Raising the Minimum Wage and Redesigning the EITC

To boost earnings for low-income families and reduce poverty and inequality, we propose increasing the EITC and raising the minimum wage, in tandem. Specifically, we recommend the following hybrid policy:

  • Raise the minimum wage to $10.10 and index it for inflation;
  • Provide a more generous EITC to families with young children (and somewhat less to large families);
  • Expand benefits to young childless individuals;
  • Eliminate the marriage penalty for most households by basing credits on personal instead of family income;
  • Impose a work requirement for childless workers (and a less stringent one for second earners) and restrict eligibility for these two groups to households at or below 200 percent of the federal poverty line.

Proposals to increase the minimum wage at the federal, state, and local levels are currently receiving a lot of attention. Workers from Seattle to Washington, D.C. have been promised a raise.

Advocates for an increase point to the failure of the minimum wage to keep pace with inflation or with average wages in the economy as a whole. A single parent with two children earns less than $15,000 a year working full-time on a minimum-wage job: hardly enough to support her family, especially after deducting payroll taxes and work-related expenses such as child care. Whatever her level of effort, she will end up poor and probably dependent on government benefits to survive.

While a higher minimum wage will help to boost earnings, critics worry about its effects on hiring, arguing that employers will create fewer jobs if they have to pay higher wages. Although past increases do not appear to have adversely affected employment, there is no denying the risk that much larger increases might pose to the least skilled workers. Raising the minimum from its current $7.25 to $15.00 per hour, as some have advocated, would more than double the cost to an employer and likely have some impact on hiring. In addition, a higher minimum isn’t well targeted on just the poor. Many of the people who would benefit from a higher minimum are secondary workers from more advantaged families. About two-thirds of current minimum-wage earners live above 200 percent of the federal poverty line. Only about a fifth are poor.

If we are really worried about families at the bottom, a better way to improve their lot is to increase the Earned Income Tax Credit (EITC) since it is well-targeted on those who most need assistance, and will not significantly affect employers.

That said, any increase in the generosity of the EITC could cost billions of dollars—unlikely to be approved in today’s fiscally constrained environment. Moreover, as currently designed, although it clearly encourages work, it may discourage marriage or encourage unwed childbearing.[1]

This proposal is a solution that combines the best elements of each policy.

On January 10, 2014, we released a policy brief entitled “A No-Cost Proposal to Reduce Poverty and Inequality.” This paper updates that analysis by incorporating some largely technical corrections and some modest shifts in the design of the EITC. The basic conclusion of the earlier analysis – that it is possible to reduce poverty at no cost to the government—has not changed.[2]

This revised proposal reduces the poverty rate by about 4 percent, lifting nearly 1.8 million people out of poverty. Its anti-poverty effectiveness would be enhanced over the longer run if the new plan encourages work and marriage, or reduces unwed childbearing (current research suggests it will increase employment, but any effects on marriage or childbearing are hypothetical at this stage). The effects will also be larger to the extent that an increase in the minimum wage has a ripple effect on wages just above the new minimum. Perhaps more importantly, because we make a series of conservative assumptions regarding marginal tax rates, the results reported in this paper likely underestimate the true poverty reductions that would be generated from raising the minimum wage.

Implementing both policies makes good fiscal sense, too. We estimate that enacting our proposed EITC reforms would, by itself, add approximately $10 billion to the current EITC budget. But raising the minimum wage in addition to implementing our proposed EITC plan would reduce total government expenditures by approximately $11 billion, meaning that, on net, our proposal is predicted to reduce government expenditures by about $1 billion a year. While we have crudely modeled the tax increases and reductions in means-tested government benefits that would arise with higher wages in the private sector, we have made a series of assumptions that likely make our cost-savings projections as well as our poverty reduction estimates conservative.

Over the longer term, any solution to the plight of these families must involve improving the U.S. education and training system along with reversing the rise of single parent families, as we argued in an earlier paper, “Strategies for Assisting Low-Income Families.” However, long before those goals are achieved, the policies that would most help such families are, first, a return to full employment, and second, boosting the earnings of those with jobs. Our earlier paper showed that the most effective policy for improving the incomes of the struggling working class would be to reduce the unemployment rate to 5.4 percent, a commonly used benchmark of a full employment economy. Now that the economy seems to be on the road to recovery, we need to also focus on making work pay.

[1] Empirical evidence for the last two effects is lacking, but they remain a concern.

[2] Compared to our original analysis, the EITC parameters are slightly more generous, the estimated cost savings are larger (because we include more offsets), and the effects of the minimum wage are smaller (because we do not include subminimum wage workers in our analysis). All of these assumptions make our estimates of the poverty-reducing or cost-reducing effects more conservative than they might otherwise be. For details, see the remainder of this paper.