Why a Hike in the Minimum Wage Is Better Than a Hike in the EITC
Since the conventional wisdom threatens to harden around the idea that a hike in the minimum wage is an inefficient workaround driven by budgetary constraints, while a more optimal policy would be to simply increase the Earned Income Tax Credit, it’s probably time for me to push back. It’s not nearly as simple as that.
First of all, because the EITC phases out with income, it creates very high marginal tax rates at the low end of the income scale. This is, of course, a problem with any means-tested benefit. But that’s the point: it’s one reason to prefer regulations that address bargaining power imbalances in the market—like hikes in the minimum wage—over means-tested benefits. A hike in the minimum wage does not have the perverse consequence of reducing incentives to earn more income.
Second, the EITC may depress pre-subsidy wages. If we assume a person was willing to work for, say, $7/hour without a subsidy, then it is reasonable to assume that, once a $1/hour subsidy is attached, that person would be willing to work for $6/hour in pre-subsidy wages. More to the point, once the subsidy is put in place, a business would have a powerful financial incentive to lower wages, and thereby capture the subsidy for itself, or pass the subsidy on to customers and thereby gain market share. Who gets the benefit of the subsidy is very much a function of the elasticity of market in question—which, in the context of labor markets, is another way of saying who has the greater bargaining power. In circumstances of high prevailing unemployment, it’s reasonable to assume that the employer has the upper hand, and would capture the lion’s share of the subsidy. (See this paper for a detailed discussion of how the EITC can depress pre-subsidy wages.)
By contrast, a minimum wage hike would be expected to drive a positive cascade of wage hikes at the bottom of the scale. If burger flippers go from $7/hour to $8/hour, and you were previously paying the manager $8.50/hour, you are going to have to hike her wages as well—even though she’s already earning more than the minimum wage. So, while an EITC hike encourages employers to hold wages down across the board, a minimum wage hike forces employers to do the opposite.
Third, and relatedly, a hike in the minimum wage creates incentives to improve productivity, while a hike in the EITC has the opposite effect. A hike in the EITC makes it more possible for employees to continue to work, and survive, at very low wages. Because of the low wage, the employer has little incentive to invest in the worker—indeed, any investment is likely to “pay off” by seeing the worker leave for a higher-paying job. By contrast, a hike in the minimum wage creates a dilemma for employers: either they need to get more value out of their employee, or their profits will decline. That creates an incentive to invest in the employee, in order to derive value that justifies the higher wage. And, in fact, there’s empirical evidence that hikes in the minimum wage can reduce turnover and drive productivity improvements at the bottom of the wage scale.
Fourth, a substantial hike in the minimum wage would create a powerful disincentive to hire undocumented workers, while an EITC hike does not. Assume that one driver of illegal immigration is that there are workers in poorer countries willing to take jobs at lower wages than similarly-skilled Americans would consider. If you legislate a hike in wages, there is no longer a reason to prefer imported labor (outside the informal sector, where enforcement is difficult regardless). Ron Unz has made the case for a minimum wage hike on these grounds at great length in these pages before; I won’t repeat that case here.
Fifth, there is a substantial psychological difference between getting a bigger check from an employer and getting a check from the government. And there is a relatedly substantial psychological difference between legislating a higher minimum wage and legislating compensating payments from the government. The check you get from your employer is what you’ve earned, and legislating a minimum level for that check is a way of saying, as a society: no matter who you are, if you are working, your labor hour is worth at least this much. By contrast, the check from the government is a benefit you are receiving for being poor. And legislating a hike in that benefit has the air of public charity about it. I don’t mean to suggest that public charity is a bad thing—it isn’t, and, indeed, has a vital place among the sentiments that motivate policy. But there is still a meaningful difference between the two approaches to low wages, and I would contend that directly increasing wages shows rather more respect for the dignity of labor.
I don’t mean to suggest that there are no arguments on the other side of the ledger. There are. It’s true that a hike in the minimum wage redistributes more than “necessary”—it isn’t narrowly targeted at poor workers the way an EITC hike would be. As well, in times of high inflation, a hike in the minimum wage is likely to add fuel to the inflationary fire and thus create more macroeconomic problems than it solves. Those are also the conditions under which a hike in the minimum wage would be expected to raise unemployment the most.
But that is not the environment we are currently in. Under current conditions, there’s a good case to be made that a hike in the minimum wage would reduce unemployment, not increase it (because the stimulative effect of higher wages would more than offset the incentive to business to cut jobs or hours to reduce costs). And at a time of high corporate profits and massive corporate cash hoarding, coupled with a persistent shortfall in demand, it’s a little weird to be worrying about redistributing “too much” from business to labor.
It’s worth remembering that the great virtue of the EITC was not that it dramatically reduced poverty—it’s not obvious that it did that—but that it increased labor force participation among the poor. It was an alternative to welfare. There’s a very good cultural case to be made for making the switch from paying people not to work to subsidizing the wages of poor people who do work, and there’s empirical evidence that simply getting on the employment ladder makes a big difference in long-term outcomes, not only for them but for their children. But a hike in the minimum wage should be seen as complementary to that effort, not competing with it.