The EITC And The Minimum Wage

by hilzoy

Here it is: the latest installment of Posts That Try To Deal With Questions That Came Up In My Last Minimum Wage Post. (PTTTDWQTCUIMLMWP, for short.) This time: the Earned Income Tax Credit.

It's kind of fun trying to piece together exactly how the EITC works from the IRS' website, but even though I now know what the rules for counting kidnapped children are, and whether you can count a child who only lived for 40 minutes (yes), a simple explanation of how the darned thing works was harder to come by. So I popped over to the always useful CBPP, where I found this explanation, complete with accompanying graph:

"For a single mother with two children, the EITC provides a tax credit of 40 percent for every dollar earned up to $11,340 in tax year 2006.[7] A family earning between $11,340 and $14,810 will receive the maximum credit of $4,536. Thereafter, the EITC is reduced by 21.06¢ for each dollar earned until it is eliminated for earners above $36,348. The maximum EITC for families with one child is $2,747 and for childless workers is $412. Figure 1 shows the EITC as a function of income for households headed by an unmarried worker with various numbers of children.

In addition, the child tax credit is partially refundable – the so-called “additional child tax credit,” augmenting the EITC. In tax year 2006, families making over $11,300 are eligible for the additional child tax credit."

So (sticking to mothers with two kids for simplicity): if you make less than $11,340, then your credit goes up with every dollar you make; if you make between $11,340 and $14,810, then it stays constant at the maximum amount allowed; if it's between $14,810 and $36,348, then it decreases slowly for every dollar you make, but not enough to make it not worthwhile for you to work more. Plus, it's refundable: if your credit is greater than your tax bill, the government pays you the difference. (And, just to forestall the reappearance of this objection, you can get the money in increments during the year; you don't have to wait for a big lump sum in April.)

As you might expect, I love the EITC. However, I don't think it's a good substitute for increasing the minimum wage to a decent level and then indexing it to inflation. The reason is obvious from the shape of the graph: how much you get from the EITC depends on how much you earn. The bend points of the EITC are indexed to inflation, but the minimum wage is not. If you're working a minimum wage job, as the janitors I discussed in my last minimum wage post are, your wages will go down in real terms, and so will the amount of money you get from the EITC. If we never raised the minimum wage, then eventually the real value of a minimum wage worker's earnings (in future dollars) would approach zero, and so would her EITC.

Or, more simply: if you look at the graph I posted, you'll see that at very, very low earnings, the value of the EITC is very low. The minimum wage ensures that someone who works full-time, all year, will necessarily be near the top of the graph's ascending slope, not at the near-zero earnings part, where the EITC is practically worthless. Likewise, one of the Houston janitors, who works 20 hours a year at minimum wage, would be about halfway up the slope, not at the bottom. This means that a decent minimum wage ensures that the credits that workers actually get are worth something. And ensuring that people who work a given amount are at a given point on the slope, not at the bottom, and thus not getting a credit that's worth next to nothing, is something that the EITC, in anything like its present form, can never do.

A negative income tax, on the other hand, would remove the need for increases in the minimum wage, if it (basically) said: if you make below a certain amount, then the government will give you money, and the less you make, the more you get. (Imagine the graph above with a uniform downward slope, not the funny-looking flat-topped mountain that it currently shows.) We can debate a negative income tax if anyone wants -- it would clearly be good at reducing poverty, but would also greatly reduce the incentives to work.

However, unlike tweaks to the EITC, a negative income tax is pretty clearly not going to happen. Neither the Democrats nor the Republicans have shown any interest in it, and if some politician does mention it, I predict that that person will meet with scorn, laughter, and pointed reminders about the last candidate to propose a negative income tax. Debating it, however fun, would clearly be an intellectual exercise, not an examination of a policy proposal that's going to be implemented in the foreseeable future.

If we're talking about proposals to address poverty that actually do have a chance of being passed, I favor a combination of the following: raising the minimum wage and indexing it to inflation, keeping the EITC, and doing something to help people who make too much money to qualify for Medicaid get health insurance. For the longer run, the Employee Free Choice Act, featuring card check for unions, would be a great start. National health care, of course, but that's not going to happen as long as Bush is in the White House, so I'm not going to bother proposing it, even though I think it would matter more than any other single step we might take. (And it should include dentists. There are people in this country pulling their teeth out with pliers, not to mention Sebastian heading off to Mexico.)

But the EITC and increases in the minimum wage work best together, I think. They're complements, not alternatives.

***

Late news flash, from Ezra: the Houston Janitors won!

"What a difference a day makes! We have reached a tentative agreement for a 3 year contract for janitors.

Wages: $1.15 increase the first year, $1.00 the second year, and $.50 the third year.

Health Care: The third year is when single payer health insurance will kick in and janitors will pay $20 per month into that plan. It is a plan designed and managed by SEIU and we are hoping to get all of our members nationwide on this plan.

Vacation: Two weeks paid vacation per year

Holidays: 6 paid Holidays

Hours: 1st year everyone must work a minimum of 4 hours a day, 2nd year everyone must work a minimum of 5 hours per day, 3rd year everyone must work
a minimum of 6 hours per day.

Protection: We have a grievance procedure in place. We have protection for all of the striking workers to get their jobs back with no discipline, We have a disciplinary proceedure in place so that no one can be illegally fired for no reason any more."

Yay! And for all you conservatives out there: don't worry, this is just the free (labor) market at work. Nowhere in Adam Smith is bargaining prohibited.

Comments

[Debbie(aussie)]

Great news for the janitors.

[Sebastian Holsclaw]

We could index the whole EITC system after extending or broadening it.

[hilzoy]

Seb: the EITC is indexed. The problem is that if the minimum wage isn't indexed as well, minimum wage workers will be starting with a smaller and smaller income, so they will get a smaller and smaller credit (in real terms.) The minimum wage is what sets a limit to how far down the ascending side of the slope a person who works a given number of hours can possibly start; the EITC can't do that, as long as it has anything like its current form.

[Alex]

And if you tell'em Milton Friedman invented it, the conservatives might even support it - wahey! bipartisanship!

[Dantheman]

Alex,

Not likely -- at Republicans' insistence, auditing of EITC recipients is at a higher rate than people earning over $100,000 per year.

[OCSteve]

Between 15% and 25% of those eligible don’t claim the EITC now. Any thoughts on what can be done about that? I know that there are local groups that do outreach initiatives for this, but should the federal government be doing more to reach people?

Any thoughts on why someone wouldn’t file for it? It seems that if you even went through the motions of determining whether you had to file at all, you would have to bump into it.

If it’s really as high as 25% - that’s millions of people who aren’t taking advantage of what is already available.

What can be done about it? Targeted public service spots? Requiring employers to insure that all of their employees are aware of it?

[Anarch]

A question about the EITC: would it be equivalent if the EITC were given as a tax credit to all businesses that employed people for at or near the minimum wage (which would then be substantially raised to compensate)? It seems as if this might help people claim their credits without them actually having to claim their credits, if you know what I mean...

[Sebastian Holsclaw]

I suspect that Alex was talking about the negative income tax when he said that Friedman invented it.

Hilzoy, "The problem is that if the minimum wage isn't indexed as well, minimum wage workers will be starting with a smaller and smaller income, so they will get a smaller and smaller credit (in real terms.)".

In theory, this is a problem, currently however a minimum-wage single-mother of two gets an effective 40% increase in pay from the EITC, and is eligible for other benefits as well. People rarely stay at minimum wage for long, so it gets better from there. I would be more interested in increasing the ratio of money earned to 'rebate' as a method of helping out low income workers. (If for example you didn't change the max-point this would increase the starting level of the benefit, decreasing the slope of the benefit curve.)

[Sebastian Holsclaw]

"A question about the EITC: would it be equivalent if the EITC were given as a tax credit to all businesses that employed people for at or near the minimum wage (which would then be substantially raised to compensate)?"

Without careful implementation I worry that the existance of such a credit would give an incentive to depress wages in order to qualify for the credit. The phase-out works well for individuals because your earnings go up enough to make it worthwhile to try to keep earning more. From the position of making payments for labor, the incentives wouldn't work the same way.

[Jonas Cord]

What can be done about it? Targeted public service spots? Requiring employers to insure that all of their employees are aware of it?

Maybe someone with better knowledge of taxes will object, but it seems like enrollment ought to just automatically "happen" when you fill out your taxes. I'm unaware of why anyone would want to opt-out.

[hilzoy]

OCSteve: I don't really know the answer to your question, but I found the IRS website pretty confusing, and I have a PhD -- and the all-important internet access. If there were some way to implement Jonas Cord's suggestion, I'd be all for it.

Wes Clark, in his wonderful tax plan that (warning: pet peeve ahead) the media almost completely failed to cover, had some mechanism whereby people who live simple financial lives (no investment income, just work and maybe kids and mortgage deduction) would not have to file tax returns (though they could if they wanted; no one would be prevented from slaving over a tax return.) I can't find it on the internet anymore, but it was very good. I told the people who clean my house about it, and it convinced them to register to vote on the spot. (Conveniently, I am certified to register people, and had registration forms handy. Grin.)

[Ara]

So I read from the EPI faq:

New economic models that look specifically at low-wage labor markets help explain why there is little evidence of job loss associated with minimum wage increases. These models recognize that employers may be able to absorb some of the costs of a wage increase through higher productivity, lower recruiting and training costs, decreased absenteeism, and increased worker morale.

So what I wonder is: lots and lots of minimum wage jobs are in industries where demand elasticity means that employers get to pass on the additional costs. If that's so, the costs get absorbed higher up the income chain rather than leading to a loss of demand. I wonder if that has implications (as many as vague factors mentioned by the quote). So then a minimum wage increase is more redistributive than it is market-distorting. Does this sound plausible to people?

[Ara]

Addendum to last post: I just realized (an analogy here to Giffen goods) that you have to consider demand here as demand for the industry as a whole (that is, for the type of good, very broadly construed) because minimum wage labor is part of all of my (as a consumer) alternatives to the good. A minimum wage law, by being federal, will affect any alternative I might turn to as well. So, my point: demand elasticities become less elastic the wider the class of goods we consider, which makes it all the more plausible that demand is inelastic and costs can be passed on.

[Ara]

Addendum to addendum (sorry, this popped into my head an hour later): If any of this is true (and this is how seriously I should be taken: I've never taken an econ class, and I'm just speculating without a statistic to save my life), it wouldn't be a particularly progressive form of redistribution. For the most part it would be like redistributing betweeen the working poor and those slightly above them in the paygrade.

Another question is whether there is a relationship between changes in minimum wage law and the price level.

[Sebastian Holsclaw]

Ara, you don't have to apologize for thinking aloud (so to speak). We write half-formed ideas here all the time and try to hash them out. That is why we try to keep things friendly enough to actually make it possible to hash things out.

[dutchmarbel]

Since we're thinking aloud anyway... Isn't one of the disadvantages of working via the EITC that it needs more government? Wouldn't the party of small government prefer higher minimum wage to make sure it ends up with working people (EITC doesn't necessary) and government involvement is as small as possible?

[Jesurgislac]

But the Republicans aren't "the party of small government". They never have been. What they are is "the party of government for and by a small number of people" which is a very different thing.

[von]

1. "A negative income tax, on the other hand, would remove the need for increases in the minimum wage, if it (basically) said: if you make below a certain amount, then the government will give you money, and the less you make, the more you get."

The EITC is a form of negative income tax, albeit (as you discovered) a horribly complex and convoluted form. (Indeed, you can thank us free marketeers for the idea --e.g., Milton Friedman -- just not the execution.) So far as I'm aware, no proponent of a negative income tax favors the formula you suggest; all favor a negative income tax with an incentive structure. I do, however, favor simplification.

2. The janitors collective bargaining victory had little to nothing to do with the minimum wage and nearly everything to do with, well, their collective bargaining efforts. I don't see the sense in linking the two.

3. "Yay! And for all you conservatives out there: don't worry, this is just the free (labor) market at work. Nowhere in Adam Smith is bargaining prohibited."

No problem with bargaining; it's the interventions in the workings of the labor market by regulators (i.e., the government) that are generally (although not always) the problem.

[kathy woodard]

i wanna know what is the least amount of money you have to make to be eligable for the eitc? we made a very low amount this year and not sure if we qualify could someone please let us know what the limit is thanks a bunch!!!