Sunday, June 22, 2014

Every Economist in America Is Wrong: The Minimum Wage Is Better Than the EITC

Maybe I'm missing something obvious, but...

Let's say we want to help low-wage workers. Which of these plans sounds better to you?

Plan A
Tax:  Rich
Benefit:  Poor and middle class

Plan B
Tax:  Rich and middle class
Benefit:  Poor and rich

It's a matter of taste, but I think most people would prefer Plan A. Plan A is the minimum wage. Plan B is the Earned Income Tax Credit.

You may recall my discussion of this in a recent post. The basic economic analysis is that the minimum wage is equivalent to a tax on low-wage jobs and a transfer of the revenue from that tax to workers in those jobs. Economists, even liberal economists, see a few problems with that.
  • A lot of the transfer doesn't go to poor people. A good chunk of it goes to people from non-poor households. 
  • Putting a tax on low-wage jobs would be expected to reduce the number of low-wage jobs. This seems obvious, but is now hotly contested, with a substantial amount of empirical research finding zero effect; the consensus now is that the effect is zero or small.
  • Businesses will pass along some of their cost increases to customers, who may be poor themselves.
Much better, economists say, to use the Earned Income Tax Credit. This is a wage subsidy which is targeted at the poor. It presumably is funded from general tax revenues, so it doesn't discourage low-wage jobs. And it doesn't get passed along, because it's not a cost to employers. In fact, a portion of it ends up benefiting employers, because the wage subsidy reduces the wage employers have to pay. (For example, if I'm paying my employees $7/hour, and employees get a $1/hour subsidy, I may find  that I can pay them only $6.50 per hour, so they end up with a wage of $7.50.) If that's true, I may actually increase my hiring. You can find a liberal economist's view of the minimum wage here and a conservative economist's here.

What every economist thinks is what I thought, until, as I was writing that recent post, I read the Congressional Budget Office's report on the minimum wage. The media summarized the conclusions of the report as: raising the minimum wage will raise the incomes of the poor, but a small number will lose their jobs. But that summary, while true, misses the main point. Here, for example, is the Washington Post's Wonkblog:

The CBO's report reminds us that the main effect of raising the minimum wage is to redistribute income from consumers and owners/higher-wage earners to lower-wage earners. As this chart shows, most people earning under six times the poverty line would benefit from the increase.

When I read the CBO report and saw Figure 3, my eyes almost popped out of my head. "Everyone needs to see this chart!" I thought. And yet the people at Wonkblog not only saw it but posted it, and missed the point completely. Try this instead:

The CBO's report reminds us that the main effect of raising the minimum wage is to redistribute income from the top 10% to the bottom 90%. As this chart shows, the average family earning up to six times the poverty line (around $150,000 per year for a family of four) would benefit from the increase, even net of price increases and job losses.

Perhaps they didn't realize that 90% of all American families earn less than $150,000 per year, or didn't make the connection.

Apparently, in a lot of middle-class families there is someone earning the minimum wage. Some small fraction of those people will lose jobs if the minimum wage increases, and all will pay slightly higher prices. But the net effect is to make them, on average, better off.

What if your family earns, say,  $200,000 per year? That's more  upper-middle class than rich. Are you a net loser? Actually, we don't know, because everybody in the top ten percent is lumped together in the chart. Many things we once thought were true about the top 10 percent, like their getting a much larger share of national income than they used to, turn out to be mostly attributable to the top 1% (see Figure 2 here).

My guess is that people earning $200,000 per year end up being slight net losers. But clearly the big losers are people who earn a big chunk of their income from business profits, and (I can't find an estimate, but) those people are overwhelmingly the rich.

So as a first approximation, I'm going with Plan A above as a description of the effect of an increase in the minimum wage: hurts the rich, helps the poor and middle class.

In contrast, the EITC, being "better targeted," does not directly benefit the middle class. And because it presumably comes out of income-tax revenue, a good chunk of the middle class, as well as the rich, end up paying for it. Moreover, as I discussed above, some of the benefits end up being captured by owners of businesses, i.e., the rich. Some of the minimum wage "leaks" out to the middle class; some of the EITC leaks out to the rich. Yet somehow economists consider the former more of a problem than the latter.

Finally, there's the employment effect. As noted above, there's a large body of empirical work finding, surprisingly, that modest increases in the minimum wage have no effect on employment. I looked at the CBO report to find the basis for their estimate that 500,000 jobs would be lost. That's not a huge number-- it's about 0.3% of the labor force-- and there's a lot of imprecision around it, but I still wondered how they had come up with it.

When I got down into the weeds, I found that they had done careful work. They ended up making separate calculations  for teenagers and adults, then adding them together. I was curious how much of their final estimate of 500,000 jobs lost was made up of teenagers. But they never said.  So, using CBO's "conclusion" that adult employment is about one-third as sensitive to changes in the minimum wage as teen employment, and the fact that almost a quarter of jobs at or below the minimum wage are held by teenagers, I tried to calculate it.

My result is that 48% of the job losses will be by teenagers. The adult job loss is not 500,000; it's about 260,000. An editorial comment: When people argue that increasing the minimum wage will be ineffective, they always talk about teenagers. When they say there will be job losses, those teenagers are never mentioned.

Here, then, are the main takeaways from my reading of :the CBO report:
  • The minimum wage transfers income from the top 10% of the population to the bottom 90%. Quite likely a large part of that transfer is coming from the top 1%, but we don't know.
  • The number of people losing jobs is modest, and almost half of them are teenagers.
I can't quite get over the feeling I'm missing something, so if you happen to know any economists, run this by them.

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