7.8.2005
 
New Research in the Bank of Israel: "Expected Effects of Operating A Negative Income Tax"
The opinions brought in the study referred to herein are those of the authorד and do not necessarily reflect those of the Bank of Israel
 
  Operating a negative income tax in Israel, i.e., subsidizing low-level wages, could at a reasonable budgetary cost considerably reduce poverty in families with working members, but is not expected to increase employment significantly.
  Operating a negative income tax could reduce the number of poor households with working members by 18 percent, at a budgetary cost of NIS 1.3 billion a year, assuming that the benefit is set according to the number of children and that it is based on the higher of the wages earned by the husband and wife.
  If the size of the negative income-tax payment does not take into account the composition of the family or the couple's income, the cost would double and its effect on reducing poverty among working families would be reduced by 40 percent.
  In order to operate a negative income tax in Israel at a reasonable budgetary cost and in a way that would significantly reduce poverty among employees, the information infrastructure must first be improved so that information regarding employees' wages and their spouses' income is available to the income-tax authorities (or National Insurance Institute) when required.
  Negative income tax is not expected to have a marked effect on employment, particularly if it is formulated with an eye to reducing poverty and based on family composition and the couple's income. A system based on a more comprehensive subsidy could make a greater contribution to employment, but not among the weaker strata of the population.
Research carried out by Dr Adi Brender and Dr Michel Strawczynski of the Bank of Israel Research Department examines the expected effects on employment, poverty and government expenditure of the introduction in Israel of a negative income tax (subsidizing low incomes). The researchers studied the effects on entry into the labor market of changes in the potential wages of those out of work, and the effect of changes in the potential wage of workers on ending employment. It was found that these effects are relatively small, so that a negative income tax is not expected to increase employment significantly. However, it was found that negative income tax is likely to be an effective tool in reducing poverty among families with working members, by increasing their income. The researchers explain that negative income tax is paid only to low-wage earners, and does not affect poverty among jobless families. The research also finds that the groups whose entry into or exit from employment are sensitive to changes in the wage are not those groups with high rates of poverty.
Three alternative systems of negative income tax were examined: (1) payment according to the worker's income; (2) payment only to parents of children up to 18 years old, based on the wage of the higher earner of the parents (if that wage is low enough to qualify for eligibility); (3) payment only to parents, and based on wage of the higher earning spouse, but with a larger benefit and over a wider range of incomes paid to workers with more than two children. It was found that the first scheme bore a very high budgetary cost of NIS 2.7 billion a year, but would increase employment by about 0.6 percent only, and by a lower partial employment fraction than among those who were in jobs prior to the introduction of the scheme. Furthermore, the main effect is on the employment among households not in the weakest strata, and among couples without children. The budgetary costs of the second and third alternatives are considerably lower, NIS 0.75 billion a year and NIS 1.3 billion a year respectively, but they have a smaller effect on employment, as a larger share of the subsidy is directed to sections of the population among which the elasticity of employment to the wage is low. In particular the effect on employment is reduced because the benefit is not paid to unmarried workers or couples without children.
In contrast to its small effect on employment, a negative income tax can, at a reasonable cost, significantly reduce poverty among working families. Operating a policy with enhanced benefits for working families with two or more children, as in the third scheme above, can reduce poverty among these families by 18 percent, and among working families with at least three children by almost 30 percent. On the other hand, introducing the first type of scheme, costing almost double, as stated, would reduce poverty among working families by only 11 percent. The researchers explain that these findings show that for a negative income tax system to reduce poverty significantly, at a reasonable cost, the benefit must be paid on the basis of family composition and must take into account the income of both parents. For this purpose an information infrastructure must be established that will enable a program to be introduced based on the availability of the required data.
 
Type of program
  (1)
Benefit paid to all low-wage earnersa		 (2)
Benefit paid to spouse earning higher wage, only to families with childrenb		 (3)
As in (2), with enhanced benefit to parents with at least three childrenc
Additional employment (percent of employees) 0.6 0.1 0.2
Families rescued from poverty (percent of poor working families) 10.7 7.3 17.8
Budgetary cost (NIS bn. a year)d 2.7 0.8 1.3
 
a Grant of 20 percent of monthly wage between NIS 1,000 and NIS 3,500, with gradual phasing out up to NIS 5,000.
b Children up to 18 years old.
c AAs in (2), but benefit paid to families with at least three children is 30 percent of monthly wage between NIS 1,000 and NIS 4,000, with phasing out up to a monthly wage of NIS 7,000.
d Not including operating costs and one off cost of establishing data infrastructure.