Wage subsidies

There has been a lot of talk about raising the minimum wage lately. Minimum wage is one of those things where the public strongly disagrees with economists - Americans are very strongly in favor of minimum wage hikes, but most economists think it's a bad idea. Economists generally prefer the EITC, also called a "negative income tax". Minimum wages can cause higher unemployment, and often just give money to high school kids who don't need it; EITC suffers these problems much less.

Why do Americans like minimum wage hikes and ignore the EITC? Two reasons, I'm guessing. The first reason is that people like feeling like they are being rewarded for work. Wages are money that people feel like they have "earned", even if the government has mandated above-market wage levels. Second, EITC is  just clunky to use - you have to file for it through the clunky tax system, you have to know about it in order to claim it, and the acronym "EITC" itself has no meaning for the vast majority of poor Americans. A bunch of eligible Americans don't even claim their EITC. Minimum wages, on the other hand, are easy to use, because the company does all work of administering it.

So is there a policy that would combine the economic efficiency of the EITC with the popularity of the minimum wage? I believe that there is. It's called a wage subsidy. This means paying companies to offer their employees higher wages. Jim Pethokoukis of the AEI has recently endorsed this idea (I think I managed to convince him in our recent podcast interview, if he wasn't convinced already). It's a good one.

Wage Subsidies vs. EITC

Wage subsidies are better than EITC, for several reasons. For one, they are automatic - poor people don't have to take the time and initiative and mental energy to go claim them. Second, they will probably make people feel more valuable, since people tend to view wages as money they "earn". From the worker's perspective, it will just look like wages went up. In fact, a better name for wage subsidies might be "wage matching".

Wage subsidies would replace the EITC, but in order to do this, we would have to supplement wage subsidies with some other form of welfare (such as a basic minimum income), since we don't want unemployed people to starve. 

Wage Subsidies vs. Minimum Wage

Wage subsidies are better than the minimum wage. For one thing, minimum wage doesn't necessarily raise wages for people who are slightly higher up the wage distribution but still poor. Wage subsidies can push up wages for all of the working poor.

Also, wage subsidies encourage higher employment, while minimum wage encourages higher unemployment. This is always an important difference, but much more so right now, for two reasons. First, we are in the middle of a long economic stagnation - a large number of Americans are languishing in long-term unemployment, causing their job skills and work ethic to decay. Second, we may soon face increased downward pressure on wages from increased automation - the so-called "rise of the robots" - and wage subsidies would be a way of placing our thumb on the scale for the human beings.

Problems with Wage Subsidies?

Kevin Drum highlights some potential problems with wage subsidies. This one actually isn't a problem at all:

How do you prevent employers from gaming the system and reducing wages because they know the wage subsidy will make up the difference?

This might be a problem higher up the wage distribution, because at some point you have to phase out the wage subsidy or your program ends up getting really expensive (supplementing every American worker's wages with a flat $3 subsidy would cost upwards of $1T). But if you phase it out slowly enough, this won't be much of a problem.

On Twitter, Brad DeLong noted that while minimum wages are a mandate, wage subsidies would require govt. bureaucracy to administer. True. But this bureaucracy is actually already fully in place - it's called Social Security. You see, a payroll tax cut is a kind of wage subsidy.

The final problem with wage subsidies is that they might be politically infeasible. For one thing, they would be paid for with higher taxes on the wealthy, which Kevin Drum points out is certainly going to make Republicans balk at the idea. Second, as Paul Krugman notes, the minimum wage is well-known and already has wide support.

Drum and Krugman are probably right; the minimum wage is a lot more feasible than wage subsidies, at the present moment. But if conservatives like Pethokoukis start campaigning for it at the elite level, then I think there's some chance Republicans could eventually come to see it as a more palatable alternative to the minimum wage. And if Republicans campaigned on a platform of "raise wages for working Americans", it seems to me there's a good chance they'd smash the Democrats. Supporting wage subsidies would be a way for the GOP to move from being the party of rich people (a small constituency by nature) to the party of business.

As for us technocratic-minded liberals, of course we should not let the better be the enemy of the good - we should still keep campaigning for a minimum wage hike, if for no other reason than to force Republicans to offer wage subsidies as an alternative. But if Republicans ever do get behind wage subsidies, we should join them, instead of sticking to the minimum wage out of pure traditionalism.

So I think that wage subsidies - or "wage matching", if you prefer - are a great idea, even if we can't manage to implement them right away.


Update: Via Carola Binder, I see that I am very, very, very late to the wage subsidy party. Here is a letter sent by a whole bunch of prominent economists in 2010:

Dear Speaker Pelosi, and Messrs. Boehner, Reid, and McConnell: 

A great number of different policy actions--including the American Recovery and Reinvestment Act, the financial rescue, and the extraordinary monetary policy measures taken by the Federal Reserve--have in their sum played an important role in changing the trajectory of the economy from one of terrible decline to one of growth.  But with the latest unemployment rate at 9.7 percent, it is clear that additional emergency policy measures to jump-start job creation are still warranted. 

A well-designed temporary and incremental hiring tax credit is a cost-effective way to create jobs, and could work well in the current environment.  At a time when GDP is beginning to rise and demand is starting to return, private firms are likely to respond to such a tax incentive by hiring sooner and more aggressively than they otherwise would have done. Such a credit could thus help put Americans back to work more quickly than otherwise. And by targeting firms that are growing, such a tax credit supports the businesses most likely to lead the recovery of employment. 

There are many ways to design an effective hiring tax credit, but in general the beneficial effects will be greater the stronger the hiring incentives and the lower the administrative burdens placed on firms.  It is critical that such a tax credit be put into place quickly and that it is publicized widely.  Firms will begin to accelerate hiring only when know they can count on such tax relief. 

We judge that a well-designed hiring tax credit is a well-targeted and economically sound strategy for aiding job creation at this phase of the recovery, and so we support a well-designed hiring tax credit. 

In our personal capacities, we are sincerely yours, 

Mark Zandi
Justin Wolfers
Laura Tyson
Mark Thoma
Peter Temin
Joseph Stiglitz
Betsey Stevenson
Isabel Sawhill
Dani Rodrik
Robert Reich
Richard Portes
Larry Katz
Barry Eichengreen
Peter Diamond
Brad DeLong
David Cutler
Robert Cumby
Tyler Cowen
Menzie Chinn
Alan Blinder
George Akerlof

Now, they were talking about it as a temporary measure to deal with the recession, but I think it works as a long-term distribution and incentive program as well.