Wage Floors vs. Transparent Credits

by Reihan Salam

One of the downsides of the earned-income tax credit (EITC) is its administrative complexity and the potential for fraud. Edmund Phelps’ low-wage employment subsidies address these concerns to an extent, and they benefit non-parents — a good thing if we assume that one of our goals is, for example, to make less-skilled men more attractive marriage partners. Edward Glaeser offers a proposal along these lines:

There are better ways of making work pay. The earned income tax credit has helped make work pay since 1975. It rises initially with income up to a maximum of $5,236 for families with two children, and then it phases out.

It has downsides, such as administrative complexity and monitoring, but it has been shown to increase employment, especially for single mothers. It can be improved and increased, and it remains the best alternative to raising the minimum wage.

Perhaps the simplest way to alter the credit is for it to provide a clear per-hour benefit directly to workers earning less than $9 an hour. An extra $1.75 an hour, the proposed increase in the minimum wage, for the 1.67 million workers who currently earn the minimum wage, would cost about $4 billion, which could be easily funded with minor cuts to other programs such as highway spending. [Emphasis added]

As Glaeser explains, this approach is an obvious fit for an enterprising GOP politician –

The Republicans have a chance to show their support for the working poor if they counter the president’s minimum wage proposal not with an angry “No way,” but with a smarter alternative, such as increasing the earned income tax credit and making its benefits simpler and more salient.

While Glaeser notes that at least some of the $4 billion can be shifted from highway spending, Republicans might propose cutting the wind production tax credit, which costs roughly $1 billion a year, to cover a quarter of the cost. Advocates of the wind production tax credit at the BlueGreen Alliance observe the following:

Extending the Production Tax Credit through 2016 would increase total wind-supported jobs to 95,000, while total wind investment would grow to $16.3 billion.

Yet this number is arguably outweighed by the 1.67 million workers who would benefit from per-hour benefit Glaeser has in mind this year, or rather the 417,500 workers who represent a quarter of the total. 

A larger transformation of the EITC along the lines of a clear per-hour benefit would presumably prove more costly than the idea Glaeser has sketched. But it is worth considering. Among other things, it would greatly simplify tax filing for low-income households and reduce the incentive for fraud. Phelps’ approach is slightly different, as it subsidizes only full-time low-wage workers, an idea that has a reasonable normative foundation (i.e., we as a society might want to subsidize those who make a full-time commitment to market work rather than teenagers and secondary-earners who choose to work part-time to earn supplemental income) and it tapers off:

The best remedy is a subsidy for low-wage employment, paid to employers for every full-time low-wage worker they hire and calibrated to the employee’s wage cost to the firm. The higher the wage cost, the lower the subsidy, until it has tapered off to zero. With such wage subsidies, competitive forces would cause employers to hire more workers, and the resulting fall in unemployment would cause most of the subsidy to be paid out as direct or indirect labor compensation. People could benefit from the subsidy only by engaging in productive work – that is, a job that employers deem worth paying something for.

Phelps larger argument merits close attention:

Some people still think of wage subsidies as a welfare hand-out. But these subsidies are very different from social assistance and social insurance programs. Although such programs have been substantial in Europe and the US, the working poor remain as marginalized as ever. Indeed, social spending has worsened the problem, because it reduces work incentives and thus creates a culture of dependency and alienation from the commercial economy, undermining labor force participation, employability, and employee loyalty. What is needed is higher employment and pay through higher demand for the least productive workers.

This part of Phelps’ analysis is palpably “right-wing,” while the rest of his analysis is less so:

Some would count on the free market to solve the problem with time. But market forces alone are unlikely to solve the unprecedented levels of labor-market exclusion that developed from the mid-1970’s to the early 1990’s. The prevailing belief in a reliable tendency to return to some normal degree of inclusion has little ground to stand on. True, most recessions are reversed, just as most booms end. Nevertheless, what is “normal” is itself shifting all the time.

We often discuss the deterioration of the labor market position of less-skilled men, a problem that emerged long before the housing bust and post-crisis stagnation, yet that has been greatly exacerbated by both. As discomfiting as some might find Phelps’ prescription, it is best understand as an alternative to other social transfers that is explicitly designed to include marginalized workers in the economic mainstream, an essential first step before these workers can achieve some modicum of upward mobility. 

Glaeser’s column invokes what he calls the anti-enterprise bias of some advocates of wage floors:

Political progressives see raising the minimum wage as a tool to promote equality without raising taxes. Some of them even seem to like the idea of punishing big business. But such anti-enterprise authors are wrong to bash those employers who are helping to solve the American underemployment problem. The economy’s larger challenge isn’t the companies paying $7.25 an hour, but the companies that only employ workers at the top end of the skill distribution and pay much more.

One of the important aspects of Glaeser’s critique is that large employers are much better than small employers in facilitating asset-building. The more we can encourage big firms to hire workers at the low end of the skill distribution, and the more we can help innovative small firms become big firms that do the same, the better off we’ll be. The reason is that, as Ray Boshara has explained, employers are one of several institutions that move capital into households: (1) government mediates capital flows to households and to itself through the tax code, with various tax expenditures designed to encourage savings (and that skew towards middle- and upper-income households as a general rule); (2) financial institutions play an important role, of course, and the banked generally fare better than the unbanked and the underbanked — which is why financial services innovation designed to meet the needs of low-income households is an important aspect of the larger economic inclusion agenda; and (3) employers, aided by government, sponsor 401(k)s and other savings vehicles. Bigger employers tend to be better employers when it comes to providing these asset-building infrastructures. So subsidizing these employers, as well as smaller employers, isn’t an intrinsically bad thing to do. 

Glaeser and Phelps are onto something very important, but someone has to pick up the baton to cost out their ideas and to assess their real-world viability.