Poverty politics

by Russ Roberts on July 21, 2006

in Politics, Standard of Living

I recently stumbled across this excellent essay by John Cogan and Tom Macurdy on the minimum wage. Though written in 1996, it makes the timeless point that workers earning the minimum wage don’t have to try and get by on $5.15 an hour. They are eligible for food stamps, the earned income tax credit (EITC) and so on. So when measuring the working poor’s standard of living, you should include other benefits beyond wages.

They go on to point out that if after making that calculation, you still want to increase the standard of living of the working poor, it is much better to raise the EITC. The latter is funded by taxpayers. Increases in the minumum wage are paid, in part by the poor themselves who lose their jobs as businesses seek to avoid the burden of higher wages.

Cogan and Macurdy end their argument there. But it raises the question as to why any politician supports an increase in the minimum wage rather an increase in the EITC. One answer is that raising the minimum wage is a hidden tax while funding an increase in the earned income tax credit is a visible tax. The minumum wage looks like a free lunch—the citizenry assumes the burden is paid by businesses. Politicians exploit this ignorance and keep taxpayer’s funds to give away to other groups.

The world would be a better place if more people understood the seen and the unseen.

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{ 11 comments }

Mike July 21, 2006 at 5:23 pm

Russ,

Part of me thinks that some of the current supporters of minimum wages have fallen in love with the notion of labor market frictions – wherein increases in the minimum wage increase both average wages and employment.

Another part of me is a bit cynical and thinks that union influence leads many to support the minimum wage – but I have nothing but a hunch to support that claim.

-Mike

save_the_rustbelt July 21, 2006 at 8:30 pm

Could it be because the EITC has various qualifications and the minimum wage does not?

quadrupole July 22, 2006 at 12:17 am

The EITC also has REALLY nasty effects in terms of retaining the current tax system. There are regimes overwhich it is effectively a -40% tax rate on people. As a result anytime you start talking about *any* kind of fundamental tax reform, you are talking about raising taxes on the poor, because 0% tax is a lot higher than -40%. It essentially creates a sacred cow preventing any tax sanity. Tax codes should fundamentally be mechanisms for raising revenue, not handing out welfare.

spencer July 22, 2006 at 9:44 am

It is nice to see you make some sense on the issue rather than the usual rants.

Tim Worstall July 22, 2006 at 10:55 am

"But it raises the question as to why any politician supports an increase in the minimum wage rather an increase in the EITC."

It could be an artefact of the way that poverty is actually measured. Those 37 million under the federal poverty level in 2004 (as John Edwards tells us) will be, even if we raised the EITC to $100 k a person, still, 37 million under the federal poverty level.

Because the EITC is not included when calculating who is under the poverty level.

Ann July 22, 2006 at 10:56 am

"Could it be because the EITC has various qualifications and the minimum wage does not?"

That's precisely why the EITC makes more sense, since it can be targeted to heads of household, whereas much of the minimum wage increase goes to middle class teenagers.

If liberals truly understood the effects of a high minimum wage, I would think that they would be more hesitant to support something that can lock vulnerable groups out of the job market altogether. If black teenagers can't enter the labor force, how will they build the skills they need?

And what about all those autistic and other special needs children that are growing up? Wouldn't it be nice for them to be able to contribute to the economy in some way? I once heard Temple Grandin, a very capable autistic woman, talk about how much her job meant to her. She was arguing that, if they're helped to find the right job, there are many ways that most autistic people can have the pride of contributing.

But the higher the minimum wage, the more 'special needs' individuals will be forced to sit out their entire lives. After they're out of school, should they just sit around and watch TV for 50 or 60 years, until they die of old age? What if they are able and anxious to do more? As the mother of a special needs child, it makes me angry that these people want to rob my child of the chance to contribute.

liberty July 22, 2006 at 12:58 pm

It is interesting to me how so many pro-market economists tend to assume that the EITC is better than the minimum wage. They fight the good fight against the minimum wage, pointing out all of the unintended consequences; they then promote the EITC as an alternative — but how many studies have been done to compare the two, and more so, how many have been done looking at the consequences of the two together?

We still have federal minimum wage, though its obviously lower than the minimum that is being promoted, at state and federal levels; and we have a federal EITC. When an economist promote one against the other, he is implicitly suggesting that we can keep a low level of the other and only raise the one that he sees as better, unless he advocates abolishing the other entirely.

What would studies show about a low (but not zero) minimum wage and a high EITC – how would this combination affect employment, poverty, median wage, and so on?

My research suggests that the combination of minimum wage and EITC means that the EITC actually adds to poverty and unemployment, rather than reducing the two. If this turns out to be true – even at a low minimum wage – well meaning free market economists might be disappointed with the results of their policy program.

JohnDewey July 22, 2006 at 11:04 pm

"But the higher the minimum wage, the more 'special needs' individuals will be forced to sit out their entire lives."

That's an excellent argument, Ann.

I've always admired Goodwill Industries, which has helped millions of disadvantaged workers gain skills. But I also believe that "special needs" individuals shouldn't be isolated in organizations such as Goodwill.

All employers should be able to provide jobs for workers at the level of compensation equivalent to their level of contribution. Minimum wage laws seem to demand that only workers who can meet a certain contribution level be allowed to work.

Governments could allow employers exemptons from minimum wage laws, or reimburse employers who hire "special needs" workers. But that just creates a huge bureaucracy to administer exemptions, and puts some workers in the dfficult position of defending their disability.

One can make a case that any marginally employable worker has some sort of "special need". Minimum wage advocates seem to believe their legislation will magically raise the level of contribution of these marginal workers.

Russell Nelson July 23, 2006 at 2:12 am

Rustbelt: the minimum wage requires that you have a job. If that wage is set higher than your labor is worth, then …. you don't HAVE a job.

Xmas July 24, 2006 at 2:01 pm

quadropule,

The EITC has its analogs in other tax systems. If you went with a VAT, you could call it a VAT Rebate or something to that effect. Or you can have different VAT rates for different items, such as no VAT on "essential" items, such as food and non-luxury clothing.

If you could get a flat (or flatter) tax system, you could still have the EITC.

OneEyedMan July 25, 2006 at 8:29 am

The problem is that now poor workers are facing a huge marginal tax rate. If you don't design the phase-out of the rebate carefully, then you can easily make the marginal tax rates of joining the middle class enormous.

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