I must disagree with your suggestion that employees "accept" lesser paying jobs simply because they know that EITC will compensate. As a minimum wager for a number of years (who qualified for EITC in spite of being single with no dependents), I clearly liked EITC. But none of us "accepted" lower pay because of it. We accepted the jobs that were there because they were the only jobs that were there. EITC was viewed as a bonus, but was hardly a motivating factor.

On the other hand, you are certainly correct in describing EITC as a subsidy transfer for inefficient employers. I have made this argument a number of times myself but have come under substantial criticism for it from the "capitalism is everything" crowd. Because of this, I modified my argument to suggest that it is either a subsidy for inefficient employers or a subsidy for consumers of the products and services provided by affected employees. This change in my argument has allowed me to escape the stupidity of charges that I am anti-capitalism.

But another interesting thing occurrs in this area: Because these employers are allowed to pay less than a living wage, there is a negative pressure on them to explore ways to become more efficient producers. These more efficient methods of production would almost always involve capital investment, but this simply does not occur.

In effect then, the existence of sub-living wages actually creates a drag on the economy far greater than the drag produced by people with no discretionary income. The net total effect of moving to a living wage would thus be to spur capital investment in the name of efficiency. And of course, with this would come greater profitability for employers as well as higher paying jobs for employees.

Before I buy into your arguments, I'd like to see an actual model from you to support your claims. As it is, all you've done here is laid out verbal and impressionistic talking points that might or might not hold within a well-quantified scenario.

I also hope you realize that the Card-Krueger study was marred by serious methodological and statistical shortcomings, and has been pretty thoroughly debunked. There is simply no evidence to back the assertion that more than token minimum-wage hikes do anything other than transfer income from one group of low wage earners to another, while imposing a net welfare-loss on society as a whole. The evidence continues to weigh in favor of the EITC.

Abiola- the whole "minimum wage costs jobs" argument is based on modelling without empirical evidence. And to say that Card-Krueger have been "debunked" betrays ridiculous bias. Check out endorsements of their book here. There are those who have disputed their research but their work is still probably the most cited studies in minimum wage empirical research.

"Ridiculous bias"? And an appeal to authority as support for the worth of the Card-Krueger study (why else would I care for the endorsements their book has received)?

If we're going to rely on big-name endorsements to settle this, I'll throw in mine - Gary Becker, Nobel Prize winner, trashed the methodology employed by Card and Krueger. But rather than stop with throwing out a big name of my own, I'd suggest you actually read the following critique of their study:

Neumark, David and Wascher, William 1995. "The Effect of New Jersey's Minimum Wage Increase on Fast-food Employment: A Re-evaluation using Payroll Records." NBER Working Paper: Cambridge, MA.

I'd be interested in seeing just where you think the paper above actually misses the mark in its' criticisms, rather than accusing me of "bias" and wheeling out a list of endorsements.

Yes Abiola-- you cite the endorsement by one of the most rightwing economists in the nation, Gary Becker, to support the authority of a study by Neumark and Wascher. I should add that the American Economic Association awarded its John Bates Clark Medal—its most prestigious award—to David Card for work on this study. Of course calls to authority matter when you say a study has been "debunked," since that implies discrediting among the whole economics profession. You can argue that Card and Krueger's findings are debated, which is of course true, but they are still the gold standard of research on the subject.

"I should add that the American Economic Association awarded its John Bates Clark Medal—its most prestigious award—to David Card for work on this study. Of course calls to authority matter when you say a study has been "debunked," since that implies discrediting among the whole economics profession."

Ermm, no, you're flat out wrong. The reason I cited Gary Becker was to show that one gets nowhere playing that sort of silly game, not because I think his name automatically settles anything, and whether he is "right wing" or not has no bearing on anything in any case - to suggest otherwise is simply to resort to cheap ad-hominem tactics. And winning the John Bates Clark medal does not automatically confer an irrefutable mantle of correctness on any study, no more than does a Nobel Prize mean that Rigoberta Menchu wasn't a liar. Why don't we lay aside all appeals to authority and try to settle the issue on the merits? I'm assuming here that we're both competent to understand the substance of the debate, rather than relying on wise old elders to tell us what to believe.

As for your claim that Card and Krueger are "the gold standard of research" on the subject, that is simply a bald assertion on your part, and one I outright reject. I've read any number of subsequent studies that contradict Card and Krueger's claims, and in fact they themselves have retreated from their earlier gung-ho assertions about the benefits of minimum-wage hikes.

If you believe that their study is so solid as to be irrefutable, why aren't you willing to provide actual arguments to brush aside the criticisms levelled in the paper I cited? I've given you a reference to an actual paper that you can read that critiques the Card-Krueger study, if you so desire. I'd appreciate it if you would reciprocate the courtesy by either laying out a rigorous argument of your own against the claims made by Neumark and Wascher, or else point out other studies that invalidate the criticisms they made of the Card-Krueger paper. If you aren't willing to do even this much, then I'll be forced to assume that you're simply relying on bluster and handwaving to win the day, rather than on any sort of objective reasoning.

But transfer payments means that the rest of us are subsizing sweatshop employers, who artificially dump their operating costs on the public. This is bad not just because it's hard on us as taxpayers, but it distorts the labor market and encourages less productive and less efficient production methods.

But doesn't a government-imposed minimum wage, by definition, distort the labor market, too? And it's unclear to me how paying a given worker with the identical skill set more money adds to efficiency.

And, of course, operating costs are always passed on to the public.

Aside from the economics, it strikes me that Matt's solution has the advantage of fairness, as well. It is society, via its government, that's saying it's somehow morally required that everyone who has a job be able to afford a certain standard of living. So why shouldn't the society pay the cost of this marginal improvement?

to Abiola,
It seems somewhat inappropriate to be disputing Mr. Newman's points on the basis of a study on the basis of YOUR OPINION, but require that HE refute the arguments one by one from something you cite, while neglecting to present logical arguments on the merits of the studies yourself. I hope that you are not trying to cover up the inadequacies in your position by applying double standard for the level of evidence/credibility in this debate.

I find it interesting, just in terms of the rhetoric, that the forces that produced a reduction in the minimum wage- in real dollars- are seen as somehow natural whereas any attempt to reverse that trend by fiat is seen as artificial. What it comes down to is an idea of what is or is not normative in any given period. I understand how this needs to be considered in any analysis of human affairs, but to view any of this as 'hard' science is silly. Perhaps we should call economics the science of governance by psychological manipulation.

Nathan,

I have a question regarding your example.

In the situation without EITC, the employer who pays more wages outcompetes the employer who doesn't. Isn't this an argument in favor of the market setting wage rates?

Luke-

Yes, but it's not an argument against offering a minimum base standard of living to all employed citizens, which is all the minimum wage intends to achieve.

Just another of the many forms of regulation we have on our 'free market'.

Your analysis is faulty. The major problem is that you ignore how wages are determined in the market. In equilibrium, wages equal the marginal product of the person's labor. So, someone getting a wage of $7.50 before EITC has a marginal product of $7.50. If his/her employer tried to bid this down (using EITC as an excuse), the person would simply find an employer who would pay him/her $7.50. A $2.50 subsidy would bring the person's effective wage to $10.00./hour. Put another way, if the employer is paying $5.00 for labor (w/ or w/o EITC), then he/she is getting a worker with a marginal product of $5.00. The firm, then, loses the cost advantage you described. Consider, too, your proposition that wages will be reduced to $5.00 in the presence of a subsidy. Unless all workers were covered by EITC (and those with spouses with decent wages or second jobs wouldn't be), the employer would have to pay some workers $7.50 (those w/o subsidies) but would be allowed to pay other $5.00 (those with subsidies), for work that requires the same skill, hours, working conditions, etc. That wouldn't happen. There'd be too many personnel problems.

Fragen-- I at least note that the labor market is a weird beast and poorly understood. For you to claim that you know "how wages are determined" should merit you the Nobel Prize, but you won't get it for your analysis.

If wages were set by "the marginal product" of that labor, you would see the same prices globally for the same work. You don't. What sets wages is the alternative to that work-- starvation, rural sharecropping, prostitution, or McDonalds burger-flipping. And the degree of welfare and other social transfers unquestionably changes the calculus of what jobs people will accept. How much it changes it is an open question, but to argue it has no effect ignores a range of economic theory. See Polanyi for historical examples.

James: It is society, via its government, that's saying it's somehow morally required that everyone who has a job be able to afford a certain standard of living. So why shouldn't the society pay the cost of this marginal improvement?

You seem to hold the view here that EITC is a sort of subsidy from society to the employee, when it is in reality a subsidy from society to the consumer. When viewed in this manner, several problems with your suggestion become obvious. First, comsumption is optional. Why then should society as a whole subsidize consumption decisions made by individual consumers? For example, if you choose to eat fast food and I choose not to, why should I subsidize your dining choice?

Second, if society does decide to subsidize comsumption, wouldn't it also be appropriate for them to decide exactly what comsumption they wish to subsidize? For example, society might decide to subsidize new home construction, viewing it as a net positive for society as a whole, but I would be hard pressed to find any net societal benefit to a $1 hamburger. Yet, society currently is simply being asked to pay the tab without any input as to what is on the bill. Largely, the employer gets to make that decision, and once it is made, society has no equitable method of overruling it.

Finally, once society does decide to subsidize some comsumption, why should it not simply subsidize all comsumption? Where is the line to be drawn? Now of course, this is nonsense, because the economics of this would drain the bank long before this pond was filled. Yet, it is in the compelling interest of mostly every employer to seek to drive down wages as much as possible. At the same time, it is clearly in society's interest to put a floor on what this wage can be. A living wage does this. EITC does not. In fact, EITC actually encourages the employer to go beyond this.

As someone who received the EITC for several years I will vouch for it coming as a welcome bonus rather than something that could be counted on.

Because that money is received nearly a year after it is 'earned' it can't be used to pay for bills or rent. It is hard to see the downward pressure from the credit equaling the entire amount of money received.

Neumark, David and Wascher, William 1995. "The Effect of New Jersey's Minimum Wage Increase on Fast-food Employment: A Re-evaluation using Payroll Records." NBER Working Paper: Cambridge, MA.

Abiola and others-

You might be interested to know that David Neumark recently did a major empirical study of the effects of living wage laws (minimum wages with limited coverage) in California and concluded that the net effet was to raise the total income received by low-wage households and to reduce poverty -- i.e. the increase in incomes significantly outweighed the disemployment effect.

His papers are here and here. There are some methodological objections to these papers (discussed here) but if we're playing the lining-up-authorities game, Neumark has to be shifted to the pro-minimum wage column.

You can't have it both ways, Nathan. The "if you knew how wages were set, you'd win a Nobel Prize" and then your references to the magic of markets elsewhere. Of course we don't know everything about how wages are set, but we do know a lot and there's a huge body of empirical evidence. The big sign that you're dodging: the reference to global markets (which don't clear) when we're talking about local labor markets. The fact is that in your example, you have workers who merit $7.50 in the local labor market and then poof! are willing to accept $5.00 (which might even be below their reservation wage) rather than find other employment (in the local labor market) that would pay them $7.50. The idea that marginal product determines wages isn't without problems, of course, but it captures the fact that worker attributes--skill, education level, experience--affect wage levels in local labor markets. It's a lot more sound than a manufactured example. Polanyi's great, but you'd be better off reading the the Handbook of Labor Economics and the last decade of the Quarterly Journal of Economics. It's fine if you don't want to accept the (broad) areas of basic agreement in labor or other branches of economics; it might even be okay to pick and choose. But it's odd that you're rejecting generally accepted claims (with lots of empirical evidence) and then relying on less-accepted ones and your own manufactured theories to make a case. Speculation is great, but your example rises and falls on the existence of a set of workers who will agree to wage cuts of $2.50 and stay at the same job. There's no evidence that would happen and lots of theoretical and empirical evidence that it wouldn't. Faced with that prospect, workers would find another job that pays more than $5.00 and actually realize the benefits of the EITC.

As a general note, I would add that in the real world, the marginal product of labor sets a ceiling to wages and the marginal disutility sets a floor. Actual wages are almost always somewhere in between.

The existence of involuntary unemployment confirms the second half of this. As for the first half, imagine a business that finds that as a result of an increase in demand, it can sell more of its products at their current prices. Will hiring more workers now increase profits? If the answer is yes (and I think we all agree that in most cases it will be), then current wages must be below workers' marginal products.

Fragen-

You're missing the point.

The EITC allows the employer to reduce their labor costs without afecting the worker's take-home pay.

JW--I think you're missing the point. Workers are not locked into jobs and wages will be determined by bidding for their services in the local labor market. Workers can benefit from EITC. If you believe that EITC (money that doesn't come until some time the next year) is being used to allow employers to drive down wages, then you'd have to believe that employers ask workers during interviews about their EITC status, that work forces at one site pay different wages depending on EITC status (and that workers accept this), that employers will raise wages (retroactively) if the worker loses EITC status (b/c e.g. their spouse gets a job), and cut wages (immediately and retroactively) if a worker suddenly gains EITC status (e.g., spouse loses a job). This is all impractical and in some cases, illegal.

Wokrkers who are aware of the EITC need only be somewhat more willing to take low-paying jobs. I'm not aware of any god empirical work on this one way or another, but it doesn;t seem like a stretch to me.

On the employers' side, the idea of offering different wages for the same job is a non-issue. If the EITC makes any workers more willing to accept a job for say $7/hour, then employers offering jobs for $7/hour will find those jobs easier to fill than in the absence of the EITC. Low-skilled workers who aren't eligible for the EITC have their wages forced down, since the EITC increases the supply of low-skilled labor.

We can argue about how strong this effect is in practice, if you've got any empirical evidence. But there's no reason to reject it in principle.

I'm curious if you believe that the tax code has no effect on labor supply in general? -- because by far the highest marginal rates in the tax code are in the phase-out range of the EITC.

Fragen-- I'm not actually rejecting or accepting much of any claims on the labor market. I specifically said my example was a simplification and unlikely to match the actual result in the marketplace, just that it illustrated how wage subsidies could encourage lower wages and a bias towards less productive production models.

My basic argument is that the labor market is poorly understood with lots of speculation and argument. Which puts the onus on those arguing against raising the minimum wage, since unless there is strong evidence against it, it is an unmitigated good for the workers effected.

I'm not actually arguing against the EITC with the arguments presented -- since I support it-- I'm just arguing that the theoretical problems with it are quite substantial, especially without a complementary minimum wage. So I am skeptical of those arguing that the EITC is a replacement for the minimum wage.

These are actually limited points. Since 80% of the population thinks the minimum wage is a good thing and should be increased (and lots of economist support them in that), I feel quite justified in not taking the anti-minimum wage position as a consensus viewpoint.

JW--Nice post. I agree with all of your points and if someone told me that with EITC, the $7.50/hour jobs became $7.00 or $7.30/hour jobs, I'd believe them (mostly b/c of the effect on labor supply). If someone said, as in Nathan's example, that the full benefit (or even close to it) of the EITC is offset by declines in wages, I just don't believe it, in part because of the structure of EITC implementation. At the wage levels we're talking about, i.e., the ones where EITC is operational, the delayed payment of the benefit (one-time, during tax season) will dull its effect on labor market decisions. These workers are likely to (be forced to) make decisions based on how much money the job will yield that week or that month. So, yes, I do believe that tax rates affect labor supply, but I also think that in this case the delayed nature of the payment and the financial needs of EITC recipients probably blunt the effect. If EITC were built into weekly take-home pay rates (and they actually could be) the labor market effects would be much larger.

The other reason the wage-depressing effect that you mention (that it's enough for the marginal worker to be willing to accept $7.00) will be offset to some extent is the existence of the marginal employer who bids wages back up (to $7.50, say--I'm not proposing that employers are generous or that low-skilled workers don't get exploited) to get better workers. My starting point is Nathan's example: that without EITC, workers make $7.50, which tells us something about their contribution to employers' output and profits. Employers should be making hiring choices based on profits associated with hiring workers, not wage levels per se. (If they're not making decisions based on profit criteria, they probably won't be around too long.)

Fragen-- I don't actually disagree with either you or Max that it's unlikely that even the majority of EITC payments go to employers rather than workers themselves. As I said, I support the EITC and think it's a good program generally.

But my point was to raise questions for liberals who think the EITC is an unproblematic gain, while the minimum wage is suspect according to ECON 101. Liberals have bought into EITC to the extent that they have abandoned a historic commitment to the minimum wage, which is a bad mistake in my viewpoint for all the reasons I'm documenting this week.

Nathan--You certainly nail the politics and I'm looking forward to the rest of your posts this week. I hope you will tackle the issue of who pays for EITC/minimum wage. I haven't thought a lot about it, but I imagine that there might be real distributive differences. EITC is paid for by all tax payers, while the benefits accrue to individual workers (of course) and their employers, to the extent that it subsidizes the wages they pay. (On this point, we seem to all agree that there's some subsidization but it's less--and perhaps much less--than the full EITC amount.) To assess the distribution of costs for minimum wage, we need to look at where minimum wage workers are employed (fast food, low-end retail (e.g., CVS, supermarkets) and domestic and personal services come to mind), how much of the costs can be passed on to consumers, and who consumes minimum-wage services. My hunch is that the wealthy and the poor consume a disproportionate amount of minimum-wage labor and that the burden would fall on them. Hmmm. In any case, I'll be interested to read your thoughts on this.

Fragen- I'll touch on the "who pays" issue and hopefully the inflation issue in a post, since they are related, although again it really depends on the labor market model used. Card & Krueger note that the different models vary substantially on who pays. To the extent you assume that wages are below productivity, then pushing the wage up with the minimum wage pretty much takes the money out of the employer's profits, while other models see more pass-through to the consumers (I think Card & Krueger favor the latter, although their own empirical results showed less price increases than that would assume.)

But one fact speaks for itself- employers fight the minimum wage tooth-and-nail which indicates they see it as a threat to their profits.

Abiola--The debate between Cark/Krueger and Neumark/Wascher seems to be pretty much resolved in favor of the former. Read the exchange of articles in the December 2000 issue of the American Economic Review--C/K clearly have the better of the exchange.

In this discussion of the EITC what is woefully missing is the historical basis that brought about the EITC. I do believe this was an attempt by the right to rollback working class gains. The Nixon Administration – no friend of working people – proffered the “concept” of the “negative income” tax to deflect and compete against the idea of raising the minimum wage.

Once again, Liberals, ever abandoning the working class, bought into this concept. Why? Because if favors elite interest. On its face there are several problems with EITC:

• Workers have to wait a full year before receiving any benefits therefore workers do not base their job prospect on EITC but on the actual wage rates.

• As Nathan points out the EITC serves to benefit employers who suppress wages are rewarded over employers who can lift workers standard of living.

• The EITC also SHIFTS power to employers and away from workers

Over and over Liberals ignore the real UNFAIR power relations that exist in Capitalism because economists are indoctrinated and paid to gloss over them. Seeing remarks on ECON 101 in this thread is absolutely laughable. All of the models in ECON 101 are based on the oxymoronic assumption of “perfect competition”. In other words economists build their “models” on the assumption that capitalism promotes “equality”. How else can you explain the ridiculous notion of “perfect competition”.

Also on “inflation” and raising the minimum wage, the way to offset inflation is to have HIGHLY PROGRESSIVE TAXES (ex. 100% for wages over 250K and wealth over 500K) acting as sort of a societal maximum. In other words Liberals fail to teach and express to the public that capitalism is an UTTERLY UNFAIR and BIASED system of resource and power distribution. And as such a HIGHLY PROGRESSIVE TAXES structure is a much needed regulation to curb elite power and correct misdistribution. In fact that was the original intent of the income tax system and not as a means to pay for services. That came later with the advent of Keynesianism

The cold war is over and capitalism stands alone. Therefore people’s misery is attributable to policies that preserve the existing economic arrangements.

WB

It is often forgotten that the EITC was initially instituted in the early 1970's to at least partially offset the effects of substantial increases in FICA (social security and Medicare) taxes on low income people that were then being legislated.

Your analysis is faulty. The major problem is that you ignore how wages are determined in the market. In equilibrium, wages equal the marginal product of the person's labor. So, someone getting a wage of $7.50 before EITC has a marginal product of $7.50. If his/her employer tried to bid this down (using EITC as an excuse), the person would simply find an employer who would pay him/her $7.50. A $2.50 subsidy would bring the person's effective wage to $10.00./hour. Put another way, if the employer is paying $5.00 for labor (w/ or w/o EITC), then he/she is getting a worker with a marginal product of $5.00. The firm, then, loses the cost advantage you described. Consider, too, your proposition that wages will be reduced to $5.00 in the presence of a subsidy. Unless all workers were covered by EITC (and those with spouses with decent wages or second jobs wouldn't be), the employer would have to pay some workers $7.50 (those w/o subsidies) but would be allowed to pay other $5.00 (those with subsidies), for work that requires the same skill, hours, working conditions, etc. That wouldn't happen. There'd be too many personnel problems.

Actually, I think it is your analysis that is lacking. The unstated assumption underlying this entire post is that wages are set in a perfectly competitive labour market, which is, quite frankly, nonsence.

With imperfect competition (usually in the form of oligopoly) the norm in most sectors (for a simple reason, but one I won't get into here: in perfect competition, economic profits in the long run average zero) the labour market (especially in low skilled labour) is already distorted before the institution of the EITC or minimum wage becausse you have oligopoly firms with market power bargaining with individual workers with no market power what-so-ever to set wage rates.

Minimum wages, or an EITC, are second best solution to counter the existing distortion present because of imperfect competition. Minimum wages force producers (and in turn, consumers) to bear those costs while an EITC socializes the cost of correcting the distortion and acts as a subsidy to producers and consumers, though obvious it is unlikely that it acts at a perfect 1:1 ratio.