hence be £8,520 (£8,000 + £520). In effect, Freda’s wage is being topped up by the state through the tax system.

NB. 20% x (£8,000 – £10,600) can be written as 20% x £8,000 – 20% x £10,600

So why not stick to tax credits currently operated by HMRC?

The NIT calculation is very simple and should logically be preferred to the complex strictures and administrative expense of the tax credit schemes currently operated by HMRC. A further point is that IDS’s intention is to bring in-work tax credits into the benefits sanction regime via Universal Credit.  This will add further complication to an already over-complicated system.. An NIT could ease the burden on Universal Credit, which is already creaking under the weight of its own complexity. The implementation proposed here is modest and cautious. Over time, increasing confidence would hopefully impel a government to implement NIT comprehensively, perhaps with a view of complete replacement of other social security benefits.

Would a negative income tax have disincentive effects?

IDS et al hold that low income earners are discouraged from increasing their earned incomes because they are in receipt of tax credits and other means tested benefits. Increased use of sanctions (the withdrawal of benefits) has been IDS’s chosen method of countering these putative disincentive effects.  NIT would be perceived by IDS to have disincentive effects given the evidence. IDS et al would thus argue that receipt of NIT should be conditional and subject to sanctions should a recipient be perceived as “free-riding” on the revered tax-payer. IDS is not a libertarian.

The withdrawal rate, (the amount by which the state top-up is reduced for each additional £ of income) is  equal to the 20% starting rate of tax. This is far lower than the 65% withdrawal rate aimed for by Universal Credit. The NIT implementation proposed here thus compares favourably to IDS’s Universal Credit.. This suggests that sanctions should not be necessary to “motivate” NIT recipients to increase their incomes

How much would NIT cost?

Confining NIT (at least to start with) to recipients of market incomes and to pensioners then the answer is not much. This is because their benefits and tax credits would be reduced by the amount equal to the NIT payments received by them. NIT would be payable only where market incomes and pensions fall below £10,600, so many people would not be NIT recipients, The total social security bill and tax take would be identical as between the current arrangements and NIT.

So why implement NIT then?

A modest and cautious implementation has been recommended here so that the costs and risks of failure are low. Over time, more benefits of NIT can be captured. These benefits include

  1. reduced administration costs;
  2. better incentives;
  3. increased flexibility;
  4. a basic income;
  5. simplicity;
  6. reduced benefit costs;
  7. a more constructive role for DWP;  and
  8. less state coercion

Self-employment and negative income tax

Introduction

Previously, in “Is Universal Credit the wrong approach?”, I proposed that a thoughtfully designed negative income tax system would be more effective in delivering UC’s stated aims. I believe UC is fundamentally flawed, primarily because it does not address the UK’s low and falling wages. The feasibility of designing incentives to make work pay into UC, in an environment with low and falling wages, may be logically flawed. This doubt exists in addition to the current uncertainty about UC’s technical feasibility. In this post, I set out how negative income tax (NIT), the proposed alternative to UC, would apply to the self-employed.

Recap of the negative income tax proposal

1. Income tax would be assessed on Comprehensive Realised Income (CRI).

2. An individual’s tax-free allowance would be calculated according to the number of hours worked. The value of each hour worked would be £20 and be capped at 40 hours per week (2,080 per year).

3. A single rate of tax would be applied to comprehensive realised income, By way of example, and for philosophical reasons, the single tax rate has been set at 50%,

4. Carers, the disabled, and the infirm would be credited with 40 hours per week by HMRC. This would release  a payment of £800 per week (40 hours x £20/hour) to individuals falling in these categories. Any earnings would not disqualify recipients from this minimum income guarantee. However, earnings would be taxed at the marginal rate of 50%.

5.  Job seekers would be paid according to the hours they work part-time, voluntarily in the charitable sector, and in work placements. These hours would be notified to HMRC by the placement providers using HMRC’s Real Time Information reporting system. Payments would be accordingly triggered at HMRC. The placements would not be compulsory – job seekers would have choice as to the  number of hours and type of work they took on. The role of the DWP would be to find and arrange work placements in cases where the job seeker has been unable to do it for themselves.

6. The self-employed (sole-traders and partners), would be allowed a tax-free allowance equivalent to deemed hours of work. The imputed hours would be capped at 40 hours per week (or 2,080 per year), as for all other cases. The hours worked would be imputed by dividing the tax-adjusted earned profits by the standard value of an hour (£20) and multiplying the result by the marginal tax rate. This arrangement would be necessary since no third party could attest to the number of hours worked.

H(n) = m x Y(n)  ⁄ c

Where

H(n) are the imputed hours for the period (capped at 52 x 40 = 2,080)

Y(n)  is the tax adjusted profit in period n

m is the marginal tax rate (set to 50% in the examples)

c is the standard value of an hour worked (set to £20 in the examples)

Example 1

Stephen enters self-employment at the start of the tax year. His (tax-adjusted) profits for the year come to £10,000. He has no other sources of income.

His imputed hours for the year would be

H(n) = £10,000 x 50% / £20 = 250

Hence Stephen’s tax charge for the year would be 

T(n) = 0.5 x £10,000 – 250 x £20 = £0

Stephen’s disposable income is hence £10,000 because his tax charge is zero. He has used up 250 hours of his annual allowance of 2,080 hours. He could have used the unused allowance to do part-time work and/or voluntary work. His income would have been supplemented had he done this.

Had Stephen also sold his house at a capital gain of £40,000, his income tax computation would be:

 T(n) = 0.5 x £50,000 – 250 x £20 = £20,000

Hence his post-tax comprehensive realised income would be £30,000. He is charged no tax on earned income but is charged 50% on his capital gain (an unearned component of comprehensive realised income)

 

Example 2

Anita enters self-employment at the start of the tax year. Her (tax-adjusted) profit for the year comes to £100,000. She has no other sources of income. Her imputed hours of work in year n are calculated as thus.

 H(n) = £100,000 x 50% / £20 = 2,500

The hours must be capped to 52 weeks x 40 hours per week = 2,080.

Her tax for year n would be:

T(n) = 0.5 x £100,000 – 2,080 x £20 = £8,400

Anita’s disposable income (take home pay) is hence £91,600. Her tax rate is 8.4% on her earned income. 

Had Anita also received rental income (i.e., unearned income) of £10,000 in the same year then her income tax computation would be:

T(n) = 0.5 x £110,000 – 2,080 x £20 = £13,400

Note that the unearned components of comprehensive realised income have again been taxed at a straight 50%. This feature, whereby an individual’s tax-free allowance is calculated on hours worked, assists in aligning the tax system with the “making work pay” agenda that underpins the government’s welfare reforms and UC.

NB. The parameters used in these examples, i.e., a working week capped at 40 hours, a marginal tax rate of 50%. and a standard hour set to £20, produces a tax-free allowance of £83,600 on earned income. This produces low average tax rates on middle earnings and is very generous by current standards. It is intended to incentivise. Of course, the average rate will approach the marginal rate of 50% as incomes rise.

Analysis of JSA sanctions in Birmingham and Solihull

Are sanctions being applied consistently?

On 6 November 2013, DWP published sanctions counts by job centre. As far as I aware, this is a new data series – prior to this sanctions counts were not published, still less at the atomic level of individual job centres. Moreover, the published sanction counts are in time series for each job centre, and this too is helpful in building a picture.

At about the same time, perhaps coincidentally, Roger Godsiff, MP for Birmingham Hall Green, sponsored a parliamentary Early Day Motion to reflect his concern that sanctions are being over-used by the Sparkhill job centre, one of two job centres situated in his constituency. It may be relevant that the other Hall Green job centre, Kings Heath, is the origin of the Caitt Reilly case, where the courts found that insufficient decision-relevant information had been provided to her and other claimants.

Given this, it seemed worthwhile to conduct a comparative numeric analysis of the newly published data for each of the relevant parliamentary constituencies comprising Birmingham & Solihull.  Eleven of these constituencies have job centres and hence are relevant to the study.

By matching the JSA sanction counts published by DWP with the JSA claimant counts published by ONS, the sanction rates for the eleven parliamentary constituencies were computed for the months Nov 2012 to June 2013. This is as much as the new DWP data series permits at the current time. October 2012 was excluded because it is an incomplete month.

A national sanction rate for the country as a whole was also computed, so that sanction rates for each of the constituencies forming the study could be compared, the national sanction rate being the comparator. The ONS claimant count imposed a limitation in achieving this purpose because, prior to February, a claimant count for Great Britain, as distinct from the United Kingdom, is not provided. The Great Britain claimant count is needed because the DWP sanction count is only given for Great Britain. Thus matching the national sanctions count to the national claimant count is only possible for the months Feb 2013 to June 2013 where both series are provided in aggregate for Great Britain.

The graphs below show the results of this study.

Sanctions rates for Birmingham and Solihull parliamentary constituencies having job centres

Sanctions rate data 1

Sanctions rate data 2

Sanctions rate data 3

What do the graphs show?

With the exception of Selly Oak, the local sanction rates depart significantly from the national sanctions rate.

The local sanctions rate of Birmingham Hall Green and of Solihull appear to be particularly high for all of the five months Feb to June when compared to the national sanction rate. There may be valid reasons for this apparent over-sanctioning but to date a valid reason has not been identified. This has led to speculation that individual job centres are pursuing their own, or locally determined, sanctioning targets.

An alternative reason for the apparent over-sanctioning may be demographic. Younger claimants may attract sanctions more easily and frequently than older claimants. However, this is speculation. The age profiles of claimants in these two constituencies have not yet been ascertained still less compared to the national age profile of claimants.

The departures from the national sanction rate are statistically significant (ie more than 2 standard deviations away from the expected counts) for all constituencies, save for Selly Oak.

Appendix: Source data

Appendix 1 Sanctions Appendix 2 Sanctions