Wednesday, June 30, 2004

Labore Omnia Ditat

Welfare, and the Minimum Wage Versus EITC

Opponents of Welfare make the argument that welfare benefits create a disincentive to looking for work. While I would suggest that lack of free child-care and the like are larger factors, they are correct in one respect; in some areas, welfare pays better than a job, especially when one has to pay for ancillary costs related to that job, such as transport, childcare, better/more expensive clothing, etc.

Other than changing the level at which non-cash welfare benefits (food stamps, Medicaid) are means-tested, and set them to phase out more gradually as incomes climb, the real problem is that some jobs pay too little to create any kind of incentive.

The standard remedy in the policy vocabulary of the left is a higher minimum wage. The Right argues (reasonably) that insofar as companies will add the higher labor costs to product prices, the minimum wage is directly inflation-causing. The standard response, that competition will force those prices back down, is not only practically inadequate, but besides the point; we don't want to punish industry for hiring unskilled labor in this country.

Instead, why not have a radical expansion of EITC. Instead of forcing companies to pay more, shunt tax revenue to make these jobs more attractive and better able to support a household's needs. This remedy provides for solving the incentive problem, and gives the working poor the relief they need. But is it good for the economy as a whole?

First of, it doesn't have to be; only a moron equates a higher annual GDP growth with a better society. However, such a flat answer is unnecessary, as this policy is actually good for the economy, and don't worry, analysis to that effect follows.

Our economy is not supply-limited. We have no real investment-capital shortfalls, and even current production capabilities (ignoring the ease of expansion through financed investment) are capable of much higher output. This can be seen in the utter lack of real inflationary pressure. Perhaps some of the productivity gains made in the 90s were illusionary, but if that is so, the highest demand we have seen in 30 years was insufficient to cause any real supply inadequacy. We are a demand-limited economy.

What are recessions but shortfalls in demand? To minimize their severity and duration, demand supports are used. Obviously, the marginal dollar is better served being spent on demand stimulus, and the increased monetary velocity that implies, rather that supply stimulus in a situation of overcapacity. The Right may argue that investment in supply regards demand as well, but not only is nonconsumer spending only 35% of private sector spending, but the velocity of money in the nonconsumer arena is much lower; capital stockpiles, escrow accounts pending order completion, it simply takes longer for companies to spend the marginal dollar.

It is axiomatic that the poor accrue greater utility per the marginal dollar, but more relevant to the discussion at hand, they have, equally obviously, the highest marginal propensity to consume. They spend each dollar virtually as it comes in, and thus the velocity of capital is highest when resources are reallocated to income supports for the poor.

Now the costs of this redistribution come in the form of higher costs for capital. However, the increase in demand benefits more than the increased cost for increased supply for several reasons. First, the velocity argument, second the sunk lax capacity in production, and third the exposure of our capital markets to foreign direct investment (FDI) means that an marginal increase in capital cost brings with it a commensurate increase in capital availability. In other words, capital supply is global, but our power to impact demand is local.

All of this admittedly dances around the issue of the simple effect of increased demand. It should be noted that to deal with any drastic increase in consumer demand, supply increases would have to occur to remain inflation-neutral. Thus it would seem that the financing of this proposal should be borne by higher-bracket income taxes, rather than corporate taxes. After all the decreased capital investment by our rich can easily be replaced by foreign capital, but to directly tax the companies will slow capital expansion, and also lead to higher prices as the costs are borne by the consumer.

Last but not least, having this labor in the workforce means that rather than funding their existence through welfare, we are only subsidizing it, and receive the benefits of their labor in return. What we save by not paying out welfare reduces the additional tax burden this implies. It is indeed possible that this policy may in fact reduce the claims on the federal fisc, even without factoring in revenue increases due to economic expansion.

Now EITC is no replacement for the Minimum Wage; to the extent that these wage supports increase the supply of willing labor, we are in effect subsidizing companies that rely on low-income labor. While this has the beneficial impact of increasing the supply of low-income jobs, the companies should not be allowed to freeload by dropping their wage levels, and thus increasing the burden on the federal government.

In the end, while inflation is a general concern, both the humanitarian and economic arguments seem to indicate that low-income wage supports in the form of EITC expansion would be a generally beneficial policy. To the extent that demand could provoke inflation, the government has tools far more efficacious at arresting inflation than it has hitherto possessed to stimulate structural growth in the economy.


At 9:41 AM, [REDACTED] said...

I agree. You leave out the part where this is incredibly good politics - instead of regulating business, we provide a tax cut the right isn't willing to support.
As usual, we've taken an issue where we're on the right side (that is, more economic security for the working poor) and provided easy and intuitively appealing critiques of our solution. EITC is far more difficult to treat as big, intrusive government.


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