An Alternative to a Higher Minimum Wage

By Adam Ozimek.

"As states and cities respond with higher minimum wages to the "Fight for $15" protests, some economists have called for boosting the Earned Income Tax Credit instead. Yet others insist that the minimum wage complements the EITC by ensuring that the benefits go to workers rather than employers. However, the minimum wage achieves this by preventing the EITC from increasing labor force participation. This is a problem given the research showing that work has positive spillovers for low-income households. In other words, the minimum wage does not complement the EITC, it undermines it.

To start, it’s important to understand what the EITC is and how it works. It functions like a negative income tax for low-income households. To oversimplify a bit, the EITC provides a subsidy on top of every $1 in income a qualifying person earns. Estimates suggest it has taken 9.7 million people, including 4.7 million children, out of poverty.

One major benefit of the EITC over other types of public assistance is that it encourages people to hold a job by increasing the payoff for working. There is wide agreement that the EITC increases labor force participation for single mothers, and in particular for low-skilled women with multiple children, at whom it is targeted.

One consequence of the greater propensity to work is that employers faced with a greater pool of potential job applicants find they don’t have to pay as much to attract workers and pre-tax wages go down. As a result, economist Jesse Rothstein estimates that for each $1 spent on EITC, workers incomes go up by only $0.73. For workers who don't get EITC benefits but compete with the new labor market entrants, the net effect can be lower income. These lower wages also mean that employers capture some of the benefits because they are able to hire more workers at a lower cost. It's this decline in pre-tax wages that leads some to conclude that the minimum wage should "complement" the EITC by preventing wages from falling.

However, there are two important caveats with the “complements” argument. First, some look at the minimum wage literature and conclude that employers' demand for low-skilled workers isn't responsive to wage changes. However, there is relatively widespread agreement that the EITC increases labor force participation, which can be true only if employers are responding to lower wages by hiring more. For a “complementary” minimum wage to prevent lower wages, it must also prevent the added labor force participation. In other words, lower wages are why employment goes up. If you stop the low wages, you stop the employment gains.

Indeed, some researchers are explicit about this. For example, in another paper Rothstein suggests that compared with the EITC, policies that reduce low-skilled employment are "much more effective."

However, there are good reasons to encourage work among low-income households. First, low-income families already face extremely high marginal tax rates due to means-tested welfare programs. The EITC can help offset some of that.

In addition, in his review of the literature, Rothstein argues there is “robust evidence of quite large [positive] effects of the EITC on children’s academic achievement and attainment, with potentially important consequences for later life outcomes.” While some of this may be due to households having more income, Rothstein argues that the results are significantly larger than the usual association between income and student test scores. The most plausible explanation for this is that a working mother is good for children in low-income families, a result that was also found by a recent analysis of 69 different academic studies.

Overall, the minimum wage is only a “complement” to the EITC if we ignore the positive effects of helping low-income people get jobs. This is not to say the EITC cannot be improved. Both President Obama and Representative Paul Ryan have argued that the EITC for childless adults should be expanded, which would help remove some of the concerns. But improving and expanding the EITC remains a superior alternative to the minimum wage, not merely a complement to it."