Saturday, May 15, 2010

Fixing The Budget Mess: Part 1, The Negative Income Tax

It boggles the mind that the United States, along with the rest of the world, could find itself in the budget mess we are now in.  For current information on the nature, size and difficulty of the budget deficit, yesterday's blog is a great place to start:

The solution is a lot easier than one might think.  In fact, just about anyone, on an individual level, has found themselves in a similar position:  too many bills, too much debt and not enough income. 

The difference is that NONE of us can print money and/or change the rules so as to circumvent the system.  Uncle SAM can do both.  Although NEITHER are appropriate options and NEITHER work.

Step 1:  Change incentives to REWARD productive behavior and PUNISH suboptimal behavior.  Sound tough?  Hardly!  As Milton Friedman pointed out time and time again in his prolific writings, if you want more of something, SUBSIDIZE IT!   If you want less of something, TAX IT!

Here are some real life examples of how this has worked in the past.  A couple of decades ago, it was common practice to subsidize dairy farmers.  The result?  A surplus of milk and cheese.  Milk had to be poured down the drain to keep prices from crashing and cheese was given out from huge warehouses.  The oversupply of Milk, in turn, caused farmers to convert dairy cows into hamburger - thereby putting pressure on meat prices.  Instead of helping farmers, the "invisible hand" of government stupidity slapped them in the face.

In the case of oil, the decision was made to impose possibly one of the most idiotic taxes ever created:  the Windfall Profits Tax.  Used as a method to PUNISH the oil companies, the tax was levied to keep them from profiting on the Middle East Oil Embargo.  The result?  A complete cessation of drilling, at a time when new sources of oil were desperately needed to be created.   Once President Reagan ended this tax immediately upon taking office, the price of oil crashed soon thereafter and the next 25 years were marked with ample and cheap oil supplies.

This brings us to the utterly counter-productive income tax system.  Taxing the "rich" is nothing more than a means to curry political favor among the public, which doesn't understand that only the successful are in a position to create jobs.   The result?  Fewer productive people working less at creating jobs and more at discovering tax loopholes.  Less time spent building business and developing technological innovation.  LESS, not more income taxes generated.

As for the other side of the coin, WELFARE subsidizes the non-productive.  The result?  More people on Welfare!  And, more people who become "addicted" to the lifestyle of receiving handouts for fear of losing their benefits should they be able to return to the workforce. 

The solution?  A NEGATIVE Income tax.  First proposed, to my knowledge, by Milton Friedman, the Negative Income Tax would provide a base level of support without strings, thereby eliminating the need for most, if not all, assistance programs. 

Here's how it would work:  Set a base level of income of, say $50,000 per year.  Anyone below that level would qualify for some support.  The negative income tax would be applied to any shortage of earnings below that level.  For example, if someone earned $30,000, they would receive some subsistance.  Using a negative tax rate of 25%, the individual would recieve $5,000 (($50,000 - $30,000) X .25)).  The individual would still keep 75% of additional earnings up to $50,000 and pay the normal income tax rate on anything earned ABOVE that level.  So, instead of being incentivized to stay home and do NOTHING, the person is rewarded for at least doing something.  Society, as a whole, is much better off.

In addition, by being a CASH distribution without strings, the Negative Income Tax would not interfere with the allocation of resources.  Take Medicare... PLEASE!  Because health care is subsidized, it is OVER-consumed by beneficiaries - which results in the entire health care system being stressed to the point of malfunctioning.  If consumers were allowed to CHOOSE the level of healthcare they wanted, the system would be in balance and we wouldn't need to create government behemoths like Obamacare.

Just fixing the reward system, by itself, would go a long way toward generating economic growth, lowering un- and under-employment and alleviating the economic distortions caused by the interference with a free market. 

Tomorrow, we'll tackle the next part of "Fixing The Budget Mess" by reviewing the issues of entitlement spending, which now consumes more than half the budget.

Marko's Take

Our new You Tube channel and our video blog series is designed to focus on topics such as solutions to the problems facing us as a society.  The next episode, due to be posted shortly, is entitled "Social In-Security:  The Solution" and goes through a 7-step solution to undo this ill-concieved and immoral wealth transfer scheme.  Currently posted is "Social In-Security:  The Problem" which can be accessed by clicking here

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