Several days ago I had a post entitled “A Rational Approach to a National Minimum Wage,” in which I expressed support for a national minimum wage level of somewhere between $8.00 and $9.00/hour combined with an expansion of the Earner Income Tax Credit program to single, childless workers, paid for by tightening up on the EITC payment methods. There is an interesting alternative to this combined minimum wage/EITC approach. It is the so-called wage subsidy program described in the book, “Rewarding Work: how to restore participation and self-support to free enterprise” by the economist Edmund Phelps. Click here for a short summary.
The idea is that low wage work would be directly subsidized by the government to the employer. A firm employing low-wage workers, let’s say from $7.25 up to $10.00/hour, just to be specific, is paid a subsidy for each such employee on a sliding scale. The higher the wage is, the lower is the subsidy, until it has tapered off to zero. The subsidy is paid to the firm once a year as a nonrefundable credit against taxes. Competitive forces would ensure that most of the subsidy would be paid out to the low-income workers as higher wages. Mr. Phelps gives a persuasive argument that his program is a much more efficient way to increase low-income employment than either a minimum wage or the EITC.
It is unrealistic to expect a rollback of our current minimum wage of $7.25/hour. However, a wage subsidy could take the place of an increase in the minimum wage. Raising the minimum wage, even to $9.00/hour, is predicted by the CBO to lead to a loss of 100,000 jobs.
Likewise, as Mr. Phelps says, the EITC “program is not really a tool to reward and stimulate the unemployment of low-wage workers so much as a program of credits for those who, for whatever reason, have low wage incomes.”
Conclusion: a wage subsidy creates low-income jobs and boosts their pay by making it profitable for businesses to hire low wage workers and pay them well. Such a program, a la Phelps, would need to be carefully melded with our current EITC program to achieve maximum cost efficiency.
In my last post I endorsed raising Nebraska’s minimum wage from $7.25/hour to $9.00/hour because Nebraska’s unemployment rate is only 3.6% and so a minimum wage boost is unlikely to put very many people out of work. I also stated opposition to President Obama’s proposal for a raise in the national minimum wage to $10.10/hour because it would likely put at least 500,000 people out of work. A recent article in National Affairs by Charles Lane, “A Grand Bargain on the Minimum Wage,”suggests an approach to end a perennial controversy over how to set a minimum wage at the national level. It is based on the following observations:
Increasing the minimum wage has broad public support. A recent Gallop poll found that 76% of Americans support an increase to $9.00/hour.
However, just 4% of minimum-wage workers are single parents. Only 11.3% of workers who would benefit from an increase in the minimum wage come from poor households. The majority of minimum-wage workers do not live in poverty.
A more efficient, better targeted support program for the working poor is the Earned Income Tax Credit which provides a refundable tax credit as high as $6,143 for an adult worker with three children.
Since 1959 the average income for a full time worker earning the minimum wage has equaled two-thirds of the poverty line for a family of four. The current poverty line for such a family is $23,850. This equates to a minimum wage set at $8.00/hour.
Another option would be to set the minimum wage at 45% of today’s average private sector wage of $20/hour. This would make it $9.00/hour. The CBO has estimated that a $9.00/hour minimum wage would put “only” 100,000 people out of work.
Once a new minimum wage level is determined, it should be automatically adjusted for inflation using the Consumer Price Index.
The EITC is not cheap; it currently gives $63 billion in benefits to 27 million workers. However the EITC’s improper-payments rate regularly exceeds 20% per year.
An expansion of the EITC to single, childless workers could be paid for by tightening up EITC’s payment methods.
All of these considerations suggest a way forward to end a long-standing political controversy in a productive manner. The national minimum wage should be raised to somewhere between $8.00 and $9.00/hour and then indexed to the CPI. At the same time the EITC should be tightened up and expanded to single, childless adults. Such a program combines fairness with a strong work incentive and should have broad appeal.
My post on February 27, “A Breath of Fresh Air” praises the new tax reform proposal from the House Ways and Means Committee which both lowers and consolidates tax rates in a revenue neutral way as well as greatly simplifying the tax code. It would be a big step in the right direction. But the Washington Post’s Robert Samuelson makes a good case in ”Does Tax Reform Have a Future?” that the House bill does not go far enough. Mr. Samuelson argues that if we’re going to eliminate tax deductions and loopholes, and thereby alienate lots of special interest groups, in order to get lower tax rates, then we should avoid half measures and eliminate virtually all deductions in order to get the lowest possible rates. In other words, eliminate the mortgage interest deduction rather than just limiting it, eliminate deductions for charitable contributions as well as deductions for state and local taxes. Eliminate the deduction for employer provided healthcare (which by itself would go a long way towards reforming healthcare.)
Mr. Samuelson would retain only the Earned Income Tax Credit (which encourages low-income people to work) and also the tax preference for contributions to retirement accounts (without which most Americans wouldn’t save for retirement.)
We badly need broad based tax reform to stimulate our economy. Douglas Holtz-Eakin, the former director of the Congressional Budget Office, has estimated “Reforming Taxes, Goosing the Economy”, that even the imperfect House tax reform proposal would raise GDP by .5% annually for 10 years and create 500,000 new jobs each year over this time period.
Full-fledged tax reform, a la Samuelson, would provide an even greater stimulus but let’s at least do something to put the millions of unemployed and underemployed people back to work and reduce our staggering budget deficits!
I have had many recent posts addressing the problem of income inequality in the United States and what can and should be done about it. Below is a chart, from the Congressional Budget office, which also appeared in my December 24, 2013 post. It shows that all income groups have made gains since 1980 but that higher income groups have gained the most. This means that income inequality is increasing. The question is what to do about it. My own attitude is to try to provide more economic opportunity for low income people. How do we do this in the most effective way?
First and foremost by stimulating the private economy to grow faster and therefore to create more and higher paying jobs. This can be done with broad based tax reform (lowering tax rates offset by closing loopholes), fiscal stability achieved by eliminating deficit spending, expanded foreign trade for a more efficient global economy, and finally, immigration reform to give legal status to undocumented workers and allow more high skilled foreigners to immigrate to the U.S. Such measures as these require action by Congress and the President.
Secondly, by improving human capital, meaning fixing underperforming schools, improving rundown neighborhoods, combatting inner city crime more effectively, providing at least part-time jobs to young people and combatting teenage pregnancy. Problems such as these are best addressed at the state and local level.
Finally, providing more motivation for the unemployed and underemployed to find jobs and hold onto them. A very effective way to do this is with the federal Earned Income Tax Credit. It supplements the salary of working adults with children. New York City is conducting an experiment to see if a similar program will also motivate childless adults to try harder to find work and stay employed.
Conclusion: the best way to address inequality is to give people the best possible opportunity to obtain full time employment. This means 1) creating more jobs, 2) providing better qualified workers for all jobs and 3) motivating the unemployed more strongly to find jobs and hold on to them.
Government at all levels can help people find jobs, in one way or another, and therefore become more productive citizens. This will lead to a happier, healthier, and therefore a stronger society. All of us will benefit from this happening!
Wall Street Journal columnist William Galston suggests in “Where Right and Left Agree on Inequality”, that both sides of the political spectrum agree that economic inequality is increasing in America and that government needs to address this problem. “Poverty is part of the explanation, as liberals insist. But so are parenting and family structure, as conservatives believe.” It so happens that we have a broadly supported federal program which simultaneously addresses both poverty and family structure. It is the Earned Income Tax Credit program. It provides $3,305 a year to low-income working families with one child and up to $6,143 for families with three or more children. The U.S. spends $61 billion a year on this program and it has proven to be very successful in encouraging low-income people to find and keep jobs. In fact, the economist, Gregory Mankiw, recommends the EITC over a higher minimum wage as a better way to increase the earnings of the working poor.
The New York Times’ Eduardo Porter reports in “Seeking Ways to Help the Poor and Childless”, that New York City is conducting an experiment to see if a locally run program similar to the EITC will have the same positive effect in increasing employment of childless adults. It is understood that many of the jobs being created in today’s economy are low paying service jobs. As Mr. Porter says, “for the American market economy to remain viable, being employed must, one way or another, provide for workers’ needs.”
Conclusion: as important as it is for Congress and the President to adopt measures to increase economic growth (e.g. tax reform, fiscal stability, expanded foreign trade, immigration reform), in order to create more and better paying jobs, government also has a responsibility to provide direct help to the needy who are trying to help themselves. The EITC program is an excellent way to do this!