How to Help the Working Poor

Like me, Greg Mankiw believes that the best way to help the working poor is through the earned income tax credit. Unlike me, Professor Mankiw uses a particularly ingenious method to make his point:

. . . those who are worried about inequality look for more immediate ways to help workers with limited skills. Before turning to President Obama’s proposal, let’s consider two other possibilities. For lack of better terms, call them Plan A and Plan B:

PLAN A The government subsidizes the incomes of low-wage workers. These subsidies are financed by increasing taxes on middle- and upper-income Americans.

PLAN B The government again subsidizes the incomes of low-wage workers. But under this plan, the subsidies are financed by taxing those companies that hire low-wage workers.

Stop reading for a moment and consider: Which of these plans would you prefer, and why? If you have a pen or pencil handy, jot down your reasons.

O.K. — and now, here are my answers:

To me, Plan A is distinctly better than Plan B, which suffers from two problems — one involving fairness, and one involving efficacy.

First, fairness: If we decide as a nation that we want to augment the income of low-wage workers, it seems only right that we all share that responsibility. Plan A does that. By contrast, Plan B concentrates the cost of the wage subsidy on a small subset of businesses and their customers. There is no good reason this group has a special obligation to help those in need.

Indeed, one might argue that this group is already doing more than its share. After all, it is providing jobs to the unskilled. Asking it to do even more, while letting everyone else off the hook, seems particularly churlish.

But even putting fairness aside, there is reason to doubt the efficacy of Plan B. Taxing businesses that hire unskilled workers would alter their behavior in ways that would hurt those we are trying to help.

To avoid the tax, businesses would have an incentive to hire fewer of these workers. For example, they would have greater incentive to replace workers with labor-saving machines.

In addition, some of the tax would be passed on to customers in the form of higher prices. These customers, in turn, would have an incentive to spend more of their income elsewhere. Over time, these businesses would shrink, reducing the job opportunities for the unskilled.

All in all, the Plan B tax-and-subsidy plan sounds like a pretty bad idea. Why, you might wonder, did I bring it up? Because it is the one favored by President Obama. He calls it an increase in the minimum wage.

The analogy is apt. And there is plenty of proof that the earned income tax credit does more to fight poverty than does an increase in the minimum wage.