Proposal: The High Wage Tax Credit

Shifting some of the cost of higher minimum wages to taxpayers puts the minimum wage on a more equal footing with other redistributional policies.

Photo by Sharon McCutcheon

by David Neumark | August 30, 2018

The evidence that minimum wages reduce employment of low-skilled workers is, in my view, incontrovertible. But it is also incontrovertible that there is strong political support for minimum wage increases in some quarters, which is leading to an increasing number of states and cities enacting high minimum wages. At the end of 2017, thirty states had a minimum wage that was, on average, 26% higher than the federal level of $7.25. New York, California, and the District of Columbia are set to go to $15 over the next few years, joining Seattle, and other states are debating similar raises. And if Democrats do well in the upcoming November elections, the odds of a substantially higher federal minimum wage will rise substantially.

Recognizing the potential harm from higher minimum wages, but also the apparent inevitability of high minimum wages, I have developed a proposal for a High Wage Tax Credit (forthcoming in an Aspen Institute Economic Strategy Group volume.) The HWTC preserves the benefits of higher minimum wages, while mitigating the harm, and turns the minimum wage into a more sensible means of redistributing income. The HWTC partially offsets the costs that higher minimum wages impose on firms that use low-skilled workers. When the federal government (or a state or local government) increases the minimum wage, the HWTC would provide a tax credit of 50% of the difference between the prior minimum wage and the new minimum wage, for each hour of labor employed. The credit phases out at wages higher than the new minimum wage, and as wage inflation erodes the value of the new minimum wage.

The HWTC accomplishes three main goals.

First, it reduces the incentive of employers to use fewer low-skilled workers in response to a higher minimum wage. While the effects of minimum wage increases are contested, it is impossible to dismiss the large body of evidence showing that minimum wage hikes reduce employment among the least skilled. This includes recent research that addresses revisionist evidence claiming that minimum wage increases do not cost jobs.

Minimum wages reduce employment of low-skilled workers for two reasons. Minimum wages raise the cost of low-skilled workers, incentivizing employers to substitute away from them and toward higher-skilled workers or capital. And the product demand declines because the higher costs of production raise prices. By offsetting part of the cost of higher minimum wages, the HWTC reduces employers’ incentives to substitute away from low-skilled workers, and moderates price increases that lower product demand.

The second virtue of the HWTC is that it helps transform the minimum wage into a more sensible redistributional policy. Most redistributive policies transfer money from high-income families to low-income families, via the tax system. The minimum wage, instead, transfers money from owners of businesses that employ minimum wage workers, and towards minimum wage workers and their families. We do not have data on the family incomes of the owners of businesses who employ minimum wage workers. However, there is good reason to believe that many of them do not have high incomes. Moreover, owners of low-wage businesses are not especially greedy or exploitative; they just tend to operate in businesses that use low-skilled workers. By operating through the tax system, the HWTC transfers some of the costs of higher minimum wages to high-income taxpayers — for example, shift some of the costs of higher minimum wages away from the owners of child care centers and restaurants and towards investment bankers, doctors, and lawyers. If we are going to redistribute income, this is a better strategy.

The third contribution of the HWTC is political, not economic. Voters think income inequality is too high, and politicians who want to keep their jobs must respond. Raising the minimum wage sounds like a good way to reduce income inequality, even if other policies like the Earned Income Tax Credit clearly do more to help the poor. I suspect politicians support higher minimum wages so they can claim credit for addressing inequality without having to raise taxes. But the sense that minimum wages don’t impose costs is an illusion; somebody clearly pays the higher wages. As I argue in a recent Wall Street Journal op-ed, by shifting some of the cost of higher minimum wages to taxpayers, the HWTC puts the minimum wage and other redistributional, anti-poverty policies on a more equal footing, which should encourage policymakers and the public to choose among alternative policies based on their actual benefits, rather than their misperceived costs.

The HWTC might be viewed as a cynical ploy to slow the growth of minimum wage increases, by linking higher minimum wages to higher government spending and hence higher taxes. There are two responses to this criticism. First, it would be hard to fault the HWTC for slowing the rate of minimum wage increases if this occurs because the public and policymakers better understand and weigh the costs of these increases. And second, the HWTC should reduce business owners’ opposition to higher minimum wages, by reducing the costs that higher minimum wages impose on affected businesses.

The HWTC may speed the transition to higher minimum wages. But if so, the job losses from higher minimum wages will be less severe. Or the HWTC may encourage policymakers to choose alternative policies to help workers in low-income families that cost fewer jobs and do more to redistribute income from top earners. Either outcome would likely benefit workers struggling to make ends meet.

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