The underlying principle of the negative income tax (NIT) is that
a family of a given size should be guaranteed a minimum
annual income. The tax system must be designed, however, to
guarantee this income without eliminating the household’s
incentive to be self-supporting.
As an example, consider a system in which each household is
guaranteed a minimum annual income of $10 000 and the
marginal tax rate on all earned income is 40 percent. Money
can be thought of as flowing in two directions; the government
gives every household $10 000, and then every household
remits 40 percent of any earned income back to the
government. The break-even level of earned income in this
example is $25 000. All households earning less than $25 000
pay negative taxes overall; they receive more money from the
government than they remit in taxes. Households earning
exactly $25 000 pay no net taxes—their $10 000 from the
government exactly equals the taxes they remit to the
government on their earned income. All households earning
more than $25 000 pay more than $10 000 in taxes so they are
paying positive taxes overall.
The figure shows the operation of this scheme by relating
earned income on the horizontal axis to after-tax income on the
vertical axis. The red line shows what after-tax income
would be if there were no taxes—it would exactly equal earned
income.
45 °