LOCAL and state minimum-wage increases are in style this season, with cities nationwide moving toward a $15-an-hour floor. But simply mandating that employers pay more is a clumsy and potentially counterproductive way to help the poor. Although some workers gain, others lose out on jobs altogether, while consumers — many poor themselves — face higher prices.
Still, if done right, increasing take-home pay for low-wage workers is the best way to tackle poverty: It responds to the challenging economic landscape facing unskilled workers by raising their incomes, while increasing the incentive for those outside the labor force to step onto the first rung of the economic ladder. And it does so without shoving the poor into government programs, instead integrating them into the economy and giving them resources to allocate on their own.
The often-cited alternative to an increased minimum wage, the earned-income tax credit, gets rave reviews from economists and politicians from both parties. The credit, paid to low-income households as a tax refund, increases as income initially grows, and then decreases as income goes above the poverty line.
On the blackboard, this approach appears ideal. Low-wage workers benefit from additional income, but employers do not face new costs that might drive them to reduce hiring or increase prices. To the contrary, the program functions as a subsidy from which employee and employer both benefit, expanding the labor force by producing an incentive to offer and accept low-wage work.
But life is messier than a crisply drawn supply-and-demand graph. A worker receives the tax credit as an after-the-fact lump sum, producing a boom-and-bust cycle for household finances. Twenty percent of eligible households fail to claim the credit, and even among claimants, most of them do not understand its calculation or what portion of their refund it contributes, diluting its incentive. Even worse, because the credit phases out as earnings increase, many households face a significant disincentive to work longer hours or have another member work.
For the economy as a whole, the earned-income tax credit has several advantages. But individual workers prefer the larger paycheck a minimum-wage increase offers. A different policy — a direct wage subsidy — can accomplish both.
A direct wage subsidy pays additional dollars-per-hour to low-wage workers. A “target wage,” proportional to the median wage in each local market, defines when the subsidy is no longer required; a worker's subsidy is calculated as half the gap from market wage to target — that way it phases out gradually as the hourly rate increases. For example, if the target wage is $12 an hour, then a worker earning $8 an hour receives a $2 an hour subsidy, added by the government to the worker's paycheck.
From the worker's perspective, this policy looks much like a minimum-wage increase. From the economy's perspective, it looks like the earned-income tax credit. A federal program could put at least $150 billion toward such a subsidy by replacing the $65 billion spent on the earned-income tax credit and redirecting current spending from other, less effective anti-poverty programs for the working poor.
To appreciate the strengths of a wage subsidy over other wage supports, consider its performance on each relevant dimension.
First are the incentive dimensions: the effect on the behavior of workers and employers. For workers, the wage subsidy and minimum wage both pay the same benefit rate regardless of total earnings, so the total benefit increases with each additional hour worked; the earned-income tax credit has the drawback of decreasing as hours increase. For employers, the wage subsidy operates like the tax credit to subsidize employment; the minimum wage raises labor costs and so reduces hiring.
Second are the distribution dimensions: the effect on the recipients and payers of the benefit. The recipients of the subsidy are low-wage earners, so that, as with the minimum wage, all similarly situated workers are treated equally. The tax credit focuses on households based on their family structure and total income, which keeps costs down, but at the expense of distorting the labor market by discouraging hiring.
Taxpayers, meaning disproportionately higher-income households, pay for the subsidy. This is a key advantage over the minimum-wage increase, whose cost must be borne by some combination of the employers, other employees and customers. While much debate surrounds the distribution of that burden, it cannot help but land more heavily on lower-income households than federal taxes do.
Third are the experience dimensions: alignment with the needs of workers and the abilities of government and employers. The wage subsidy adopts the more desirable format for workers by delivering a clear benefit in every paycheck. Implementation of the wage subsidy may seem daunting, but adjusting worker paychecks based on earnings is something the federal government has decades of experience doing via the payroll tax.
Politically, there is much for both the left and the right to like about a wage subsidy. It does not discourage hiring or raise prices, some of the right's main complaints about the minimum-wage increase. But it also lifts paychecks directly, which is what the left likes so much about raising the minimum wage.
Best of all, it would use current government spending in a way that helps the poor find work and better helps the working poor — which should make everyone happy.
This piece originally appeared in The New York Times