Move Over, Minimum Wage; Tax Credits Are on Target

THE establishment of a minimum wage to lift the children of the working poor out of poverty was considered the best social policy in the 1930s.

But now that there is the Earned Income Tax Credit (EITC), advocacy of raising the minimum wage to help today's working poor families constitutes social-policy malpractice.

The EITC, introduced in 1975, provides a tax credit equal to a specific percentage of labor earnings up to a maximum dollar amount. In 1987 the credit was indexed for inflation. The credit was substantially increased in 1993, so that by 1996 it will raise the effective minimum wage for workers with children who live in poverty from $4.25 per hour to between $5.70 and $5.95 per hour.

The EITC will provide a direct government payment of 40 cents for every dollar of wage income earned up to $8,900 by families with two or more children. The payment to workers with one child will be 34 cents per dollar. Hence, minimum-wage earners who live in poor families with two or more children will receive $4.25 plus $1.70 of EITC benefits per hour of work. For poor workers with one child, the EITC will add $1.45 to the minimum wage for a total of $5.70 per hour. Thus, the EITC ensures that minimum-wage workers who live in poor families will, in fact, receive net wage income well above the current minimum wage of $4.25 per hour.

Note, however, that low-wage workers in high-income households do not receive these tax benefits. Unlike the general increase in the minimum wage, which the Clinton administration is proposing, the EITC targets its revenues to low-income households. The result is a much more focused and less expensive program to help poor working parents.

Using data from the Current Population Survey, a just-completed study I conducted simulates the distributional and cost consequences of the Clinton administration's original proposal to raise the minimum wage from $4.25 to $5.00 per hour. It would cost employers and their customers $9.7 billion. But only about 14 percent of this added cost of doing business will go to poor households. In contrast, over one-third will go to households with income greater than three times the poverty level, defined as $14,800 for a family of four in 1994. The Clinton administration's new proposal to raise the minimum to $5.15 per hour will cost even more, with an even smaller share going to poor families.

Most low-wage workers in today's market are second and third earners in households well above the poverty line. Therefore, poor households will receive a small share of benefits from a general minimum-wage increase. In contrast, workers in low-income households will receive the bulk of EITC benefits.

My study shows how the scheduled increases in the EITC, slated to be in place in 1996, will be spread across all households in the income distribution. The added cost is close to that caused by raising the minimum wage for workers in rich and poor households alike, $10.8 billion. But the EITC increases will go to workers most in need. Over three-quarters of the EITC benefits will go to poor or near-poor working parents. Only 2 percent go to those with incomes over three times the poverty line.

Although not included in my calculations above, poor workers with no children will also receive a small EITC credit, 7 cents per dollar beginning in 1996. This will cost about $600 million in 1996 and will also go mostly to poor families.

Like the rest of the labor force, the majority of the working poor already earn hourly wages above both the current minimum wage and the proposed new minimum. Hence, the EITC is not only a more direct way to provide income to working parents in or near poverty, but it will also reach the full-time working poor who are not covered by the minimum wage as well as the majority of the working poor who earn more than $5.15 per hour but whose families are either too large or whose hours are too low to enable them to escape poverty.

The EITC has an important additional advantage. Because it is a government-provided credit, it will not destroy low-wage jobs, especially teenage jobs, as an increase in the minimum wage would do. Such job loss, while not large in the aggregate, is most likely to be felt disproportionately by teens in poor households.

Those concerned with helping working people who live below or near the poverty level should focus on ensuring that the scheduled increases in the EITC are carried out and that the EITC is extended in a much more generous way to the working poor who do not have children. This will be far more effective than resurrecting policies that have long outlived their usefulness.