Explaining the Earned Income Tax Credit, and how it can be used with a minimum wage.

 

One of the largest economic issues our country currently faces is stagnation of wages that have made the American dream more and more difficult to achieve for working and middle class citizens. With the relative rise of technology since the 1970s, wages have, and will continue, to see a downward pressure. This puts us in a very precarious situation, how do we help working and middle class Americans put a little bit more in their pocket without adversely impacting the labor market? This has been a very fun (for some reason I enjoy this shit) idea to grapple over the past few weeks, and after doing hours of research, I realized two things:

  1. Wow, this is really complicated
  2. See realization A

The most popular argument to combating stagnating wages is raising the minimum wage. The arguments for and against are pretty straightforward, one side says: “It will raise wages for workers, and the other side says: “Yeah, but it’ll increase unemployment so much it won’t matter”.

The truth? Well it’s actually somewhere in the middle. In fact, I used to be vehemently opposed to a minimum wage increase, but I recently developed a line of thinking that (kind of) shifted my opinion. Before laying that out, I want to tell you how the rest of this paper is going to go.

 

  1. I will explain a lot of the misconceptions about increasing the minimum wage
  2. I will then explain how it could actually increase productivity
  3. But then I’ll realize that there is a sizeable segment of the population that would be severely damaged from a sweeping increase in minimum wage
  4. I’ll then talk about EITC and what that is for those of you who aren’t familiar
  5. Then I’ll talk about how that, along with a limited increase in minimum wage can be used to help grow our wages in a sustainable manner.

Alright friends, to begin, let’s talk about some of the misconceptions regarding the minimum wage, and the effects it would have on the economy were there a federal mandate to raise it.

 

 

  • Raising the minimum wage would lead to unacceptable levels of inflation.

 

Screen Shot 2017-07-28 at 3.01.15 PM

 

Screen Shot 2017-07-28 at 2.56.02 PMSo, let’s think about what this means, and see if history supports this idea. For this to be true, it would have to be true that every time the minimum wage increases, that we would see some sort of uptick in inflation. To see if this holds up, let’s check out the graphs above:

What you probably see, are 2 very different pictures. In the top picture, you see random spikes of high inflationary periods, all of which can be explained (more on that soon), and on the bottom, you will see the gradual increase in nominal minimum wage, and the stagnation of real wages (real wages are nominal wages adjusted for inflation). Take another look at the top graph, check out the 3 massive spikes in inflation between the years 1940-1955. Were these inflationary spikes driven by minimum wage? Hardly. The first spike you see is a result of increased debt financing in order to pay for World War II. The second and third spikes were actually part of a global trend of inflation, as the world began to industrialize and governments everywhere printed money in order to pay for infrastructure projects like the Federal-Aid Highway Act signed by Dwight “the g.o.a.t” Eisenhower (seriously, that dude was a stud). Anyway, you can see that inflation is more driven by debt financing and money printing than anything else.

 

  • Raising the minimum wage will increase prices, making the increases in wages useless

 

Here is a list of everything an Economics major learns in school:

  1. Theory
  2. Theory
  3. Theories about theories
  4. Economic theorist who theorize about theoretical theories
  5. Econometrics. Damnit I hated that class.

Anyway, one issue with this, is that Economic theory always states that for a particular theory to hold true, the rest of the factors in the economy must be in a steady state. This never happens, so while Economic theory is sound and logical, it isn’t always that practical. In Economic theory, an increase in wages should lead to an increase in prices, but there are so many other factors at play that it is impossible to make a direct correlation. Don’t believe me? Check out this table that gives you how much higher/lower wages are around the world next to how much higher/lower the price of a Big Mac is:

Screen Shot 2017-07-26 at 1.40.44 PM.png
Do you see any correlation what so ever here? I don’t. This table isn’t meant to be a “be all end all” for the case of minimum wages, it is merely just to show you that wages and prices are not inextricably tied to one another. Anyway, this piece is getting long so I’ll stop opening on this point.

 

  • A higher minimum wage will lead to lower employment and less productivity.

 

This is what I’ve been waiting for! This is by far the most interesting and counterintuitive point that relates to the minimum wage discussion, so let’s give it a shot. Once again, straight up Economic theory would tell you that if the government makes businesses pay their employees more, they will either cut the number of employees or raise their prices. This is only kind of sort of true. To explain why, I’m going to need another paragraph!

Okay so first off, corporate profits are at all time highs. This means that if companies were to have an increased minimum wage mandate, that they would probably opt for slightly lower net profits rather than increasing prices in the short run. Why is this? Well, even with a higher minimum wage, companies still have an incentive to keep prices as low as possible in order to be competitive on an open market. In the long run, companies probably will end up cutting down on the number of employees, but once again we must ask, is this necessarily bad?

If a company with 700 employees was able to cut 200 employees and maintain the same level of output by replacing their employees with cheaper, more effective automation systems, doesn’t it stand to reason that this company just became more efficient? On a larger scale, if companies everywhere were able to cut down on employees but maintain, or even grow output, don’t you think that would lead to increased economic efficiency? Allowing our economy to do more with less?

But then you ask, what about all those who just lost their jobs? Well to be perfectly honest, they most likely had skillsets ill suited for a 21st century labor market, in which technical skill is in far greater demand than unskilled labor. For this reason, these individuals who are temporarily displaced, must be taught skills that will allow them to go into a more technical career. This accomplishes two things, first off, it puts a takes a large portion of the population that was previously making minimum wage, and gives them a skill set that commands a much higher salary. Secondly, it helps fill the massive and growing gap between the amount of high skill workers needed, and high skill workers currently available.

So, as you can see, the case for raising the minimum wage is quite strong, however there still is one big issue that can’t be ignored. This is the issue of small business, an enormous part of the American economy. Currently, if small businesses (say, companies with under 25 people) were forced to raise their wages, they would be stuck. That is, they would have to cut down on the number of employees, but at the same time, they probably wouldn’t be able to replace their labor with automation. This dynamic would create a sizable negative effect on our economy and would further strain our government’s capability to care for the unemployed. So what is the answer to all this?

Increasing the EITC, or the Earned Income Tax Credit!

What is the EITC? The EITC is a refundable tax credit paid out to working Americans who make under a certain amount of money. The amount you get from EITC depends on your income level and number of dependents and the reason I love the EITC is because you have to be employed to qualify for it, which decreases government dependency. To explain it, let’s use an example:

Jerry and Beth are a working couple filing jointly on their tax returns. Beth is a horse surgeon and Jerry….well we don’t really know what Jerry does, but we know that they make $50,000 per year! On their tax form, they list three dependents: their son, Morty, their daughter, Summer and Beth’s father, Rick. In the current tax system, Jerry and Beth are initially liable to pay $7,500 in taxes. However, due to the fact they have three dependents, they qualify for a $12,600 deduction, meaning they only have to pay taxes on $37,400 instead of $50,000. This obviously lowers their taxable income, and will result in a nice tax refund of $1,890.

This is where the EITC kicks in:

This number ($1,890) is nice, sure, but since Beth and Jerry are earning income through jobs, they now qualify for the EITC! For a married couple with three dependents making this amount of money, they would qualify for an additional $6,269 dollars, bringing their tax refund all the way up to $8,159- that means a lot!
Conclusion

Currently, the EITC is woefully underused, and many Americans don’t even know it exists (Did you?…Exactly). In my opinion, the answer to combating wage stagnation is two fold: 1) Minimum wages for large companies should be eventually bumped to $12/hour. However, smaller companies should not have to comply to this mandate, since we know that it would actually do more harm than good to them. Secondly, the EITC must be expanded to cover more Americans, especially young ones. By expanding the EITC, we are also sending a message that if you seek work, the government will reward you. If you were unemployed and saw that the government would actually pay you extra to go work, don’t you feel that you might be incentivized to go out and find a job?

So if nothing else, this piece hopefully helped you understand what the EITC was, and how it can be used in conjunction with a minimum wage increase. Many of the criticisms of minimum wage increases are overblown, and we’ve seen that in other countries, minimum wage increases have been very helpful. Take England for example, who put a minimum wage law in effect in 1999. Even though there was initially great opposition, the minimum wage law has shown to have had almost 0 impact on employment and prices, and pushed wages up 35% for working and middle class earners in Great Britain. And in all honesty, only 3.3% of workers in our country actually work at minimum wage, so the belief that a small uptick in the minimum wage would tank our economy is quite unguided.

So there you have it, a small increase in minimum wage and an expansion of the EITC is, in my opinion, an incredibly useful and worthwhile policy option to pursue. History shows us that when the middle class is financially stable, productivity, profits, and prosperity all rise. After all, the middle class is the greatest consumer bloc in our country, so we should do everything to make sure they have disposable income.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s