Minimum Wage vs. EITC: Who Pays?

My co-blogger Mike Makowsky has a great post earlier this week about the minimum wage. Go read it before you read my post. When Mike said he was bothered by the notion that “the welfare state must be channeled through employment,” I very much nodded in agreement. It reminded me of a frustration I have with the entire debate about the minimum wage vs. the Earned Income Tax Credit as policy tools to help out the least well-off in society (yes, some argue they are complements, but let’s put that debate aside for the moment).

Here’s my frustration. In both the popular discussion and occasionally among academics/policy wonks, the difference between the minimum wage and the EITC is often framed this way: employers pay for the minimum wage, but the government pays for the EITC. I know there are important questions about the incidence of the minimum wage, but let’s assume that the proponents of higher minimum wages are correct, and the full cost comes out of business profits.

But the distinction between “employers” and “the government” is not a useful one. Where does the government get its revenue to pay for things like the EITC (or alternatively, food stamps)? They must come from society. There is some diversion of real resources from Group A to Group B. Group A is, in the case of the minimum wage, the owners of businesses — in other words, individuals with high incomes. Group B is the workers. But this is true in the case of both the minimum wage and the EITC!

Why is it also true for the EITC? Recall that the EITC is funded primarily out of dollars collected from the federal income tax. When it comes to the federal income tax, the top 1% of taxpayers pay 38.5% of the taxes (as of 2017, the most recent data available). The top 25% of taxpayers pay a whopping 86.1% of federal income taxes. I point this out not so you can shed a tear for the richest Americans (they are doing just fine, even with these taxes), but to emphasize a point about who pay for the EITC: rich Americans do! To say “the government” pays for the EITC is actually an illusion, since the government has little revenue that it generates itself. Group A is richer Americans either way.

Payroll taxes and state/local taxes are important to consider when we think about the entire US tax system. But payroll taxes fund specific programs (Social Security and Medicare) and state/local taxes fund local program. None of these taxes fund the federal EITC. True, some of the EITC is funded with new debt (as are all federal programs), but we can also mostly ignore that since the distribution of who pays the federal income tax will likely be the same in 30 years when the bonds issued today are fully paid off. Yes, it may be different rich people, but it will still be rich people paying the federal income tax.

We can certainly debate whether the EITC is perfectly designed. Should it have a phase-in at all? Should it be more generous for childless workers? Should it phase-out more quickly?

I think these are all questions worth pondering. But the EITC has one major advantage over the minimum wage: it is better targeted. For example, the EITC is not available to those under 25 unless you have a qualifying child. So it is targeted at those raising families, rather than teenagers working summer jobs. Are teenagers working summer jobs not entitled to a raise too? Perhaps, but that is typically not the sympathetic case we are worried about when discussing the downsides of low wage jobs.

And to the extent there are job losses associated with the minimum wage (yes I know, still hotly debated, I won’t wade into that debate right now), currently there is no way to “target the job losses.” In other words, it may be a single parent raising a family that ends up losing a job, while the teenager is among the lucky that get a raise without any loss of hours. This is precisely the opposite, I believe, of what most supporters of the minimum wage would want.

So, if we want to help out low-income Americans, especially those raising children, let’s do it directly. Something like a Negative-Income Tax or UBI-with-phase-out is probably much better than raising the minimum wage. And don’t worry whether “employers” or “the government” is paying for it — that’s a false distinction.

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