Minimum Wage and Negative Income Tax as Means of Poverty Alleviation

MINIMUM WAGE AND NEGATIVE INCOME TAX AS MEANS OF POVERTY ALLEVIATION By Elad WINDHanded to Dr. Mircea BOARI Philosophy and Trade, ESSEC, June 2010 ABSTRACT In this work I will prove that Minimum Wage does not provide the a relief for the low earners, the working poor and families and will compare the outcomes of a Negative Income Tax as a better solution to Poverty Alleviation. Through the use Negative Income Tax many a state could reach higher efficiencies of distribution of income while maintain work incentives for the beneficiaries of the welfare system. In this work I will provide with most common justifications of a poverty alleviation in a state. On Minimum Wage Why Minimum Wage Was Imposed on the First Place? Minimum Wage (MW) is an act of governmental benevolence. Governments set the minimum wage out of noble intentions, to include some: Give low-skilled workers an advantage; Make life easier for the poor; US Fair Labor and Standards Act of 1938: To provide for “the maintenance of the minimum standard of living necessary for health, efficiency, and the general well-being of workers.” The Effect Minimum Wage on the Labour Market “The Road to Hell is paved with good intentions” The direct outcome is that workers who’s productivity to their employer is lower than the set MW are immediately over priced and therefore are in risk to lose their job quite fast. One must remember that business owners are aimed towards the sole purpose of earnings and that other intentions can only come second. Demand for labor, like that for any good or service, isn’t fixed. Labor uncomfortably, behaves like every market. Wishes are tempered by the reality of competition.32734250 When a floor price is introduced, a surplus in the supply of workers forms, and the demand decreases. This surplus is uncomfortably called unemployment. To simply put in a day to day perspective, try to think of yourself as the stingy employer, this can easily occur when you a clogged drain - most of us will call plumbers and hire the one who quotes us the lowest price. But the employees (plumbers) are greedy and seek to work for the high wages, therefore might quote higher than our will to pay. When plumbers are too expensive, we will resort into grabbing a plunger and a wrench and trying to sort the problems ourselves. All of us stay at home and waste economic means. FOR MINIMUM WAGE Most of the arguments for MW are a cause of a human reflex: minimum wage law is seen as siding with labor, with the poor and with the underdog. Human although presented strong empirical facts will always relate to these subjects and seek means to bequeath their compassion. Other arguments would consist of: ,[object Object]

Protect the working adults from teenagers willing to work for less and.

When businesses are left uncontrolled, they will exploit their power to abuse the labor.

MW assures a minimal income to survive and pay the bills of a family. For these every worker in the market is entitled.

MW is helpful in raising the living standards and the spending power of individuals.CRITICS ON MINIMUM WAGE ,[object Object]

The low skilled workers are the ones to actually be hurt of the MW as they are the ones to be over priced. As low skilled workers become pricier, the competition they face on employers’ dollars grows. They have to face on one hand the skilled workers which are of a higher value to the firm and are now priced more attractively; and on the other hand compete with capital investments in technology that could replace a large portion of their work if not entirely. Low skilled workers might not get fired but may expect a their work environment to deteriorate to pay back these salary raises: longer hours are expected and perks are denied.

When a worker is employed, no matter it’s wage and productivity (as long as it is positive) contributes to the economy, unemployment doesn’t.

Bouncing Up the Ladder - Jobs are means to improve skills, and the wages sought for are tightly coupled with skill. A high MW prevents from getting entry-level jobs, they might simply not exist, and thus prevent from unskilled workers the opportunity to enter the market and develop the skills necessary. Disappearance of these jobs has broader economic and societal consequences: remove the bottom rung from the employment ladder and many never have a chance to climb it.

Minimum wage is set to support a family. Most young workers are not head of families and would settle for a lower fee.

Minimum Wage is exposed to abuses: Lobbies (often unions and strong firms) justify a raise in the MW. This is because strong firms suffer less from a rise in costs and it would create better market standings for them, sort of a bigger portion of a smaller pie. The unions know that an increase in the MW will lead to further raises in their pockets.

Often the MW is coupled with the inflation index, and governments care to compensate for inflation. This retains the worker with the original real spending power, but these always lead to for production costs to rise in turn after the wages. A vicious cycle begins to roll, and when the often public pressure rises the idea that “it’s time that the government did something”. The public is completely unaware that it is the government intervention which has failed, and not the free market. Usually governments in these cases are urged for further intervention.Minimum Wage throughout the World All through the world MW are enforced. The short list of developed countries without wage control holds: Brunei, Denmark, Hong Kong, Norway and Singapore. In some other countries wage is bargained by unions without governmental control: Austria, Finland, Germany, Iceland, Italy and Sweden. MW Rates for example: France: €8.82 / hourUnited States: $7.25 / hour (states and districts may set it higher) MINIMUM WAGE IS A BAD IDEA Interferences with the price system lead to unintended and unexpected consequences, which are often worst than the situation they were meant to solve. Poverty alleviation and income distribution policies are justified with egalitarian values, but in practice they do not deliver these goals. The desired equality is not in achieved, and the only real result is costly waste of resources on government establishments while the wealth switching pockets does not provide real relief. The only way to increase wages is to increase worker productivity and to ease the inferred costs of running businesses. We can resort to Milton Friedman’s opinion on MW to conclude: “Insofar as minimum wage laws have any effect at all, their effect is clearly to increase poverty. The state can legislate a minimum wage rate. It can hardly require employers to hire at that minimum all who were formerly employed at wages below the minimum. It is clearly not in the interest of employers to do so. The effect of the minimum wage is therefore to make unemployment higher than it otherwise would be... the people who are rendered unemployed are precisely those who can least afford to give up the income they had been receiving, small as it may appear to the people voting for the minimum wage” NEGATIVE INCOME TAX FOR THE ALLEVIATION OF POVERTY Nobel prize winner Milton Friedman in his book Capitalism and Freedom suggested the Negative Income Tax (NIT) concept of giving everyone a guaranteed minimum income rather than current measures which he sees and we agreed that are misguided and inefficient. Friedman a true liberal, argued much for a free market and believed that it can accomplish wonderful things, but also he stated that the free market cannot ensure a distribution of income that enables all citizens to meet basic economic needs. Another objective of the NIT is to avoid the unjust equalization of incomes practiced on one side and while keep avoiding unjust extremes of concentration on the other sides. He was determined to suggest a mean to expand support for the unemployed and poor in a way that would not undermining work incentives and thus the came up with a solution in a figure of NIT. HOW DOES NIT WORK right2266950We shall consider first the positive base of a tax system. Typically there is a tax free base of income (marked Taxable income threshold, TIT) due to tax exemptions, deductions and tax breaks. Income greater than TIT are taxed with usually a differential (progressive) percentage which increases in steps along the higher incomes. Below the point marked TIT, tax benefits are paid to those people with income, up to a maximum of B which is paid to those without income. The TIT is the breakeven point, in which a family becomes a tax payer. The actual yield can be detained by: Y<TITYd=Y-t1∙Y+BY>TITYd=Y-t2Y∙Y-TITY – YieldYd - Net YieldB - The maximal benefitt1 – constant tax ratet2Y – differentiated tax rate 32194506717030 Qualitative graph of Income under NIT Equilibrium between the two sides of the income (Yd) relies in: Y-t1∙Y+B=Y-t2Y∙Y-TIT Assuming that t1=t2Y=TIT We get: B=t2∙TIT In this way, determining two of the parameters out of B, t2Y=TIT, TIT dictates the third. Further Implications of the NIT method: Some other variations of the NIT concept were suggested along by other economists and governmental agencies: Considering a family as a tax unit – the idea is to empower the working poor, which are on average families with children in which one or two salaries do not provide an income above an artificial line of poverty (which also may be adjusted in accordance to the family size). Some may count the number of minor children supported by tax unit and present different TIT thresholds. Tax level can be a constant rate such that a fix tax is set all through the income curve as seen in the receptive side of the graph. Tax level could be differential such that higher incomes are taxed with higher rates, thus the curve is non-linear as in the contributing part of the graph above. The definition of income may include revenues from assets, savings and funds. Tax units enjoying these may be exempt from the NIT benefits. Why Would Mr. Friedman Seek the Distribution of Income? The intriguing question, however, is why a libertarian such as Milton Friedman should be concerned with inequality at all? Was equality a moral value for itself? Is it important enough to engage in distribution of income? Milton Friedman’s views on the issue of freedom versus equality are a bit confusing: He expressed a concern for the welfare of the least fortunate. The idea arose while Friedman sought for a solution to poverty through private charity: “…I am distressed by the sight of poverty; I am benefited by its alleviation; but I am benefited equally whether I or someone else pays for its alleviation; … all of us be willing to contribute to the relief of poverty, provided everyone else did… In the large impersonal communities that are increasingly coming to dominate our society, it is much more difficult for it to do so.” On the one hand , he argued that economic policy should focus on freedom as a primary value; stressing equality per se could lead to economic inefficiency as well as jeopardizing freedom itself. On the other hand, he advocated government-sponsored poverty alleviation by way of the negative income tax, a form of income redistribution that is inconsistent with his general theory of the free-market economy. NIT is quite incompatible with the theory of a pure free-market economy because it is clearly a government intervention designed to alter the allocation of resources that would have resulted from voluntary exchanges between individuals acting freely in their own best interests. Liberal Friedman argued that if government action is taken in pursuit of economic equality that political freedom would suffer: “A society that puts equality--in the sense of equality of outcome--ahead of freedom will end up with neither equality nor freedom.... On the other hand, a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality” His justification for this policy, as we shall see was not on egalitarian grounds. Rather, his main motivation seems to have been compassion. Resorting to Friedman’s background can be a key understanding, I suppose, as he lived in poverty and funded his education with scholarship. NIT Like it or not, it is a policy of income redistribution. An effective one. But it involves taking from some in order to give to others. I think that Mr. Friedman was a pragmatist, and his idea of NIT is superior over traditional welfare methods: If the main problem of the poor is that they have too little money, he reasoned, the simplest and cheapest solution is to give them some more. He saw no advantage in hiring armies of bureaucrats to dispense food stamps, energy stamps, day care stamps and rent subsidies. It could be that, by proposing a more efficient alternative to the existing welfare system, Friedman was merely making a concession to political reality. In a welfare state, redistributionist policies will be implemented, one way or another, so we might as well design such policies efficiently. From here it was a short way to governmental action: “Suppose one accepts, as I do, this line of reasoning as justifying governmental action to alleviate poverty.... There remain the questions, how much and how. I see no way of deciding quot;
how muchquot;
except in terms of the amount of taxes we... are willing to impose on ourselves for the purpose… may approve state action toward ameliorating poverty as a more effective way in which the great bulk of the community can achieve a common objective. He will do so with regret, however, at having to substitute compulsory for voluntary action” EXPERIMENTS WITH NEGATIVE INCOME TAX Despite the work of these and other economists, there has never actually been a negative income tax system applied in a state wide scale. While there is support for implementing such a system, there are also great fears and criticism, no matter how it might be created. Great pressure may be pressed from current governmental mechanisms not to overthrow their crown. Also, one shall bear in mind the great cost in time and money and the huge difficulties in completely changing the tax system of a large country. US Experiment The main goal of the experiments was to determine the labor supply response to an income guarantee. That is, how much will work effort decline if a negative income tax is introduced. Experiments were conducted in New Jersey, Pennsylvania, Gary Indiana North Carolina and Iowa between 1968-1972. A large base of single parents or two parents families, urban and rural were tested with a control group. These experiments were the first large scale social science experiment ever conducted, and they have become a model for social experiments on any issue since then. The experiments tested an experimental group on which they applied the NIT rules and on a control group without. Families were randomly assigned to one of those groups. From the standpoint of static economic theory, the NIT should reduce the tendency to work. The benefit given (up to a level of B) should produce more leisure and more non-wage work. The reduced price of leisure per marginal hour (Y-tY), which comes from the reduced wage, should also produce more leisure, “Time off is cheaper, let’s buy some more of that”. Expected to find some negative work incentive effects, the experimenters were surprised with how small they turned out to be. People did work less, but percentage-wise it tended to be in the single digits for men in particular. But there were other negative consequences: Recipients used NIT to buy more leisure, by decreasing work hours people succeeded in making their lives better off, but it wasn’t a good antipoverty program. Some of the work response came from taking more time to look for work. There was almost no evidence that people left their jobs entirely in favor for the benefit (B). Labor supply results showed about a 13% reduction of work effort for the family as a whole. In most cases, the primary earner worked more hours than the secondary and tertiary earners, and therefore, when measured in percentage terms, there were relatively small responses from the primary earner. Percentage term responses were much bigger from the female spouses in the family and from the third workers in the families. The biggest response overall came in reduction in the female labor supply and that mostly took the form of slower reentry to the labor market after absence. US Earned Income Tax Credit (EITC) Enacted in 1975 and expanded several times during the 1980’s and the 1990’s. Offers a benefit to single and double parents families. The U.S. currently implements a variant of the negative income tax called the Earned Income Tax Credit, which is credit to low-income workers that can be claimed even if those workers owe no taxes. The program has been proven to be efficient as an antipoverty plan, but flaws in that the monetary gain is diminishes as you approach the TIT thus proves to be disincentive for recipients to work more. Note that Canada and UK along with some other countries practice too NIT for the working families with a few deviations from the general idea described by Mr. Friedman. IN FAVOR OF NEGATIVE INCOME TAX 1. It can substitute all existing welfare mechanisms: NIT would not require any separate administrative apparatus as the burden is laid upon the existing tax system. Government transfers, minimum wage, social security, food stamps, subsidies, etc -- These are all means of distribution of income in the market system which can be eliminated. There is a high degree of overlap between tax collection and welfare distribution systems: One forces wealth out of the population’s pockets and the other distributes that to beneficiaries as the law provides. In modern welfare countries, and even in today’s United States, the complexity of the welfare mechanisms is enormous: multiple mechanisms targeting different segments of the population with numerous types of benefits from plain monthly wages to money like stamps and even supplies. Taxing is too mostly practiced in a differential way, such that one cannot real tell how much tax he is due to pay. On top of that the systems growing in parallel and with little or no consideration to others allows loopholes in which high income groups benefit from various tax laws while low income groups enjoy welfare payments while paying taxes. 2. NIT grants income to taxpayers, such as it is always a person’s interest to work more. In terms of incentives, the person receiving income subsidies has no perverse incentive to forego gainful employment because under any level of income a portion of any residual income earned. 3. NIT is a better way to attack poverty Poverty is only one aspect of income inequality, but the most popular by politicians and legislators to approach and the aspect most are concerned in the media and in mind. NIT, as a form of income distribution is more effective in meeting the needs of the poor, providing higher means of income to the poor especially the working poor thus reducing income inequality. 4. NIT targets the poor and them alone NIT is an economically efficient poverty alleviation system. In practice welfare countries developed mechanisms that allocate services and benefits to population such as health services, food subsidies, government transfers, child support and even more imaginative and bizarre support for religious studies. While trying to speak generally and avoid nation specifics, these mechanisms usually define the entire population as the beneficiaries of the service in order to color these acts as for the good of the general public. Most often the majority of the public is not really interested in governmental degraded services and engage in private services. In terms of resources, the abolition of such mechanisms, and the allocation of wages alone to the poor is highly more efficient. Beneficiaries are a limited known group of people, and redundant services which are partly approached by the public can be shut. 5. Coverage of beneficiaries All segments of poor people will benefit among the working poor as well, which are usually ignored in common well fare systems. Especially the working poors. CRITICISM ON NEGATIVE INCOME TAX Like any other form of government intervention acts, these policies by nature are criticized in two main points: ,[object Object]

These policies do not result in major reductions of income inequality, and often they have the opposite effect.Let’s inspect these in detail: 1. Discouragement of work incentives As the experiments suggested, a decline in the work incentive is inevitable. Baring in mind the net yield for the benefiters: Yd=Y-tY+b One can easily obtain that each for the working poor, benefitting from the NIT, an hour of work’s income is actually less than the wage paid for it, thus the incentive of adding work hours to the week drops. 2. Poverty Line being so important would be the target of politicians The poverty line as it called, a certain income below which a government see the tax unit (a family) as living below reasonable standards of living. This point should be declared as the income tax threshold (TIT) which marks who is benefiting from the taxation and who pays. Of course, the poverty line (and thus the TIT) is an index which marks the value of a basic basket of products a family consumes. This index being so complex to define is at aim of politicians and policy makers. Even the definition of what is the poverty line and of what are the contents of the basic basket are determined by politicians, and often are a political compromise rather than a decision made with academic or scientific tools. Political powers thus engage in manipulating this figure in order to satisfy pressure groups, and as a cause the poverty line is often tempered. For example lifting the threshold brings more families to the beneficiaries and could be exploited as apolitical ransom. 3. The system is highly dependent on individual assessments. It is ripe for patronage and corruption. Recipients are to report their annual earnings and there is a lot of risk in giving the temptation to them. 4. NIT’s true effect is unclear As always is the case with government intervention in the free market, the true effect of such interventions remains unclear, and also may be discovered after a long period of time; often too long, while the harm is also hard to undo. Though the effect on work incentives for subsidy recipients is clear, some economists think that the overall effect on total labor supply is ambiguous. It is possible that some workers not previously on welfare might decide to work less, given the option of an income subsidy under a negative income tax scheme. The total number of people receiving subsidies might therefore be larger than under a conventional welfare system 5. Destruction of the family structure. As experiments show, there has been a drastic change in the stability of the families forgone under the NIT experiment. Empowering the secondary earner of the house (often the woman) with wealth big enough to sustain a family by its own may be the cause of breaking fragile marriages. One can also assume that more adults will form a single parent family with this empowerment. While not arguing which family structure is better, severe sociological effects are to be dealt with and shall be considered before the country engages them. Furthermore, there should be an effect on the size of the families, and the birth rate of the families benefitting from the NIT. Aside the relatively easiness of forming a single-parent family, bringing to the world more kids to these families could be a probable option, as the benefit grows along the size of the family. Whether this effect is positive or negative shall be left for the government to decide, perhaps countries with low fertility rates like Italy or Russia could benefit with such a measure. Still, one has to remember that the births encouraged here are within a limited circle of low income families, and their future could be bright only under adequate conditions of health, education and livelihood. Some unsolved deficiencies in NIT: Rural farmers could benefit from this income way more than others: growing vegetables for self use and still living well especially in large families. If the employer is aware of the employee’s benefit of the NIT, it will end up in his pocket: The employer could exploit this benefit by reducing the pay to the worker, knowing that the worker still gains enough through the NIT system. Could also lead to frauds as the employer and the employee would engage contracts that could split the revenue from the state. MY OPINION The biggest potential of NIT is in improvements over the existing public assistance programs. It has enough tools to effectively replace almost any welfare program, mainly because the means provided to the beneficiaries will be directly used without further distribution mechanisms, making the process a lot more efficient and targeted to the people’s needs. The NIT provides a quick and unitary approach for raising poverty up to the desired level, where as existing welfare systems are often fragmented, uncoordinated and even simply off target. Cash grants enlarge the freedom of choice, instead of receiving benefits one could purchase his choice of services. The government shall still encourage investments in education, as these investments may be left out by various groups. Education and the improvement of the work skills are the best means to escape poverty. It may be true that the NIT will lower the incentive of the poor to work as the marginal revenue of each errant dollar is lower, but overall the NIT is a better alternative to MW and other forms of poverty alleviation. TO CONCLUDE As said on MW, the only valid strategy for poverty prevention is to increase opportunities for people to work. These can made by both providing the workers as much skills through education, training and good working environments. On top of that the government shall supply an infrastructure easy to build business on, efficient, stable, work incentives through low taxes, wise investments BIBLIOGRAPHY Books Milton Friedman, Capitalism and Freedom [1962] Milton and Rose D. Friedman, Free to Choose Papers Fallacies of the Negative Income TaxHenry Hazlitt, Mises Daily, December 27, 2006http://mises.org/daily/2406 A Retrospective on the Negative Income Tax Experiments: Looking Back at the Most Innovate Field Studies in Social Policy Robert A. Levine, Harold Watts, Robinson Hollister, Walter Williams, Alice O’Connor, and Karl Widerquist New Research Findings on the Effects of the Earned Income Tax Credit by Robert Greenstein and Isaac Shapiro March 11, 1998 http://www.cbpp.org/cms/index.cfm?fa=view&id=1649 Milton Friedman on Income Inequality Julio H. Cole, Journal of Markets & Morality http://www.acton.org/publications/mandm/mandm_200901121256.php#ftnt_anchr_31

Minimum Wage and Negative Income Tax as Means of Poverty Alleviation

Minimum Wage and Negative Income Tax as Means of Poverty Alleviation

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