Tuesday, August 01, 2006

Why Not Both the Minimum Wage and the EITC?

In my earlier post on the minimum wage, I stated:

Basically, I won't support an increase in the minimum wage until I hear the explanation of why we need a minimum wage if we have an EITC.

Some have suggested that we should not view the two policies as substitutes but as complements. Megan McArdle, guest blogging at Instapundit, hits this one head on:
Indeed, proponents of a higher minimum wage are also in favour of raising the EITC. They argue that we need both for two reasons, both of them unconvincing: first, because "a programme for the poor is a poor programme" (in other words, we need a huge middle class subsidy to give the programme a constituency), and second, because we should be targeting income in multiple ways.

The first is silly, because the EITC has proved politically more popular than the minimum wage; it has been raised in every major tax package in recent history. The second is foolish because when you talk about putting together a package of support programmes, you are generally trying to offset the strengths and weaknesses of the various individual components. But there is no weakness of the EITC that the minimum wage addresses; the EITC is superior on pretty much every count. Why on earth would you tack an economic inefficient, poorly targeted programme which may cause all sorts of adverse effects on poor workers, onto a structure that already works beautifully on its own?

A comment over at Angry Bear points to the counterargument, presented here (along with an interesting numerical example):
But it [a wage subsidy like the EITC] unquestionably does lead to downward pressure on wages as some people accept jobs at levels they would not have without those wage subsidies. And this inevitably gives those low-wage employers an advantage compared to higher-wage employers whose employess are unsubsidized by the government.

This is bad not just because it hurts those higher wage employees and employers, but is bad because it systematically encourages production systems with lower productivity and less skilled workers.

The comment cites a more extensive study of wage insurance here:
What makes the two fit together so well is that the existence of a higher minimum wage actually reduces the negative productivity, fiscal impact, and moral hazard effects of the EITC, while the EITC makes up for the weak target efficiency and income adequacy of the minimum wage.

In a nutshell, some of the benefit of the EITC may be appropriated by the employer of the low-wage worker or come at the expense of higher wage workers. Those shifts can be ameliorated by limiting the downward pressure that the EITC can put on the wages offered to the workers, for example, by establishing a higher minimum wage.

Those are reasonable arguments to make, so the decision comes down to whether the "negative productivity, fiscal impact, and moral hazard effects of the EITC" outweigh the employment effect of the minimum wage. The Eissa and Hoynes study suggests the fiscal impact and moral hazard are not problematic. I'll need to think more about the negative productivity effect. On the other side, I have been persuaded that the negative employment effects of the minimum wage are important. So while I naturally would say that if I have to accept that the minimum wage will go up, then the EITC should rise to offset some of the likely effects, I do not (yet?) sign on for the converse.

Also in the comments at Angry Bear, Bruce Webb asks:
Why should the burden of income security for workers fall entirely on the middle class and be no responsibility of the employer? Prove to me that there is no pricing power involved in setting wages and then we can talk about where the social responsibility lies.

If you thought that the labor market was characterized by monopoly power in hiring (whether from collusion among employers or just a natural monopoly, as in a company town or the like), then you could undo some of the equity effects of that monopoly power by specifying a wage floor. So this is a reasonable point as well, though focused not as much in my mind on alleviating poverty per se as in undoing another market imperfection that may already exist. I'll have to think more about whether in the markets that have come into play as of late--like big box retailers or even low-skilled jobs in the food industry--monopoly power is a large concern.

4 comments:

MarkW said...

On the other side, I have been persuaded that the negative employment effects of the minimum wage are important.

Andrew, everything I've read about the debate over the employment effects of the minimum wage indicates that these days it's reduced to a debate between those who say there is no employment effect and those who say there is a very small negative effect. The final exchange between Card & Krueger, on one hand, and Neumark and Wascher, on the other, in the December 2000 AER was pretty much a slam dunk for Card & Krueger. Neumark seems to have pretty much abandoned this issue to study other secondary and tertiary effects of the minimum wage. Even staunch libertarians like Steven Landsburg and Tyler Cowen now acknowledge that minimum wage increases have very little employment effect, although neither one seems able to bring himself to take the logical next step and abandon his opposition to minimum wages.

If you thought that the labor market was characterized by monopoly power in hiring

I'm often reminded these days of something that Ben Klein, one of my profs in the Ph.D. program at UCLA, said: "Every business has at least a little bit of market power." While he was talking about product markets, the point could also be well applied to labor markets--an employer, even in the absence of collusion or a company town, will almost certainly have more bargaining power than a low-wage worker. Hence a price-taking model of the labor market would not apply, and it is only in a price-taking model that you get the unambiguous prediction that a minimum wage reduces employment.

Arun Khanna said...

EITC is good for major urban areas in the U.S., minimum wage increase is good for the rest.

Samantha said...

Markw: the direct employment effects (poor people losing their jobs) are pretty clearly too small to measure accurately in a statistically noisy economy. But the indirect effects seem very troublesome; high minimum wages seem to keep unskilled or low-skilled workers from getting a foot on the "employment ladder" that leads from a job stocking shelves at Odd Lot into more lucrative positions. The evidence is not perfect, but it is compelling, particularly since the minimum wage requires us to spend a huge amount on non-poor families to target a few poor ones.

My rejoinder to the big box question is simply that most big boxers aren't all that affected by this; the average wage at Wal-Mart is well above where the new minimum would be set. Even if there are some competitive effects, they would have to be pretty large to pass through increases to people making an average of roughly $8.00 an hour, particularly since many Wal-Mart's are in areas where they are the best employer on many dimensions. It's very hard for me to see McDonalds as a monopsony employer.

Lord said...

high minimum wages seem to keep unskilled or low-skilled workers from getting a foot on the "employment ladder"

The real minimum wage has been falling for ten years as the teen labor participation has fallen. It is low level of the pay that keeps them out.

since the minimum wage requires us to spend a huge amount on non-poor families to target a few poor ones

What?! The minimum wage can now overturn economics and force businesses to pay their employees more then they are worth? Far from it. It can only force some richer customers to pay for the real costs of providing services to them rather than dumping them on the public.