Minimum Wage and Earned Income Tax Credit

157 days until class.

My job in the last 24 hours has been to write up a position proposal for the Party of Reason and Progress. I originally thought they wanted a short paragraph that they could post - a brief description - which I did not like to do because I like details. What I wrote ended up being three paragraphs and I feared it was too long.

I discovered that they want a description of the policy complete with statistics and references. This was more to my liking.

What follows is my first draft.

I must admit, I felt some sense of pressure to come up with a liberal document - not because of anything everybody said, but just because I felt it would be received better. However, what I presented was a proposal that I think is grounded on the evidence. The minimum wage issue is one in which I judge people on the left and right both to argue about poorly - embracing evidence that supports their position and ignoring conflicting evidence. It was not written to try to secure votes, and we will see what PORP does with it.

I had this draft finished before I came here and saw faithlessgod's recommendation attached to yesterday's post. One will see in this provision a recommendation to provide assistance to those who are have employment difficulties for such reasons as health and education/training. The options that faithlessgod pointed to provide ways of dealing with that.

Anyway . . . let me repeat . . . I am not speaking for PORP at this point. They claim to be a party that wants evidence-based positions, so this is my proposal for an evidence-based position on the minimum wage and earned income tax credit.

A Living Wage

In a society as wealthy as the United States, if somebody is willing to pull their weight by working the equivalent of a full-time job (e.g., two half-time jobs), they should earn enough to cover the basic needs – food, clean water, clothing, basic medical care, transportation, and some entertainment. Several policy options exist to try to achieve that end.

Two of these are the minimum wage and the earned income tax credit (EITC).

The current federal minimum wage is $7.25 per hour, with state minimum wages minimum ranging from $5.15 (Georgia) to $11.00 (Massachusetts, Washington state).1

The EITC is a wage subsidy that effectively adds a tax refund payment to earned income to produce a higher overall household income. A single mother with two children with a full-time job throughout 2016 earning the current Federal minimum wage will have $15,080 in earned income, and qualify for an earned income tax credit of $5,572. This would be a combined income of $20,652 – the equivalent of 9.92 per hour.2

The Minimum Wage

The standard argument against a minimum wage appeals to a standard principle of liberty. If one person is willing to receive $5.00 for an hour of work, and another is willing to pay it, then it is intrinsically wrong to come between them. One could respond that this intervention comes in the name of exploitation – coming from the fact that the worker is being forced by desperate circumstances (e.g.,
starvation) to accept $5.00. However, this option is blunted by the employer’s option to pay nothing, whereby the intervention makes the worker even worse off. In the name of preventing exploitation, the intervention forces the worker to accept the desperate circumstances she was trying to avoid – but at least she is not being exploited.

A recent report from the Federal Reserve Bank of San Francisco estimates that the effect of a 10% increase in the minimum wage would result in a 1% to 3% loss in employment for the target population.3

If we assume a 2% loss of jobs among minimum-wage workers with a 10% increase in the minimum wage, it follows that an increase would help 98% of the workers in that range. Those workers would not be forced to accept the desperate circumstances they were trying to avoid – they would be helped to further distance themselves from those desperate circumstances. But for the other 2%, the results would be catastrophic. Furthermore, this 3% will be made up of people who already have employment disadvantages such as implicit and explicit bias, health issues, insufficient or low quality education, and family commitments that interfere with work schedules.

Even if total employment does not decrease, there is an issue with job transfer. A higher minimum wage makes these jobs more attractive to the voluntarily unemployed in middle-income households seeking additional income. These workers are generally more highly skilled and tend to suffer from many of the employment disadvantages of current minimum-wage workers. Consequently, businesses have an incentive to replace their current minimum-wage employees with these alternative employees – providing its benefits to middle-income households rather than the poor.

Up until 1994, there was a consensus among economists that an increase in the minimum wage would decrease employment. The vast majority of households with minimum-wage workers would benefit from the increase, but some households would suffer potentially catastrophic economic results from those who lost their jobs.

At that time, David Card and Alan Kruger published a study that compared the employment effects in one state that increased its minimum wage, with an economically similar state that did not increase its minimum wage. By using the former state as a study group, and the latter state as a control group, they could control for some confounding variables. Their study showed a slight increase in employment, rather than a decrease.4

Possible explanations for this include (1) lower-income households tend to spend their additional income on goods and services which, in turn, create additional jobs, and (2) employers generally would be willing to pay the higher wage but do not do so because the economic power they have over potential workers desperate for a job.

Attempts to replicate their findings have produced mixed results. More importantly, they have produced no consensus among economists as to the employment effects on employment. In 2014, 600 economists including 7 Nobel Prize winners endorsed an increase in the federal minimum wage to $10.105, while 3 Nobel Prize winners joined 500 economists in opposing the increase.6 In 2014, when the Congressional Budget Office was asked to estimate the effects of an increase in the federal minimum wage to $10.10 per hour, they estimated that it would reduce total employment by 500,000 jobs.

Some economists who think that a higher minimum wage produces a job loss still support a higher minimum wage because – overall – it increases the purchasing power of the poor. The CBO estimated that a $10.10 minimum wage would give households below the poverty line an additional $6 billion, and households between the poverty line and three times the poverty level an additional $12 billion.7 This additional income produces the side effect of stimulating those businesses that provide goods and services to lower-income households, as opposed to businesses that cater to the very wealthy.

PORP rejects the traditional practice of embracing studies that support a favored result and ignoring other data. Until economists come to a consensus on the effects of a minimum wage, PORP considers it to be irresponsible for non-economists to declare one side or the other the victor in this debate purely because if that side were right it would support a favored policy.

What we do know is that an increase in the minimum wage will help a significant percentage of those households earning less than what would be the new minimum wage. However, there is a risk (though it is not certain) that a percentage of low-income households will suffer catastrophic economic hardship through loss of employment, and that these costs would fall on workers who have employment disadvantages.

There are good reasons to support a higher minimum wage. However, this program should be considered alongside programs that would provide assistance to those who have employment disadvantages. One option, for those employees, would be to provide wage subsidies to employers who
hire such individuals.

Recently, several states and municipalities have increased their local minimum wage. This will provide fertile ground for research.

Earned Income Tax Credit (EITC)

The EITC answers several of the challenges made to the minimum wage.

(1) The benefits go exclusively to low-income households, whereas much of the benefit of a higher minimum wage goes to middle class and even upper class households with members seeking a second source or independent source of income.

(2) It does not give employers an incentive to fire workers since the cost of employment to employers remains constant. In fact, it has been argued that the EITC provides a subsidy to employers who hire workers from low-income households because a part of their wages is paid through the wage subsidy rather than the business.

(3) It does not give the voluntarily unemployed in middle-class households an incentive to enter the labor force seeking additional income – taking job opportunities from poorer heads of household.

(4) The financial burden can be placed entirely on the very wealthy individuals and corporations through direct taxation, rather than burdening smaller and struggling businesses.

The EITC, as it is currently being implemented, has two significant problems.

One disadvantage with the earned income tax credit as currently designed is that those who qualify get a lump-sum payment when they file their taxes after a year of hardship. Some low-income households lose a percentage of that assistant by borrowing against it in the year of living on low wages. Or they have to put off important purchases, such as medical care or home repairs, until the money comes in.

Another disadvantage comes from the bureaucratic red tape associated with the program. A worker needs to know that she is eligible to apply for the assistance. The IRS has an online "EITC Assistant"8 to help people decide if they qualify and for how much. Because of this, many poor people do not acquire benefits to which they are entitled. In addition, government reports show that much of the money is paid to individuals who, strictly speaking, do not qualify for the benefit (or as much of the benefit as they receive). Some of this is fraud. However, the General Accounting Office attributes much of this to the complexity of the law and difficulty in determining eligibility.9

The EITC has another disadvantage over a higher minimum wage, though this is entirely cosmetic. The EITC shows up in the government budget in terms of tax revenues received and benefits paid out. With the minimum wage, the money transfer goes directly from employer to employee and the amounts do not show up on the government ledger. A money transfer is required in both cases. This makes it politically easier to oppose the EITC in spite of its advantages, and easier to support a higher minimum wage in spite of its flaws.

The EITC is not an alternative to a higher minimum wage. In fact, the EITC and minimum wage can work together. An increase in the minimum wage provides households with additional earned income, which, when combined with the earned income tax credit, provides the household with greater overall income.

If the single mother at the start of this entry received a pay increase due to a higher minimum wage to $10.50, she would still qualify for $4,806 earned income tax credit for a total income of $26,646 - an income equivalent of $12.81 per hour.

Policy Proposals

In principle, PORP supports the objective that anybody working the equivalent of a full-time job earn enough to cover basics needs. We support the use of both an increased minimum wage and increased earned income tax credit to accomplish these ends. We also support wage subsidies for people who are unemployed due to employment disadvantages such as implicit and explicit bias, health issues, and education/training. We support improving the EITC by arranging for qualifying workers to get their benefits throughout the year, and simplifying and expanding the eligibility requirements.

1 Labor Law Center, State Minimum Wage, https://www.laborlawcenter.com/state-minimum-wage-rates/, retrieved 03/23/2017.

2 Internal Revenue Service, “EITC, Earned Income Tax Credit, Questions and Answers”, https://www.irs.gov/creditsdeductions/
individuals/earned-income-tax-credit/eitc-earned-income-tax-credit-questions-and-answers, Retrieved 03/23/2017.

3 Federal Reserve Bank of San Francisco, "The Effects of Minimum Wages on Employment", http://www.frbsf.org/economic-research/publications/economic-letter/2015/december/effects-ofminimum-
wage-on-employment/

4 Card, David; Krueger, Alan B. (September 1994). "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania". The American Economic Review. 84 (4): 772–93.

5 Economic Policy Institute, “Over 600 Economists Sign Letter in Support of $10.10 Minimum Wage, http://www.epi.org/minimum-wage-statement/ retrieved 03/23/2017

6 “A Statement to Federal Policy Makers,
http://nebula.wsimg.com/0ac0b639d50f7fea43d0378b1ee19215?AccessKeyId=D2418B43C2D698C15401&disposit
ion=0&alloworigin=1, retrieved 03/23/2017

7 Congressional Budget Office, The Effects of a Minimum-Wage Increase on Employment and Family Income,
February 18, 2014.

8Intrnal Revenue Service, "Use the EITC Assistant", https://www.irs.gov/credits-deductions/individuals/earnedincome-tax-credit/use-the-eitc-assistant, Accessed 03/24/2017.

9 U.S. Government Accountability Office, "Improper Payments: Inspector General Reporting of Agency Compliance under the Improper Payments Elimination and Recovery Act ", http://www.gao.gov/assets/670/667332.pdf,
retrieved 03/24/2017.