We Don't Have Low Wage Poverty, We Have Tax Poverty

Over in my native UK The Guardian is running a series on the terrible manner in which all too many people don’t get paid enough money. That’s a fair enough thing to worry about if we’re honest. But they manage to get two major points howlingly wrong. So badly wrong that it undermines their entire case. Further, they’re also missing that as a result of my own shouting on this subject over the years the problem is at least halfway to being solved. All that needs to happen is that the government pick up the other half of my recommendations and it will be fully solved.

The first mistake is to insist that all in work benefits are actually a subsidy to the employer:

Cameron wants to curb in-work benefits. No wonder: just £8bn on benefits goes to the unemployed, while an estimated £76bn, according to James Ferguson of Money Week, goes to people who are working. The government says this shouldn’t be happening. Cameron insists employers should be paying wages people can live on – which, funnily enough, is the sort of thing unions say, although they no longer have any power to make it happen.

It’s what Labour says, too, now the party is out of power. When it was in power, it avoided confrontation with employers offering poverty wages, and with the unions, by kindly offering to make up the difference between the minimum wage and a living wage via the benefits system.

This is to grossly understand matters. Benefits paid to those in work are not necessarily subsidies to the employer. Benefits which are only paid to those in work are indeed such subsidies. But benefits which are paid whether one is in work or not are not such subsidies: quite the contrary, they’re costs to the employer. They raise the reservation wage, the wage that the employer has to pay to get someone to come into work. Hey, don’t just take my word for it, here’s Andrajit Dube, one of the experts in this field:

A final line of argument is that these public assistance programs have become de-facto subsidies for low-wage employers. For a program to be a subsidy for an employer, it needs to lower wages. Is this plausible for the public assistance programs considered? I think it is for the EITC, but not for other programs. Depending on where one is on the EITC schedule, that policy can increase work incentives. And there is a lot of empirical evidence showing EITC encourages labor force participation. An unintended consequence of that labor supply response, however, is that employers capture some of the tax subsidies. This can happen in a simple supply and demand framework, where an increased labor supply to the market drive wages down. This can also happen in a bargaining context where the size of the bilateral surplus expands from lower taxes, and employers capture some of this increased surplus. Work by UC Berkeley’s Jesse Rothstein suggests that for every $1 of transfer to workers using the EITC, post-tax income rises only by $0.73 because of employer capture.

But what about other programs like food stamps or housing assistance? These means tested public assistance programs are not tied to work, and we should not expect them to lower wages. Let’s take food stamps, which are available to eligible families whether or not a family member works or not. Indeed, when people are not working, they are more likely to be eligible for food stamps since their family incomes will be lower. Therefore, SNAP is likely to raise, and not lower a worker’s reservation wages—the fallback position if she loses her job. This will tend to contract labor supply (or improve a worker’s bargaining position), putting an upward pressure on the wage. Whether or not wages are increased is an empirical matter: there is evidence that the initial roll-out of the food stamps program across counties in the 1970s lowered work hours, consistent with an increase in the reservation wage. The key point is that it is difficult to imagine how food stamps would lower wages. And if they don’t lower wages, they can’t be thought of as subsidies to low wage employers. The same logic applies to other means tested programs like energy or housing assistance. Moreover, these conclusions hold in a wide array of models of the labor market, including ones that emphasize bargaining or efficiency wage concerns.

In the UK the EITC translates into working tax credits. So, yes, those are indeed a subsidy to employers: and given that they’re designed to be they seem to be doing their job. But it is not true that all benefits paid to those in employment are subsidies to the employer. Only those that are only paid to those working are.

We then come to the second error:

…by kindly offering to make up the difference between the minimum wage and a living wage via the benefits system.

There is indeed a difference between the living wage and the minimum wage. That being the tax that is charged to those low wages.

No, really, the living wage is reasonably well defined. It’s the amount that the society in general thinks you need to have in order not to be in poverty. But the most important point about that calculation is that it is a pre-tax number. It is calculated before the three taxes that apply to low wage labour. The basic income tax, employees’ national insurance and employers’ national insurance (for the US, think of income tax and the two sets of FICA, employees’ and employers’). These amounts of tax of course reduce the net income of those it is charged to. And when you do the sums you find that if the current minimum wage were untaxed then it would be within pennies per hour of that living wage as it is currently taxed.

We could, thus, immediately convert that current minimum wage into that living wage simply by taking those low wages out of the tax net. The conclusion of that being that of course we don’t have low wage poverty: we’ve got tax poverty.

After all, this is really pretty simple. If you want the low paid to have more money then stop taxing them so damn much.

As I’ve been saying for much of this past decade and as the government has in part at least been doing by raising the personal allowance for income tax. Yes, as a direct result of my analysis. All that needs to happen is that the national insurance and income tax allowances be raised to hte full year, full time, minimum wage and we’re done.

My latest book is “The No Breakfast Fallacy, why the Club of Rome was wrong about us running out of resources.” Amazon and Amazon.co.uk. $6.99 and relevant prices in other currencies.