Vanguard News Network

By George Lenz

The Fallacy of Hazlitt

Our discussion of the negative income tax has provoked libertarians from Mises.org to re-publish a long-forgotten Henry Hazlitt’s essay, critical of negative income tax. Hazlitt, an American economist and WSJ reporter, who followed the tradition of Austrian school, was highly critical of both Milton Freedman and his idea of negative income tax. Below is my answer to this criticism (in brackets):

Recognizing the calamitous erosion of incentives that would be brought about by a straight guaranteed-income plan, some reformers have advocated what they call a “negative income tax.” This proposal was put forward by the prominent economist, Professor Milton Friedman, of the University of Chicago, in his book Capitalism and Freedom, which appeared in 1962. The system he proposed would be administered along with the current income tax system.

Suppose that the poverty-line income were set at $3,000 per “consumer unit” (families or individuals), and suppose that the negative income tax (which is really a subsidy), were a flat rate of 50%. Then every “consumer unit” (this is the statisticians’ technical term) whose income fell below $3,000 would be paid a subsidy of, say, 50% of the difference. If its earned income were $2,000, for example, it would receive $500; if its earned income were $1,000 it would receive $1,000; if its earned income were zero it would receive $1,500.

Professor Friedman freely concedes that his proposal, “like any other measure to relieve poverty reduces the incentives of those helped to help themselves.” But he argues that “it does not eliminate that incentive entirely, as a system of supplementing incomes up to some fixed minimum would. An extra dollar earned always means more money available for expenditure.”

It is true that a “negative income tax” would not have quite as destructive an effect on incentives as would a straight guaranteed income. In fact, some thirty years ago I put forward a similar proposal myself. This appeared in an article in The Annalist (a weekly then published by the New York Times) of January 4, 1939. I suggested what I called a “tapering subsidy,” a relief payment that would be reduced by only $1 for every $2 the relief recipient earned by himself.

But I abandoned the proposal when I realized that it leads straight into a dilemma, which is precisely the dilemma of the negative income tax: either it is altogether inadequate at the lower end of the scale of self-earnings, or it is unjustifiably excessive at the higher end. Either it must pay only half an adequate income (by its own definition of “adequate”) to a family that earns no income, or it must pay nearly twice an adequate income to a family that already earns an almost adequate income.

(When an economist becomes primarily concerned about justice, e.g. goes political, I smell something fishy – he should first and foremost be concerned about effectiveness and efficiency of the proposal. The idea of negative tax is in fact, the first welfare idea which does not take out the natural stimuli for survival of the most able. If a person can’t get any income on his own, it’s only just to provide him with of the minimal income, which is sufficient only for survival, as a very potent stimulus to help himself or ultimately fail. In contrast if individual is helping himself, he should have a significant (and growing) stimulus to help himself more actively up until he becomes self-sufficient – at the same such stimulus should gradually be withdrawn from him. Thus negative income tax deserves the designation of the best economic welfare idea of the 20th century)

Trick names of this sort corrupt the language and confuse thought. It would hardly clarify matters to call a handout a “negative deprivation” or having your pocket picked “receiving a negative gift.”

The problem that the NIT (negative income tax) evades or glosses over is the problem of the individual or family with zero income. If an individual were given only $300 (the figure suggested in Professor Friedman’s original proposal in 1962), nobody would regard this as nearly adequate – particularly if, as Professor Friedman also proposed, NIT were made a complete substitute for all other forms of relief and welfare. If the NIT payment for a family of zero income is set at $1,700, no advocate of the guaranteed income would regard it as adequate to live on in “decency and dignity.” So if the NIT were ever adopted, the political pressure would be irresistible to make it provide the minimum “poverty-line” income of $3,400 even to families with zero earned income.

(The task of the welfare is not to provide a family with life of “decency and dignity” – this can only be done by the family unit itself – but to help it survive. Speaking of the presently suggested minimal monthly amount of negative income tax – 240 USD per adult (18+years) and 120USD per child (18- years) – it is sufficient for an individual to survive, and for no more else, as it should be. As for political feasibility, it is indeed difficult to maintain under democracy – but we are not going to live under democracy)

“Trick names of this sort corrupt the language and confuse thought. It would hardly clarify matters to call a handout a ‘negative deprivation’ or having your pocket picked ‘receiving a negative gift.'” The basic subsidy would therefore be as great as under the straight guaranteed income. But if the basic subsidy under NIT to a family with zero income were $3,400, then under the NIT 50% “incentive” formula that family would continue to get some government subsidy until its annual income reached $6,800. But this is higher than the median family income for the whole country in 1963 ($6,637). In brief, this would be fantastically expensive.

In addition, it would raise serious problems of equity. When the subsidized family was earning $6,798 income it would still be getting a $1 subsidy. When it earned $6,802 would it fall off the gravy train entirely, and have to wait until its income fell below $3,400 before it could get on again? And what about the family that had been earning $3,402 all along, and had never got on the gravy train?

The arithmetical dilemma of the NIT has received so little attention from its advocates that I hope I may be forgiven another illustration to show the paradoxical way in which it would work out.

An orthodox relief program would pay the jobless head of a family, say, $60 a week. If he then started to earn something, he would be paid simply the difference between that amount and $60. Under the NIT principle a man who was earning nothing would also receive a relief payment of $60 a week. But if he then earned $30 a week on his own he would still get a $45 payment (reduced by only $1 for every $2 earnings), bringing his total income to $75 a week. If he was later able to earn the full $60 for himself he would still be getting a relief payment of $30 a week, bringing his total income to $90. In fact, even if he succeeded in bringing his total self-earnings to $118 a week he would still be getting $1 a week in relief payment.

He would then be almost twice as well off economically as he would if he had always earned enough – say, $61 a week – not to get on the relief rolls in the first place. This would be clearly inequitable to those who had never got on relief. The incentive to get on relief, and certainly to stay on relief, would be enormously greater under NIT than under the present system.

If we tried to escape this result by using the NIT formula only in part – taking the man off relief, say, as soon as he was himself earning $60 a week – we would get an even more absurd result. When he was earning $58 a week under NIT, he would still be getting $31 a week from the government, making his total income $89. But if he then made the mistake of earning only $2 more he would end up with a net loss of $29 a week. So the negative income tax would create a tremendous positive incentive to get and stay on relief permanently.

The NIT scheme could avoid this preposterous result by paying a man with zero income only, say, $30 a week, or only half as much as its own proponents assume that he needs to live on.

Some readers may think that the dilemma of the NIT scheme can somehow be escaped by changing the percentage by which the relief payment or income supplement is reduced as self-earnings increase. But any change from 50% one way or the other merely reduces one horn of the dilemma by making the other more formidable. If we reduce the government supplement by 75 cents for every dollar of self-earnings, we correspondingly reduce or destroy the incentive for such self-earnings. If we reduce the government supplement by only 25 cents for every dollar of self-earnings, we increase the recipient’s incentive to work and earn, but at the cost of a still more expensive program for the government, and we increase the recipient’s positive incentive to stay on relief because of the violent drop in his income if he ever got off.

If we make the scheme more complicated by, say, reducing the relief payment or supplementary income by only 25 cents for every dollar of the recipient’s first $10 of weekly self-earnings, 50 cents for every dollar of his second $10 of self-earnings, and 75 cents for every dollar of his third $10 of self-earnings, or some similar scheme, we merely pile up an administrative nightmare without solving the basic dilemma. The unpalatable truth seems to be that whenever we try to “increase incentives” by reducing a relief payment by less than a dollar for every additional dollar of self-earnings, we solve an immediate problem at the cost of building up a bigger problem for the future.

(Thus the above mentioned argument is political in nature, predicated upon failings of democracy, and invalid from the economic point of view)

In addition to the special dilemma it presents, the NIT retains the fatal defects of the straight guaranteed income. By neglecting the careful applicant-by-applicant investigation of needs and resources made by the ordinary relief system, it would open the government to massive fraud, chiseling, and swindling. And it would also, like the guaranteed income, force the taxpayers to support a man regardless of whether or not he was making any sincere effort to support himself. The government is bound to get into insoluble difficulties if it starts to give money away to “the poor” not only without making sure that they are poor but without bothering to find out the reasons why any particular individual or family is poor.

(Well, fraud can and would be investigated, and the penalty for fraud would be repayment of double of the monies collected and lifelong loss of access to negative income tax. Given the fact, that the agency that would investigate would be not poor-loving state social services agencies, but IRS, we can be sure, that negative income tax audits would be very successful. What is still more important, the various administration of costs of keeping welfare bureaucrats (more than 2 mln people presently at state and federal level) employed would disappear – currently this administrative cost stand at least at 20% of each program’s budget)
How much would a guaranteed-income or NIT program cost? I have already pointed out that proponents have put out calculations as high as $38 billion a year, but we may be confident that their cost figures are systematically underestimated, even for the early years. And if once the main principle of either proposal were accepted, the minimum subsidy or guarantee demanded would be bound constantly to increase. Anyone who doubts this need merely consult the history of unemployment insurance and Social Security benefits since those plans were initiated in the 1930s.

(Well to count how much it would cost at maximum: taking all FY 2005 U. S. non-working population (145 mln.) on maximum negative income tax (app. 3000 USD per year per person) would cost 435 bln USD or 2.5 times less than the FY 2005 U. S. social spending combined. Using a more realistic set of assumptions puts the maximum cost estimate of negative income tax at 270 bln USD or 4 times less than the FY 2005 U. S. social spending. Thus more than 750 bln USD can be put on reducing taxes and paying off the U. S. national debt. As for increase in minimal payments, they are unlikely, when U. S. democracy would be discarded, but even if they would increase, the negative income tax has a built in stabilizer: it is paid out of flat 15% social support tax on all incomes above 480 USD per adult (18+years) and 240USD per child (18- years) per month, and it is paid only up to expiration of funds collected in previous fiscal year in each state. Thus negative income tax encourages responsible welfare spending)

Is there any assurance that a guaranteed-income or NIT plan would not also grow as rapidly? Present indications are that it might grow even faster. It is significant, as I have pointed out previously, that when Professor Milton Friedman first proposed his NIT plan in 1962, in his Capitalism and Freedom, he was suggesting that an individual with zero income receive a subsidy of the modest amount of $300. Now he is talking mainly in terms of a family of four and suggests that such a family, with no other income, should receive a basic amount from the government of $1,500. But already there is a prominent competitive scheme (published by the Brookings Institution, and written by Dr. James Tobin of Yale, Dr. Joseph A. Pechman, the Brookings Institution’s director of economic studies, and Dr. Peter M. Mieszkowski) that offers much more generous subsidies. Once the scheme gets into practical politics, we can expect the competitive bidding to get going in earnest.

So knowing what we do of political pressures, and of the past history of relief, “social insurance,” and other “antipoverty” measures, we are forced to conclude that once the principle of either the NIT or the straight guaranteed income were accepted, it would be made an addition to and not a substitute for the present conglomeration of relief and “antipoverty” programs. And even alone it would drastically reduce the productive incentives of those earning less than the guaranteed amount and seriously reduce the incentives of those earning more, because of the oppressive taxation it would necessarily involve. Its overall effect would be to level real incomes down, not up.

(This is simply incorrect: social support tax of 15% would replace both social security tax and cap income tax at 15%, with thus effectively reducing by a quarter effective tax rates for poor and middle class Americans. And negative income tax makes sense only as a permanent replacement of, not an addition to all other government welfare programs).

Let us take a closer look at the problem of raising taxation still further to pay for a guaranteed-income or NIT program. It is obvious that we could not expect such a program to be paid for merely by the very rich. If we were to subsidize all family incomes below $3,400 (let alone $6,800), it would hardly be consistent to tax them. Yet even before the income tax increase of 1968, single persons with net incomes (after exemptions and deductions) of $500 paid 14% on such income, 15% on the next $500, and so on, so that persons with net incomes below $6,000 were taxed at rates up to 22%.

In 1965, moreover, taxpayers with adjusted gross incomes under $15,000 (who received more than three-quarters of the total personal income there was to be taxed) paid 61.5% of the entire personal income tax. Taxpayers with adjusted gross incomes under $20,000 paid 70% of the entire personal income tax.

Why not collect the major part of the income tax, someone may ask, from the really big incomes? Because taxpayers with adjusted gross incomes above $50,000 received even before taxes only 5% of the nation’s adjusted gross incomes.

So when advocates of the guaranteed income and similar schemes insist self-righteously that “we can afford” to pay for more and more of such schemes, they ought to specify just who “we” are. They ought to explain to people who are earning their incomes the hard way why they really don’t need all that they bother to earn for their own families, and tell them also just how much more they can “afford” to have taken away from them.

Neither a “negative income tax” nor a guaranteed-income plan of the dimensions now being suggested could possibly be put into effect with dollars of present purchasing power.

(Again this is incorrect, for the above mentioned reasons)

To sum up, Hazlitt put up four main arguments against negative income tax.

First, he does not believe to be as too strict on the less industrious and too generous for the most industrious beneficiaries – but so are Nature’s ways. The fact that the stimuli of natural selection are kept by negative income tax is one of its most important advantage – it in fact encourages a beneficiary to help himself, not to ask someone for help.
Second he is afraid of the widespread fraud, while in fact fraud rates would be much lower and much more severely punished in an IRS-administered program than in current poor-loving social services programs. And we shouldn’t forget getting rid of huge and expensive army of 2 mln social security bureaucrats at state and federal level.
Third, he fears that negative income tax would be more expensive than current U. S. welfare programs. In fact, I have shown, that it would be two to four times cheaper that current U. S. welfare programs, with the saved amount available to pay off th national debt and reduce taxes.
Fourth, he does not believe it to be feasible under democracy for fear of ever rising payments and expenses, and taxes to finance it – but these political shortcomings of democracy could and would be overwhelmed under White Nationalist state by limiting franchise to those who proved that they can put interests of the Race and Volk above his own. Welfare expenses are controlled by specific way of financing negative income tax expenditures: negative income tax can be claimed for the last fiscal year only, and no funds can be used each fiscal year in each state for negative income tax other than collected previous fiscal year from 15% social support tax on all incomes above 480 USD per adult (18+years) and 240USD per child (18- years) per month in this state. Thus welfare outlays cannot exceed specific-purpose collections – the main reason for insustainability and insolvency of most welfare schemes. And finally, institution of social support tax of 15% means effective tax rates 25% lower for poor and middle-class Americans, since it replaces both social security tax and caps income tax at 15%.

Thus, Hazlitt’s arguments do not make any economic sense, and I suspect that being a fairly competent economist, he understood it, yet continued to oppose negative income tax for two different reasons:

First, he just did not want that poor and middle class Americans would loose the fear of hunger and cold, and shame associated for asking relief from them – something that negative income tax instantly does for all. He wanted fearful servants at corporate plantations – and not fearless and assertive White workers, willing and able to stand for themselves without fear of ultimate economic punishment.
Second, he did not want to truly help out those most fittest poor Americans in need, who would be able to help themselves through negative income tax – whom he hated as “losers”, without understanding that those often able-bodied and racially-whole men and women were victims of economically centered mechanical system, alien to Aryan soul; yet he would be ready to spend money on those least fittest – the deformed, deranged and depraved untermeschen, lest likely to earn income or help themselves. Thus he could never put the interest of White Race and American People above the interests of his social class. And this was the true fallacy of Hazlitt.

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The dollar is down, to 1,33 USD/EUR, continuing its correction to 1.40-1.45 USD/EUR by mid-year, while oil is down to 61 USD/p.b. and is expected to go down to 50-55 USD/pb. range by mid-year, gold is up to 640 and is expected to go up to 700-750USD/p.oz. range by mid year, and silver is flat in 13-14 USD/p.oz. range and is expected to be slightly down to 12-12.5 USD/p.oz. All this point to forthcoming recession in the U. S., that, keeping in mind rising inflation and huge and rising hidden unemployment, is likely to turn into stagflation by the year end.