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The United States currently has a large number of policies designed to assist low-income workers. The primary mechanism is the U.S. tax code, with revenue losses to tax credits for low-income workers, such as the Earned Income Tax Credit, amounting to tens of billions of dollars. Other mechanisms, such as welfare and minimum wage, are also relied upon.
This AEI conference will bring to together a group of experts to put the current policies on the table and discuss whether they are working effectively, whether they are properly formulated, and whether alternatives exist that would be preferable. The first panel will assess the state of current U.S. policies, evaluate their effectiveness, and discuss potential policy responses to identified shortcomings. The second panel will discuss Edmund Phelps’s recent proposal to subsidize the employment of low-income workers.
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Panel I: Current Policies
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Jared Bernstein, Economic Policy Institute
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Sheldon H. Danziger, University of Michigan
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Bruce D. Meyer, University of Chicago
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Kevin A. Hassett, AEI
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Panel II: Policy Options
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Edmund S. Phelps, Columbia University
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Steven J. Davis, AEI and University of Chicago
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Jason Furman, New York University and Center on Budget and Policy Priorities
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Kevin A. Hassett, AEI
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Helping America’s Low-Income Workers
The United States currently has a large number of policies designed to assist low-income workers. The primary mechanism is the U.S. tax code, with revenue losses to tax credits for low-income workers amounting to tens of billions of dollars. Other mechanisms, such as welfare and the minimum wage, are also relied upon. This March 30 AEI conference brought together a group of experts to consider whether current policies are working effectively, whether they are properly formulated, and whether alternatives exist that would be preferable. The first panel assessed the state of current U.S. policies, evaluated their effectiveness, and discussed potential policy responses to identified shortcomings. The second panel discussed Edmund Phelps’s recent proposal to subsidize the employment of low-income workers.
Economic Policy Institute
The benefits of full employment to low-income families have largely been ignored. Full employment is the best social program available for reducing poverty. Poverty rates for the most disadvantaged families fell to historical lows during the economic boom of the late 1990s. Our studies show that the lowest paid workers see the biggest improvement in wages when there is a decline in unemployment, while productivity without full employment does little to improve wages at the bottom.
Childcare is a great example of an untapped elasticity. In terms of incentivizing employment, there is actually a greater benefit gained for every dollar spent on childcare than on the Earned Income Tax Credit (EITC). When you help low-income families with childcare, you increase the consistency of their employment tenure, their hours worked, and quality of their childcare.
The analysis of our safety net policies show mixed results, because the data reveals that the safety net has become pro-cyclical since our current policies do not work well when there is an economic downturn and when work opportunities disappear.
Sheldon H. Danziger
University of Michigan
Even though we have succeeded in reducing welfare caseloads and increasing employment, poverty remains rather high. We have reached the limit of what can be accomplished with the 1996 welfare reform.
It is clear that single mothers benefit when they start working, but the benefits are usually overstated in theoretical studies because this cohort is likely to have mental problems that make work difficult.
A modest initiative to cut the poverty rate in half would begin with raising the minimum wage to 40 percent of the average wage and indexing it for inflation.
It is also important to have transitional jobs of last resort for those who are not entitled to welfare but have little chance of being hired. Even though this is a relatively small group of women, it is a group that welfare reform has not addressed.
The benefits from childcare subsidies are more modest than many assume. Studies in Michigan show that low-income women have a preference for childcare from relatives, which is a lot cheaper. In addition, middle-income mothers are more likely to take advantage of childcare subsidies since the program is nonrefundable.
Bruce D. Meyer
University of Chicago
The Earned Income Tax Credit is very well targeted at low-income families with children. When you look at the income distribution for people benefiting from the EITC, it looks very good. Ninety percent goes to families with incomes below $30,000. The minimum wage is not as well targeted. Much of the benefits from the minimum wage go to low-wage earners in wealthy families, whereas the EITC is directed at poor families. The EITC also has the advantage of increasing pre-tax earnings for low-income mothers, since it makes work more attractive than welfare.
There is little evidence that hours worked have declined because of the EITC. This is contrary to the idea that people will work less as marginal tax rates increase during the phase out part of the program. There also seems to be little evidence of a substitution effect from people not being required to work as much to receive a specific level of income.
Reform suggestions include increasing the credit for families with three or more children, since these families are more vulnerable to poverty. Another reform option is reducing marriage penalties.
Lastly, there have been considerations for expanding the existing credit for single persons, such as non-custodial fathers who are up-to-date with their child support. Not only is this a needy group, but it would encourage child support payments. However, a policy of this nature would create an overall marriage penalty if not combined with policies to encourage marriage.
Edmund S. Phelps
[Mr. Phelps has expanded on his talk, and the final version of his remarks can be accessed from the full event page.]
Many people in our country are left out of formal employment, or the pay is so little that they become distracted. They often adopt other ways to support themselves, usually in the underground economy. The cost to these individuals is their loss of the stimulation and creative interaction that productive jobs provide. Also, there are numerous social costs when these people start living a life of crime that puts other people in danger.
A good governmental remedy would be to provide a wage subsidy for low-wage workers. An eligible firm would be paid a subsidy for every low-wage employee on its payroll. The subsidy would be calibrated to the employee’s wage cost to the firm. The higher the cost to the firm, the lower the subsidy. The subsidy would be paid to the firm as a credit against corporate income taxes, and competitive forces would quickly ensure that most of the subsidy would be paid out in labor compensation.
The program would be cheaper to administer than any existing welfare program. People would only benefit from the subsidy if they kept a job and if the job was worth paying for. This would make certain that the program is only supporting productive work.
One main criticism is that this program does not let market forces solve the problem of labor force inclusion. It is true that the technology boom of the late 1990s brought relief to low-wage laborers. However, the overall trend of inclusion is ambiguous. Unemployment has improved since 1996, but jobless figures, which measure people who are not working and not necessarily looking for work, have remained flat.
Another common criticism is that, unlike the EITC, this scheme does not target poor families in particular. Therefore, the wife of an executive who earns millions would benefit from this subsidy. Yet, the entire idea of this wage subsidy scheme is to integrate people who are disconnected from the labor force without discrimination based on their background. This fulfills economic justice, since people are paid based on what they contribute.
Critics also complain that if this low-skilled wage subsidy were to be instituted, it might well precipitate an increased flow of migrant workers to the United States, which would put downward pressure on wages. But this would not be a problem if companies were required to supply adequate documentation of its subsidized workers to the federal government.
Steven J. Davis
AEI and the University of Chicago
The objectives of the Earned Income Tax Credit and Edmund Phelps’s wage subsidy proposal are somewhat different. The EITC is about income support, while the wage subsidy is about inclusion.
It is important to establish that taxes on labor income and consumption expenditure encourage households to substitute services from the market sector to home production and underground activities. Since the most easily substitutable services usually rely on less-skilled workers, there is enormous scope for government policies to influence the employment rates of people in this sector.
There are a few flaws with the wage subsidy model that Phelps put forward. First, the model excludes employees in the public sector. This is a problem because there are many low-wage jobs that offer the same services in both the public and private sector.
Another issue is that the wage subsidy model only applies to full-time workers.
An alternative plan to correct the shortfalls in Phelps program would to introduce a personal annual exception on an individual’s social security tax. This would focus on the person instead of the job. It could be paid for by raising the OASDI cap by enough to recover any loss in payroll tax revenue.
New York University and the Center on Budget and Policy Priorities
There are four major reasons why we should subsidize low-wage work. The first is distributional concerns and equity. Real wages have actually declined for low-wage workers since 1973. Wage subsidies would help to lessen the decline of these wages.
In terms of externalities, it is important to subsidize work. However, it is crucial to target people who are not working at all rather than people who are already working long hours. You would also want to subsidize work for people with the largest externalities, such as young men and single mothers. If concerns are cultural and behavior-related, it is important to target subsidies to the people with the most elastic participation.
A major problem with our current tax structure is that single low-wage workers are taxed much more aggressively than parents with children. The system should properly address single low-wage workers because they still benefit from work even though they do not have children.
A beneficial adjustment to Phelps’s proposal would be to subsidize based on earnings instead of hours because this would decrease the incentive for companies to cheat. Also, more favorable externalities could be achieved by subsidizing families rather than individuals.
AEI intern Paul Stewart prepared this summary.