Leave the Minimum Wage Alone – Add to the EITC

The minimum wage is nice, but there are more efficent ways for the federal government to prevent poverty. We should think again about another increase to minimum wage, and instead think about putting more dollars into the Earned Income Tax Credit (the “EITC.”)

We like increasing the minimum wage because it enhances the livelihood of the poor, but it is not a welfare program.  It still requires that people work.

That said, its hardly the most direct way of targeting low-income working households.  The Economic Policy Institute suggests the minimum wage hits low-income households narrowly.  In a recent report, they estimated that almost two-thirds (63 percent) of gains from a minimum wage increase go to workers in the bottom 40 percent of income.

But what about the other 37 percent?  Well, that’s the first part of the problem.  Many of the other beneficiaries of the increase in the minimum wage are going to be people from non-poverty situations.  Many dependents (young people) earn a minimum wage.  This change will enhance their earnings, even if they are living on Central Park West.  Its probably the same with a lot of second-income earners from high wealth households – again, they are earning a low wage and they’ll receive an uptick with the new increase, but they are not hurting for money, either.

The Alternative: Use the EITC

The other problem is that an increase in the minimum wage misses out on some of the social gains that other existing poverty relief programs are able to achieve.

I’m thinking of the Earned Income Tax Credit.  The EITC targets relief for working families and it helps to bring families with children out of poverty.

The EITC has been around since the 1970s and it is very successful.  It meets the social criteria of rewarding “work.” It only goes to households with wage income.

Better, though, is that is very narrowly targeted.  Recipients of the EITC don’t get their credit until after they have filled out their tax return.  High-income households don’t get the EITC. Dependents don’t get the EITC.  You have to be the head of a household to get the credit.

In fact, the EITC is a bit of child-poverty program, too.  The credit goes way up when a filer has dependents.

Reducing the Unbanked

As well, the EITC encourages more people to opt into the banking system.  It is very easy to take a large refund and establish a bank account.  In fact, the tax system makes that attractive.  If you e-file with direct deposit, you get your refund faster.

Sure, many filers make a poor choice and use a temporary deposit account provided by the tax preparer.  Those come with high fees and they cease to function once the refund has been drawn.

That said, getting the benefit of child poverty relief is important.  Adding more households to the rolls of the “banked” is a winner, too.

Our financial system would function better if fewer people went without bank accounts.  Employers would save money by not having to make paper checks.  Consumers could avoid a lot of fees at check cashers.  Our credit scoring firms would have access to more robust data about more people, enhancing the predictive power of those metrics.

Nonetheless, millions of Americans have no bank account.  Many more have a savings account, but are without a checking account.

The minimum wage has other issues, of course. It seems like there are only two data points that get mentioned in the debate about the minimum wage.  Some people argue that the minimum wage helps lmi families and indirectly stimulates spending.  Others argue that it weakens demand for low-income labor and effectively reduces the supply of jobs.

There are other impacts, though.  Some find that small businesses decide to pass higher labor costs onto their customers, but that the impact on employment is more complicated to determine.  In competitive industries, a wage hike does not reduce employment.  In non-competitive sectors, it does reduce jobs. The World Bank finds that a minimum wage increased the number of small businesses in Mexico. Hmmm. I’d wonder about a few other impacts…how does a minimum wage impact the number of employers who decided to hire workers under-the-table?

There are none of these shortcomings with the EITC.  It is narrowly targeted.  It provides relief to working households.  It goes a long way toward providing a source of income to households with children.  It encourages people to get banked.  It doesn’t put a strain on small businesses.  It doesn’t increase prices on consumer goods.  It doesn’t have the ability to reduce the demand for work among low-income wage earners.

Yep, it is too bad that we don’t give the EITC more of a chance.