Rewarding Work: Feasible Antipoverty Policy

Virtually all economists who have studied the
changing income distribution have confirmed what nearly everyone else knows. For
most Americans, living standards are stagnating and becoming more unstable. For
the bottom half, income is falling. And the prime culprit is not shifts in
family values or the work ethic, or even changes in taxes and social benefits.
Most of the problem is the erosion of wage and salary income.

The causes are multiple [see Bluestone, "The
Inequality Express
," TAP, Winter 1995], but there are proven
methods for cushioning the impact by raising incomes at the bottom and providing
"wage insurance" for those at risk. Chief among these are the minimum
wage and the earned income tax credit (EITC). The two fit together like jigsaw
puzzle pieces. Each has an inherent weakness—but the weakness in one is
precisely the strength of the other. The problem is that the real value of the
minimum wage is shrinking and the EITC is under attack.



THE FATE OF AMERICAN INCOMES

Between the end of World War II and 1973, inflation-adjusted average weekly
wages for non-supervisory employees rose by 60 percent, while real median family
income, boosted by the growth in female labor force participation, literally
doubled. Those in the bottom quintile of the income distribution saw their
incomes rise by no less than those in the top. Such a benign climate ended in
1973. Since then, average weekly wages have fallen by nearly 20 percent and
median family income has not improved beyond the level achieved more than two
decades ago.

According to Gary Burtless of the Brookings Institution, between 1973 and
1993 the average income available to the bottom quintile fell by nearly 23
percent—from $17,601 to $13,596 per year for a family of three (in 1993
dollars). A small portion of this decline was due to cutbacks in means-tested
transfer programs such as welfare. A bit more was due to reductions in the value
of private pensions. Yet the largest source of decline, amounting to 60 percent
of the total income loss, was a reduction in the earnings of either the head of
household or other household members.

As incomes of the bottom fifth of the population have fallen, poverty has
naturally increased. As a nation, we made sizable inroads against poverty during
the 1960s and early 1970s due to strong sustained growth in the economy, low
unemployment and high labor bargaining power, increases in transfer programs,
and the billions of dollars spent as part of the War on Poverty. Between 1960
and 1973, the proportion of individuals living below the official poverty line
fell by half, from 22.2 percent to 11.1 percent. But then the war stopped. By
1993, the poverty rate was back up to 15.1 percent.

The newly poor, however, were not the same as the old poor. In 1970, 40
percent of the poor were children and 19 percent were elderly. Thanks to the
expansion in Social Security and Medicare, only 10 percent of the poor today are
age 65 or older. The proportion of the poor who are children has also declined
slightly, to 38 percent, because of declining birth rates. As a result,
nonelderly adults comprise an absolute majority (52 percent) of all poor persons
in the nation. This may be the first time since the era of Charles Dickens that
the majority of the poor are not the young, the old, or the infirm, but prime,
working-age adults. While conservatives may target a breakdown in family values
as poverty's chief culprit, the data suggest otherwise. The main cause is
falling wages and diminished employment opportunity.

These trends will only intensify if "welfare
reform" compels single mothers to seek paid employment. Thirty years ago,
single-parent families headed by women made up less than one-fifth of all
impoverished households in the country. Today they make up nearly one-half (47
percent) and therefore the welfare-to-work strategy, in either its more gentle
White House guise or its harsher congressional form, will impact millions of the
lowest-income families in the nation.

If we push welfare mothers into paid employment without raising wages and
benefits, the main effect will be to increase the already large proportion of
the poor who currently work for their poverty. In 1989, three out of four
poverty households had one or more workers in them while nearly 70 percent of
all poor prime-age adults—those between the ages of 25 and 54—did some
paid work during the year. Three out of every ten of them worked year-round,
full time—giving the lie to Thomas Carlyle's remark a century ago that "work
is the grand cure of all the maladies and miseries that ever beset mankind."

Families permanently trapped on the lowest rungs of the income ladder are
not the only ones in economic trouble. Job and income instability is becoming "democratized"
as a direct consequence of ongoing corporate restructuring that targets
professional and white-collar workers for layoffs along with the traditional
blue-collar rank and file. Economist Stephen Rose, currently at the U.S.
Department of Labor, estimates for the 1970s that 67 percent of men had a "strong
attachment" to their firm. They made at most one change in employer during
the decade. Such strong company affiliation dropped to only 52 percent in the
1980s. Weak attachment—changing employers at least four times in a decade—doubled
from 12 percent to 24 percent. Rose finds that such high employment turnover—presumably
dominated by layoffs rather than quits—leads to disrupted career paths, in
turn resulting in lower average earnings. For a not insignificant number of
families, the loss of a job plunges a family at least temporarily into the ranks
of the poor or near poor.

All of these statistics suggest that we have built poverty into the very
fabric of the American labor market. In such an economic environment, there is a
critical role for public policy designed to boost wages and improve income
security. Here is where raising the minimum wage and protecting the EITC come
into play.



FIGHTING WAGE POVERTY

The federal minimum wage dates to the Fair Labor Standards Act of 1938. In
his second inaugural address in 1937 preceding the introduction of this
legislation, Franklin Roosevelt called on Congress to help the one-third of
Americans who were "ill-housed, ill-clad, and ill-nourished." The
original minimum wage of 25 cents per hour helped, but it was only sufficient to
raise a worker's earnings to the point where it would, using today's standards,
support a family of three at 46 percent of the poverty line.

After World War II, as real gross domestic product (GDP) increased, the
federal government improved the minimum wage regularly to make sure the poorest
workers would share in the general prosperity. Between 1950 and 1991, Congress
raised the wage floor 14 times. At its peak in 1968, the $1.40 per-hour minimum
represented—on a full-year, full-time basis—118 percent of the poverty
wage for a family of three.

In the 1970s, however, inflation began to outrun the minimum wage. Despite
periodic increases in the statutory rate, none was large enough to maintain the
minimum's real value. By 1995, a full-time worker on a minimum-wage job could
earn only 72 percent of the income needs of a three-person family living at the
poverty line. [See "A Minimal Wage," below.]
According to New York University economist Edward Wolff, if the minimum wage had
kept up with inflation since 1965, it would exceed the current earnings of fully
30 percent of American workers. Nearly one out of three American workers is
presently toiling for an inflation-adjusted wage that would have violated the
Fair Labor Standards Act 30 years ago.



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Real wages have fallen so far during the past 20 years that, according to
the Economic Policy Institute (EPI), raising the minimum wage to just $5.15 an
hour from the present $4.25—as President Clinton has recommended to
Congress—would directly affect more than 12 million workers who now earn
between the current minimum and the proposed one. In addition, because firms try
to maintain wage differentials between groups of workers, workers just above the
minimum typically benefit as well. EPI estimates that nearly nine million
additional workers currently earning between $5.15 and $6.14 an hour will see
their wages rise by an average of 10 percent. Together, then, more than 21
million workers—one out of six in the U.S. workforce—would see their
wages improve over the next two years if the Clinton wage floor were adopted.

Contrary to propaganda by employer groups, almost three-fourths of these
workers are adults; only 25.6 percent are teenagers. Nearly three-fifths are
women, whose families are disproportionately in poverty. Over half of all
workers who would benefit from raising the minimum wage to $5.15 an hour are
found in the poorest 20 percent of all families. Well over two-thirds work in
retail trade and services; only 10 percent work in manufacturing where the
threat of low-wage international competition may increase if the minimum is
raised.

As good public policy, the minimum wage has at least
four things going for it. First and foremost, it is a way to increase workers'
earnings without placing any burden on the taxpayer. It does not add a penny to
the federal deficit. If anything, it decreases the deficit by boosting income
tax revenue and reducing welfare payments. Second, it provides increased income
to workers who do not qualify for government transfer programs or tax credits.
Third, it is an incentive to work in the "above ground" economy rather
than in the "underground" economy where wages are often higher than
the federal minimum. Fourth, and by no means least, an increased minimum wage
may well lead to higher productivity in the economy. At current wage levels,
there is little incentive for low-wage employers to introduce new technology or
find other ways to boost the output of their workforce. Required to pay a
higher wage, firms would have an incentive to find ways to use their workers
more effectively.

Despite these advantages, economists' support for mandated minimums has been
tepid at best. The minimum wage is viewed as a double-edged sword, boosting
wages on the one hand, but forcing employers to reduce employment on the other.
Teenagers presumably bear the brunt of minimum-wage-induced job loss, being the
least skilled and most expendable in the labor pool. Until recently, empirical
research appeared to confirm the economists' concern. A battery of studies
during the 1970s and early 1980s concluded that a 10 percent increase in the
federal wage floor typically leads to a 1 to 3 percent cut in teenage
employment. Among adults, the effect was found to be substantially weaker, but
statistically significant, in the range of 0.3 to 0.7 percent.

David Card and Alan Krueger, both economics professors at Princeton
University, have carried out meticulous "micro" studies that suggest
that in the real world of fast food restaurants and other low-wage employers,
modest increases in minimum wages have no negative impact on employment levels.
Their results have been attacked by some traditional economists, but none of
Card and Krueger's detractors have fundamentally undermined the findings. [See
John Schmitt, "Cooked to Order," page 82.] Evidently, there is
sufficient slack in the relationship between wages and employment levels—especially
in industries not subject to international low-wage competition—that
employers either absorb the higher minimum wage in slightly lower profits or
find productivity improvements to justify the higher wages, rather than
compensate by laying workers off.

Yet even if the new Princeton studies are ignored and we fully accept the
critics' estimates of an unemployment effect, it would not constitute much of a
case for rejecting a higher minimum wage. Virtually every low-wage worker
benefits from a higher minimum wage even if there is an aggregate labor
displacement effect. Because of the high job turnover rate among teenagers in
particular, and low-wage workers in general, no single individual bears the full
burden of unemployment. A recent study of working welfare mothers by the
Institute for Women's Policy Research, for example, shows that they change jobs
on average every 14 months. Those who benefit from a boost in the federal wage
floor share both the higher wages and a portion of any induced unemployment. In
the case of the Clinton proposal, the typical working teenager will see his wage
go up by 21 percent and—if there is job displacement as severe as early
estimates make it out to be—a 6 percent decline in annual hours worked. One
presumes few teenage beneficiaries would vote against a wage-job displacement
deal that includes a 15 percent annual income increase in return for 6 percent
less work! For adults affected by such an increase in the minimum wage,
the 21 percent wage increase is offset by no more than a loss of 1.5 percent in
annual hours worked—hardly a dent in their improved economic condition.
This should vindicate the minimum wage, even without the Card and Krueger
results.

But there is another criticism that makes the minimum wage less than ideal
as an antipoverty remedy. It concerns what economists call "target
efficiency." Only a small proportion of the poor would directly benefit
from increasing the wage floor, despite the fact that nearly 75 percent of poor
households have someone who works. According to estimates by Richard Burkhauser
and Kenneth Couch of Syracuse University and their colleague, Andrew Glenn of
Vanderbilt, only 16.9 percent of the workers in poor households in 1991 were in
jobs paying below the proposed boost in the statutory minimum to $5.15 an hour.
Except for the possible indirect benefits noted above via maintenance of wage
differentials, the other 83 percent of working-poor households would not be
helped since their working members already earn wages above this level. Even so,
according to the EPI study mentioned above, 40 percent of the gains from the
proposed Clinton wage hike would go to the poorest 20 percent of working
families—those with annual incomes less than $22,000 in 1993. These are
clearly deserving families, even if only about half this number are below the
official poverty line.

However, the federal wage floor would have to be $6.06 per hour for a
full-time worker to earn enough to raise a family of three above the poverty
line. Hence, most workers in poor families fall into a "dead man's zone."
The Clinton minimum wage is below what they are currently making, but their pay
is not sufficient even on a full-time, full-year basis to catapult their
families out of poverty.



UNTAXING THE POOR

To assist the most disadvantaged of the working poor, an even
better-targeted program is needed—the earned income tax credit. First
enacted in 1975, the EITC is a refundable tax credit aimed directly at helping
working-poor families with children. Its original intent was to offset a portion
of the payroll tax liability of low-income families in order to reduce the
regressivity of federal taxes. Being refundable, it has aspects of a "negative
income tax." If the credit due a family is greater than its federal tax
liability, the IRS remits the balance to the family.

The way the EITC operates is quite simple. For example, a working family
with one earner and two or more children receives a 40 cent credit for every
dollar earned up to $8,900. Hence, the EITC provides a maximum benefit of $3,560
(0.4 times $8,900). When that family files its Form 1040 in April, total tax
liability is reduced by this amount. A check will be sent to the family if the
credit exceeds what it owes. A family is eligible for the maximum credit until
its total earnings from work reach $11,620. After that, the credit declines by
21 cents per dollar of earnings, and vanishes altogether only when a family's
earnings exceed $28,524. For working families with just one child, the maximum
credit is $2,156 and the credit "vanishes" at $25,120.

Since the EITC rewards work and not welfare, does not impose mandates on
employers, and involves little red tape, even President Reagan was a great fan.
In expanding it in 1985, he called it "the best anti-poverty, the best
pro-family, the best job creation measure to come out of the Congress." At
the time, Senator Bob Dole and Representative Dick Armey chimed in with warm
endorsements.

The EITC's greatest advantage from the perspective of battling poverty is
precisely the minimum wage's weakness—its target efficiency. According to
Burkhauser and his colleagues, more than 46 percent of the program's total tax
credit goes to families who are living under the official poverty line while 63
percent goes to families with incomes no more than 1.5 times this low income
standard. Only about 15 percent goes to families with incomes 3 times the
poverty line or greater—families who have relatively higher incomes but
receive only a portion of their income from wages. The U.S. Treasury estimates
that in 1996 more than two-thirds of the credit will go to families with income
under $20,000. Hence it affects millions of families in the "dead man's
zone"—those not helped by the minimum wage. For a family of four with
one earner making $7 an hour and working 1,500 hours a year, the EITC fills
nearly 80 percent of its "poverty gap," the difference between
after-tax earnings and the poverty line.

The EITC has still another great advantage often overlooked by both its
supporters and its detractors. It is a form of "family wage insurance"
in an era of job instability and earnings insecurity. Stephen Rose has estimated
that fully 39 percent of families would be eligible for the EITC at least one
year in ten. In any one year, about one in six families is eligible for the tax
credit, but over a decade, nearly two out of five families with children will
have a year or more in which their wage income declines sufficiently for them to
be eligible for the EITC. The EITC proves particularly useful for younger
families, those hardest hit by the nation's falling median-wage rate. By the end
of any given decade, more than half of families headed by individuals who are no
more than 35 years old benefit from the credit. The EITC therefore serves two
important functions. It is life support for the permanently low-wage worker; it
is earnings insurance for the middle class.



Building a Living Wage

How raising the minimum wage and keeping the EITC intact helps working
families put food on the table:





Earnings























  Gross After FICA EITC Total
Family 1

(one adult earner, two children)
Earnings Witholding Value
Current minimum wage ($4.25)/no EITC $6,375 $5,887 $0 $5,887
Current minimum wage ($4.25)/EITC $6,375 $5,887 $2,550 $8,437
Clinton minimum wage ($5.15)/EITC $7,609 $7,027 $3,044 $10,071
Family 2
(two adult earners, two children)
Current minimum wage ($4.25)/no EITC $12,750 $11,775 $0 $11,775
Current minimum wage ($4.25)/EITC $12,750 $11,775 $3,323 $15,098
Clinton minimum wage ($5.15)/EITC $15,218 $14,054 $2,805 $16,859

Earnings are for persons working at minimum wage 30 hours
per week, 50 weeks per year. These simulations assume a 1.5 percent reduction
in hours worked as a result of raising the minimum wage from $4.25 to $5.15 per
hour.


As impressive as these benefits may be, the EITC is
no cure-all and has a number of serious weaknesses. For one thing, it is of no
help to a large segment of the poor—unrelated individuals—and its aid
to childless couples is nearly inconsequential, amounting to a maximum of $324
per year.

An even greater disadvantage, at least politically, is that the EITC is
expensive from the perspective of the taxpayer. This year, the EITC will cost
the federal treasury more than $25 billion and its annual cost is projected to
rise to $30 billion by the year 2000 in order to keep up with inflation and
population growth. It is one of the reasons why, in their zeal to balance the
budget by 2002, the Republicans have targeted EITC for significant cuts despite
their previous enthusiastic support for it.

A third problem is that the EITC is considered subject to abuse. Until
administrative changes were made in the program last year, the so-called "error
rate" for the credit was found to be extremely high relative to other IRS
provisions. Some families were receiving the credit when they were ineligible;
others were receiving more credit than they were legally permitted; still others
were receiving less. Since there is benefit to be gained from overstating one's
income at very low earnings in order to move up the EITC schedule and benefit
from understating income at higher earnings levels to retain the maximum tax
credit, there will always be some enforcement issue needing attention—even
if it presents the IRS with nowhere near the headache of policing tax compliance
among the rich.

A more serious problem is related to what might be called the "Speenhamland"
effect. The EITC not only subsidizes workers, it subsidizes employers. It
permits employers to keep wages low while relying on the federal government to
help workers make up the difference between substandard earnings and something
approaching a living wage. The British learned this lesson 200 years ago when
they imposed their equivalent of the EITC in the form of the infamous
Speenhamland provisions. Introduced during the first decades of the industrial
revolution, Speenhamland subsidized factory wages to keep workers from starving
to death. Quickly, employers realized they could drive down wages and let the
government pick up the tab for their employees. By the early 1800s, Speenhamland
was bankrupting local treasuries and the laws were repealed. There is a lesson
here. Certainly in an era of "privatization," one would think that "privatizing"
wages should be high on the agenda. The EITC socializes them.

For this reason, the credit also has a potential adverse effect on
productivity. A wage subsidy tends to reduce the incentive for investment in new
technology and capital. If an employer can obtain labor for 80 cents on the
dollar, why invest in labor-saving technology?



FITTING THE JIGSAW PIECES TOGETHER

The conclusion should be obvious. An anti-poverty program aimed at low
earnings must include both an increase in the minimum wage and retention (if not
continued expansion) of the EITC. The disadvantages of the one are offset by the
advantages of the other.

The minimum wage has poor target efficiency; the EITC's efficiency is much
superior. The minimum wage does not generate jobs and may displace some; the tax
credit has no job displacement effect and might encourage some firms to expand
employment. On the other hand, the minimum wage is much superior to the EITC
when it comes to taxpayer cost, aiding unrelated individuals and childless
families, and countering the Speen hamland and adverse productivity effects.
Indeed, periodic increases in the minimum wage will over the long term actually
reduce taxpayer liability under the EITC. Whenever the federally mandated wage
floor boosts a family's earnings above $11,620, the credit is reduced by 21
cents on the dollar. Combined, then, the minimum wage and the EITC give us the
best of both worlds—target efficiency for attacking wage poverty at
reasonable public cost.

Clearly, the combination of minimum-wage regulations and the EITC makes for
good antipoverty policy, especially in an era when the majority of poor people
are working-age adults and job insecurity is on the rise. The chart ["Building
a Living Wage," page 45] provides estimates of how much an increase in the
minimum wage to $5.15 an hour in tandem with the current EITC would actually
help low-income families. Take "Family 1" with two children and one
adult earner working 1,500 hours per year at the current $4.25 minimum wage. At
the current wage floor, this family would have a total annual income of just
$5,887 (after subtracting its share of Social Security taxes) excluding its
EITC. The EITC alone boosts this family's income to $8,437. Lifting the minimum
wage to $5.15 an hour will raise after-tax earnings to $7,027 and total income
to $10,071—even if we take into account the highest possible job
displacement effect due to the boost in the minimum wage. Overall, this family's
income is raised by 71 percent as a result of the higher minimum and the tax
credit.

Depending on the wage rates currently earned, the number of annual hours
worked, and the number of earners in the family, the gain from the minimum
wage-EITC combo varies substantially. But the examples provided in the chart
indicate that few antipoverty programs could be more effective.

That Republicans refuse to increase the minimum wage—and a good number
have suggested jettisoning it altogether—shows neither compassion for the
working poor nor good economic sense. That a number of the currently fashionable
"flat tax" proposals eliminate the EITC adds substantially to the
enormous regressivity of these measures.

This is not to say, by a longshot, that reliance on federal wage standards
and tax credits is the ultimate answer to low wages and poverty. The social
policy jigsaw puzzle has many more pieces that must be fitted together to boost
employment opportunity, improve living standards, and reduce income insecurity.
Fashioning a full-employment macro policy is part of the overall puzzle, as are
education and training programs, community economic development strategies,
increased unionization, and fair trade. But in this political era of trying to
hold on to some of the gains we have made in the past, the battle for improved
minimum-wage regulation and maintenance of the EITC are well worth joining with
a lot more gusto than we have seen from the White House this past year.



FOR FURTHER READING


  • David Card and Alan Krueger, Myth and Measurement: The New Economics
    of the Nimimum Wage (Princeton University Press, 1995).

  • Lawrence Mishel, Jared Bernstein and Edith Raselle, "Who Gains with a Higher Minimum Wage,"
    Economic Policy Institute, 1995.

  • Stephen J. Rose, "Long Term Eligibility for the Earned Income Tax
    Credit," Research Report #95-05, National Commission for Employment Policy,
    1995.



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