Better Than the Minimum Wage – Refundable Tax Credits and the Earned Income Tax Credit

Conor McGrath, MPA, Staff Writer, Brief Policy Perspectives

A debate over raising the minimum wage has recently found its way into the 2016 Presidential Debate. Among the three candidates running for the Democratic nomination, Bernie Sanders and Martin O’Malley have promised to raise the national minimum wage to $15 per hour, up from the current $7.25. Hillary Clinton has also weighed in with a more modest proposal of $12 per hour, though she has voiced support for increases beyond that in areas with a high cost of living.

Boosting incomes among the working poor is a worthy goal, especially when wages haven’t kept up with productivity. Despite broad support among economists for increasing the minimum wage, raising it to $15 per hour makes many nervous. While debate will continue over the details, most economists agree that doubling the minimum wage will carry significant consequences for firms’ bottom lines, leading to job cuts and higher prices. A wage subsidy that raises working people’s’ incomes without imposing any costs onto businesses is an arguably better solution.

Setting the national minimum wage at $15 per hour would be an unprecedented wage increase. If implemented, the minimum wage as a percent of median pay in the United States would jump to 77%. This is higher than many European nations and well above the OECD average. Job cuts could possibly result as firms are forced to lay off workers to make payroll. Research also shows that higher minimum wages will likely lead firms to raise prices to stay competitive, meaning middle-class consumers will end up paying low-wage workers in higher prices. Because median income has stagnated in the last decade, this policy could end up making middle class people worse off.  

So how do low wage earners in countries like Germany, France, and the Netherlands end up with a better standard of living than their counterparts in the United States? The answer is that those countries have robust wage subsidy programs for the working poor that guarantee a basic level of income for low-wage earners.

In the United States it’s almost impossible for childless working adults to receive cash assistance; however many low income people do qualify for the Earned Income Tax Credit (EITC). This credit is fully refundable, meaning people can receive money back from the government even if their tax liability drops below zero. In this way the EITC functions like a wage subsidy, raising workers’ incomes and reducing their tax burden. Unlike a higher minimum wage, the EITC imposes no costs to businesses, so expanding it would have no impact on employment.

There have been a number of proposals to expand the EITC. In his 2016 budget proposal, President Obama proposed a significant expansion of the EITC, particularly for childless workers. That same year, Paul Ryan, the House Ways and Means Committee chairman, followed suit. An expanded EITC would function as a form of revenue forfeiture rather than new spending. In this way it could be more palatable to conservatives if marketed as a tax cut, while Liberals would be satisfied to see the program paid for by closing tax loopholes that overwhelmingly benefit the wealthy.

The EITC isn’t a perfect solution for fighting poverty. Higher tax credits could end up encouraging firms to hold wages down by expanding the labor supply and offering fewer incentives to pay workers more. While the EITC makes up for this loss in wages by increasing worker’s take-home pay, not everyone is eligible under current policy. Those who don’t qualify, such as childless workers, could end up being hurt as a result.

Fortunately, evidence suggests that this unintended consequence could be corrected by setting a wage floor to prevent wages from sinking below a certain point.  A $12 per hour minimum wage would bring the United States to par with other nations with a similar per capita GDP, and would leave room for an expanded EITC to fill the rest of the gap.

Requiring businesses to compensate their employees more fairly is an important step in reducing inequality. However, policymakers should be aware of the fact that raising wages does have negative effects on businesses and employment. An expanded EITC, along with a modest increase in the current minimum wage, would raise real wages among the working poor without overburdening employers.

One comment

  1. […] School?  This past week the blog featured pieces from Conor McGrath, MPA candidate, on why expanding the EITC may be a better choice to lift people out of poverty than raising the minimum wage; Annette Beck, […]

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