Some unfortunate results have come in for one of economists’ favorite things. This is the Earned Income Tax Credit, and I don’t know any economist who isn’t a big fan. From the quite liberal to the not so liberal, every economist loves the earned income tax credit. Despite the bad news, you should still love it, and I shall explain why. But first, there is something tricksy to know about income inequality.
You may be interested to know that pre-tax and post-tax economic inequality have approximately no relationship or correlation. Austria, Finland, Italy, Germany, the United Kingdom, Spain, France, and Belgium all have almost exactly the same pre-tax inequality as the United States, several of them more. These are much more egalitarian countries than we are overall, and you can see it in relative life expectancies for the rich versus the poor, social mobility, and other factors. For example, they generally have between one quarter and one half as many children living in relative poverty as the United States. They also have much stronger unions, which in most countries are more of wage-setting boards than the firm-by-firm labor monopolies of American unions, and appear much more powerful.
What does this say? First, it says that everything that these countries do except for redistribution is essentially meaningless. They may have the appearance of much stronger labor, but this does not matter at all. They all have the same inequality before the government moves the money around. So, among rich countries, the only thing that matters is what inequality the government will accept. If the market is creating greater inequality than this (and it almost always is, considering we live in democracies), then the government moves some money around through taxing the rich higher rates and providing public services, and everything is the way people want it. Effectively, nothing else actually matters but this.
This is largely unavoidable in a globalized world. In the United States before the 1980s, most manufacturing work was unionized and many Americans worked in manufacturing. That’s not exactly true anymore. Despite what some will tell you, this was not largely due to regulatory changes; it was mostly because of rising trade with China. In this environment, you can’t reduce income inequality very much through pre-tax means. Companies have to compete on the world market. If you raise expenses for them (by forcing them to raise wages whether via unions or wage controls), they have to compete with other countries, mostly China, where the governments are not all doing that. Thus, if you force companies themselves to be the ones to pay for the income equality you want by bidding wages far up beyond the marginal product of workers, these companies are going to go out of business.
But you still want to deal with income inequality. So you tax the rich and hand it out to the poor. There are several ways of doing this. A major factor is that countries treat things that can be easily provided by private markets as if they’re public goods as a tricksy way of redistributing money: school, housing, and busses are typical examples. However, this strategy leaves a gap, unless you publicly fund all goods that people could want, so you need something to close the gaps. One solution is to put on your YangGang2020 colors and deliver a check for $1,000 a month to every American with a pulse, but wait a moment before you buy your Math, Money, and Marijuana T-shirt. Despite the marvelous charm of every sentence that comes out of his mouth, there is a better way.
This is the Earned Income Tax Credit, or EITC. That is, for people with low incomes, the government pays them up to 45 percent of their income in the form of reduced taxes, depending on how many children they have and just how high their incomes are. It is not, in essence, all that different from a Universal Basic Income. The difference is that one only qualifies by making a certain income via working. The credit was enacted in 1975, but became massively larger in 1990 and 1993, as part of the Clinton-era welfare overhaul. The idea of the EITC was that unlike other forms of welfare which disincentives work (now, being a good Wes student, you probably don’t believe work disincentives matter, but you’re probably wrong) the earned income tax credit incentivizes work: You have to work to get it. In fact, at low incomes, working more means the difference between your income from working and from not working is even greater than it would be in without the transfer. It also works as a happy complement to a minimum wage. With the EITC, the minimum wage can be lower and still provide livable incomes, but the legal minimum helps prevent monopsonistic employers from capturing all the gains from the tax. That’s hard to explain, but Paul Krugman has already done it so let’s just say it’s a win-win and leave it at that. There is no other system of redistribution that is as pro-work as the EITC. Some economists even made the argument that the existence of the EITC will, while giving the poor money, encourage them to work more than they would if the EITC didn’t exist. Again, as a good Wes student, you probably think that getting people to work doesn’t matter. It’s not like they were making much, so why not just give them some money and call it a day. Again, you’re probably wrong, primarily because not being employed today significantly lowers wages in the future.
But this gets us to the bad news for the EITC. It turns out that increasing the EITC doesn’t actually raise employment much. This is the bad news. There was a substantial increase in employment associated with the growth in the EITC in the early ’90s, but most of the effect of this was because we got rid of old-fashioned welfare. It’s hard to portray this as good news for the earned income tax credit. Like the Wizard of Oz, it doesn’t do all the wonderful things we wanted it to do.
But, also like the Wizard of Oz, it’s good enough. What we did observe, though some rather foolish people have not noticed this, is that the EITC creates higher employment—compared to other ways of giving poor people money. Since we saw above that there’s basically no way to fix inequality without some type of redistribution, the EITC, paired with a reasonable minimum wage, is the easiest way to ensure broad human flourishing without needlessly shrinking the overall output of the economy.
Thomas Hanes can be reached at thanes@wesleyan.edu. Thomas is a member of the Class of 2020.