The federal government spent three times more on EITC refund checks in 2016 than it did on Temporary Assistance for Needy Families (TANF), the traditional cash welfare program. Good news for the working poor? That’s what liberal activists would have us believe. So would the House Majority Leader, Rep. Paul Ryan (R-WI), the Heritage Foundation, the Wall Street Journal editorial page, and disciples of economist Milton Friedman.
Conservative support for EITC stems mainly from the fact that only the employed are eligible; liberal activists, finding themselves in such strange company, would do well to ask: is there a catch? History suggests there is, and it revolves around the perverse incentives that wage subsidies—such as the EITC—have on employers.
The “Speenhamland system”—an obscure law in force in England between 1795 and 1834—is eerily reminiscent of today’s EITC. Like EITC, Speenhamland linked welfare to work. Upper class eighteenth century Englishmen were no more eager to subsidize idleness than their twenty-first century American counterparts.
And also like the EITC, Speenhamland was an attempt to raise earnings without placing a burden on employers. If wages fell below a certain level, the government paid the difference; as wages rose, the government payment fell. For those who did not work, there was no government subsidy.
Employers soon discovered they could “game” the system by cutting wages below what workers were really worth to them. Before Speenhamland they would have gotten what they paid for: mediocre, malnourished, resentful workers, or none at all. But with the country taking up the slack, they had nothing to fear.
“In the long run the result was ghastly,” wrote economic historian Karl Polanyi in his 1944 classic The Great Transformation: “Wages which were subsidized from public funds were bound eventually to be bottomless.” The result was that, as Notre Dame University economist Teresa Ghilarducci puts it, “The government subsidized wages so much they went broke.”1
EITC, like Speenhamland, rewards employers who pay workers sub-standard wages. To see this perversity at work, imagine that the economy consists of two companies producing widgets. Employer (1) hires moderately skilled workers at $10 per hour, but he produces 10 widgets per worker per hour.
Employer (2) hires only the least skilled workers. In the absence of the EITC subsidy, assume that no worker would take the job for less than $7.50 per hour. But workers on his less sophisticated assembly line produce only 5 widgets per worker per hour—half the productivity of employees of employer (1).
The result will be employer (1) will have to pay $1 in wages for every widget produced ($10 per hour for 10 widgets per hour), while employer (2) will have to pay $1.50 for every widget produced ($7.50 per hour for 5 widgets per hour.)
In this labor market, low-wage employer (2) will be unable to compete with his more productive, higher-wage competitor. Curtains for employer (2).
Now introduce an EITC program that adds, say, 50 cents to every dollar of wages. Theoretically, employer (2) could offer his workers only $5/hour, since they would receive an added $2.50 from the government. So, workers at (2) will stay on the job and produce widgets at $1 per widget—the same cost as employer (1).
Increase the EITC subsidy rate even more, and employer (2) will be able to drive his more technologically advanced, higher-wage competitor out of business.
The bottom line is that wage subsidies like EITC destroy high-wage jobs.
This is somewhat of a simplification: in the real world, employers do not cut wages a dollar for each dollar of wage subsidy. But employers have learned how to exploit a system that is ripe for exploitation—a system where government subsidizes low-wage jobs while taxing moderate wages.
Walmart, for example, has “educated” its workers about the EITC for more than a decade. “The momentum behind it is education—ways our employees can save money and live better,” a company spokesperson said at that time.2
While Amazon has left Walmart in the dust in terms of retail sales, Walmart is still the largest private employer, with 1.5 million employees in the U.S. alone. And it’s a hugely profitable one: it generated $482 billion in revenue in 2016. Yet the nation’s largest employer relies on taxpayer money to subsidize employee wages. A single adult with one child who works full time for $10 an hour (the company’s minimum wage for non-supervisory workers) will still qualify for the EITC.
Two of the largest states in which Walmart operates, New York and California, approved a statewide $15 minimum wage earlier this year. A federal bill would also increase the federal minimum wage to $15 by 2020.Yet the company claims it cannot pay workers that wage.
General Motors (GM), by contrast, does not “educate” its workers on how to utilize the EITC for this reason: it pays them too well to qualify.
Gary Gereffi, professor of sociology at Duke University, deconstructed the vastly different business philosophies of the two companies on the PBS program “Frontline.” [The Frontline interview with Gary Gereffi was conducted September 9, 2004, before Walmart changed its logo from Wal-Mart.]
Gereffi: “…it’s very interesting to compare Wal-Mart with General Motors, which was the best known, largest, most respected company 50 years ago. I think these two models are radically different models. The Wal-Mart model is premised on global efficiency. The General Motors model was premised on having workers that could afford to buy the products that they made.”3
Frontline: “Are you suggesting here that Wal-Mart is pushing prices so low and pushing wages so low that it may, in fact, eventually bankrupt its own customers because they won’t be making enough money to go shopping?”
Gereffi: “Wal-Mart is pushing wages down to a level where the people that work in Wal-Mart stores are going to be forced to buy in Wal-Mart stores, because they can’t make enough money to buy goods elsewhere in the economy.
“The traditional model of American capitalism from the mid-twentieth century was that American corporations were respected because they were globally efficient, but they also paid their workers a good wage so that workers could become consumers and part of the middle class of American society. I think we’ve lost that model today, because globalization has pushed Wal-Mart and companies like them towards global efficiency, where consumer prices are the only things that matter. ...”
Gereffi again: “Wal-Mart is also having a negative impact on employment in the retail sector. Wal-Mart is the largest employer in the United States after the federal government. But Wal-Mart is also very well known for being a non-union company and pushing non-union conditions on its workforce. ... It pays its workers at a minimum pay scale with very few fringe benefits. Because Wal-Mart’s the largest private employer in the United States, whatever Wal-Mart does in terms of the labor market, all other businesses have to follow. So Wal-Mart is really determining the direction in which the U.S. labor market is moving.”4
Walmart, and its enabler, the EITC.
EITC from the employee’s perspective
Consider a household with two children and income less than $50,597 in 2018. For each dollar earned up to $14,040 the government kicks in an extra 40 cents. Between $14,040 and $23,930 the benefit is the same, $5,616, neither increasing nor increasing with additional earnings. So if this hypothetical two-child household earned the minimum wage in 2018, they would receive an extra $5,616 after filing their income taxes.
But once the family’s income exceeds $23,930—hardly enough to support four persons—their EITC payment starts to “phase out.” For this unfortunate family, this means they lose 21.06 cents of EITC for every additional dollar of income. Add in Social Security and income taxes, and in some states more than 50 percent of any pay hike is lost to higher taxes and lower credits—a higher marginal tax rate than the wealthy pay.
Why earn more if the government takes over half of the increase?
Why invest time, effort, and money to improve your work skills?
If poor families are rational, they will respond to the work disincentives of EITC by working less. Data backs this up. Around 77 percent of EITC recipients have incomes that fall in the flat or phase-out range of the credit. Economists generally agree that most of these folks will work fewer hours, and devote less time and effort to improving their work skills and education, because of the negative EITC incentives.5
In the short run, the EITC is effective in moving people out of poverty. But over the long haul, the program enables employers to offer less to workers, who because of the program’s perverse incentives, may be satisfied with less. As a result, the program originally envisioned as a transfer to low-wage workers has become a transfer to their employers.
EITC vs. the Minimum Wage
The minimum wage law is most properly described as a law saying that employers must discriminate against people with low skills.
In this statement the great conservative economist gives voice to what has become the conventional wisdom among free market libertarians: Minimum wage laws hurt the poor.
Their argument runs like this: In a free market, wages will track a worker’s “marginal productivity”— his or her value to the firm. Employers who try to pay workers less than their true worth will only lose them to competitors. They either match the competitive wage, or go out of business. But minimum wage laws interfere with this process. Many unskilled, uneducated workers simply do not contribute enough to a firm’s bottom line to justify receiving the minimum wage. They are its victims rather than its beneficiaries.
Or, as Friedman cheekily observed: “It has always been a mystery to me why a youngster is better off unemployed at $4.75 an hour than employed at $4.25.”
In fact, Friedman’s minimum wage takedown does not hold up in the real world. We’ve had dozens of state minimum wage increases and now have 19 states with minimums above the federal level. If the classical labor market model so beloved by Friedman and his fellow libertarians were correct, we would see fewer workers employed in low-wage jobs. This has not happened.
In the real world, employers absorb modest minimum wage hikes without reducing employment of minimum wage workers. They can raise prices, accept lower profits, or demand higher productivity from minimum wage workers. History shows that minimum wage hikes that affect less than 10 percent of the workforce do not significantly reduce employment of the workers affected by the change.6
The impact of higher minimums on employment has been researched ad nauseam by economists in academia and the private sector. John Schmitt, an economist with the non-partisan Center For Economic and Policy Research, summarized this extensive literature a few years back:
The employment effect of the minimum wage is one of the most studied topics in all of economics. This report examines the most recent wave of this research—roughly since 2000—to determine the best current estimates of the impact of increases in the minimum wage on the employment prospects of low-wage workers. The weight of that evidence points to little or no employment response to modest increases in the minimum wage.7
An earlier study of state minimum wage laws found that “wages are higher and employment is no lower” in states with a higher minimum wage than those without. The median minimum wage was $1.40 (more than 25 percent) higher than the federal minimum in states that had raised their minimum wage.8 Another study, outlined by economists Alan Krueger and David Card in their book Myth and Measurement, finds that raising the minimum wage actually increases employment for the poor because it encourages higher productivity and creates more spending in the poor communities themselves.9
The pro-EITC crowd argues that the minimum wage is too blunt a tool to be effective against a complex, nuanced problem like poverty. While it reaches low-wage workers, it doesn’t take into account family size or household income. Indeed, many of these critics believe the typical minimum wage beneficiary is a teenager working part-time while living with parents in a middle-class neighborhood. Not so! An analysis by the Economic Policy Institute finds that nearly three-quarters of workers affected by minimum wage laws are in the bottom half of the workforce by household income level. Eighty-four percent are at least 20 years old, and nearly half (47 percent) work full time.
Nevertheless, ideological objections to minimum wage laws have influenced public policy:
Since 1990 the average EITC benefit, adjusted for inflation, has more than doubled (up by 125 percent), while the minimum wage grew by a mere 5.3 percent. The federal minimum wage was last increased in 2009. Since then its real value declined by 10 percent, while the average EITC payment has risen 1 percent. Even during the period of its sharpest expansion the EITC fell notably short of offsetting the drop in the minimum wage.
Raise the EITC even more, you say? That would merely increase the government subsidy to low-wage employers. The obvious answer is to increase the minimum wage to a level where the EITC subsidy is no longer necessary.
EITC and Immigration
The same business groups that tout the virtues of EITC also support mass immigration. That should come as no surprise: the influx of unskilled, un-educated foreign workers depresses wages for all American workers—foreign and native-born alike. Lower wages mean higher profits, higher share prices, and a net transfer of hundreds of billions of dollars from the pockets of workers to employers.
EITC and immigration share joint responsibility for one of the most pernicious economic trends of our time: the obscene income gap between rich and poor in the U.S. George Borjas, an economist at Harvard’s Kennedy School of Government, estimates that “almost half the decline in the relative wage of high school dropouts may be attributed to immigration.” Black Americans in particular are big losers, with immigration reducing the income of the average native black person about $300 per year (Peter Skerry, “How Immigration Re-Slices the American Pie,” The Washington Post, October 28, 1999).
EITC reinforces the negative impact of immigration by subsidizing low-wage employers and eroding the work incentives of their employees. One must also consider the direct impact EITC has on the number of immigrants entering annually. As the most accessible, generous, and immigrant–friendly of all federal benefits, it undoubtedly ranks high among factors considered by potential entrants.
Mass immigration in the modern (post-World War II) era dates from the Immigration Reform Act of 1965. Prior to that law only about 250,000 immigrants a year entered the country; By the 1990s the country was admitting more than 800,000 legal immigrants a year, with an additional 300,000 to 500,000 aliens entering and staying in the country illegally.
During the decade of the 1990s, 47 percent of U.S. civilian labor force growth was due to immigration. This represented the largest influx of foreign workers ever to enter the U.S. in a given decade—substantially exceeding the number who came here during the Great Wave of 1890 to 1910.10
In the first decade of this century (2000 to 2009), the foreign-born share of labor-force growth remained at the lofty 47 percent. More recently, as native-born Baby Boomers start to retire, the immigrant share of labor-force growth has gone beyond that level, to 60 percent, over the 2010 to 2016 period.
The foreign-born share of total employment rose from 10.6 percent in 1996 to 17.0 percent in 2016. Only in the Great Recession (2008 and 2009) did the immigrant share of total employment fall (see chart below, left column).
Even more important than quantity is the decreased quality of recent immigrants. In 1960 the average immigrant man living in the U.S. earned about 4 percent more than the average native man. By 1998, the average immigrant earned about 23 percent less.
The worsening economic performance of immigrants is due mainly to a decline in relative skills of the more recent cohorts. The newest immigrants arriving in the country in 1960 were better educated than the average native; by 1998 the newest arrivals had nearly two fewer years of schooling. As a result of this growing native/immigrant education gap, the relative wage of successive immigrant waves also fell. Immigrants entering around 1960 earned 13 percent less than natives; by 1998, the newest immigrants earned 34 percent less.11
The diminished quality of post-1965 entrants reflects fundamental changes in criteria for admission. The 1965 law repealed the national origins system, which granted visa mainly to persons living in the U.K., Germany, and other Western European countries. In its place, the law made family ties to persons already living in the key factor in determining whether a visa applicant is admitted to the country.
One notable consequence: the increased Mexicanization of U.S. immigration. This phenomenon’s downside is neatly captured by Professor Borjas:
…In 1940, 0.5 percent of all male high school dropouts were Mexican immigrants. Even as recently as 1980, only 4.1 percent of male high school dropouts were Mexican immigrants. By 2000, however, 26.2 percent of all male high school dropouts were Mexican born.12
How much does immigration reduce the income of native-born Americans? A 2016 report from the National Academies of Sciences, Engineering, and Medicine provides insight. The NAS study (on page180) finds that native-born workers at every educational level suffered wage losses due to immigrants arriving between 1990 and 2010. High school dropouts lost 4.9 percent; high school graduates lost 2.3 percent; college grads 2.7 percent; and even native-born Americans with advanced degrees suffered a 3.3 percent wage decline.
That native-born high school dropouts saw wages drop the most is not surprising, given that a disproportionate share of immigrants arriving between 1990 and 2010 were in that educational category. In general, education-related wage declines among native-born workers in a given educational level will rise or fall as the share of immigrants in those educational levels rises or falls This is not rocket science; it’s supply and demand.
As might be expected, the biggest losers were earlier (pre-1990) immigrant cohorts with similar educational levels. Foreign-born dropouts here since 1990, for example, lost a whopping 8.5 percent of their wage income, while foreign-born college grads lost a hefty 8.1 percent. The 1990-2010 influx increased the supply of dropouts by 26 percent, and college grads by 11 percent. ■
1. J.W. Mason, “Is the Earned Income Tax Credit as good as it looks?” City Limits, May 2002. https://citylimits.org/2002/05/13/big-idea-the-flattering-tax/
6. Jared Bernstein, Raising the Minimum Wage: The Debate Begins…Again, On the Economy, February 14, 2013. http://jaredbernsteinblog.com/raising-the-minimum-wage-the-debate-begins-again/
7. John Schmitt, Why Does the Minimum Wage Have No Discernible Effect on Employment?, Center for Economic and Policy Research, February, 2013.
8. Paul Wolfson, State Minimum Wages: A Policy That Works, Employment Policy Institute, 2006. http://blog.aflcio.org/2006/11/29/minimum-wage-increase-does-not-cost-jobs/
10. Andrew Sum, et al., Foreign Immigration and the Labor Force of the U.S., [PDF] Center for Labor Market Studies, Northeastern University, July 2004
12. George Borjas and Lawrence Katz, The Evolution of the Mexican-born Workforce in the United States, National Bureau of Economic Research, April 2005.