How To End Welfare `As We Know It' Fast

It would be wonderful if an alternative to both a higher minimum wage and an extensive welfare program would sharply target poor families without reducing employment, encouraging a welfare mentality, or raising government spending. Sound too good to be possible? Such an alternative is not only feasible, but is already part of the U.S. federal income tax code: the Earned Income Tax Credit (EITC).

This program rewards rather than penalizes poor families with working members. In 1996, a family with two or more children that earned less than $9,000 would get a credit equal to 40% of its income. For example, a family with one member working 2,000 hours during the year at the federal minimum of $4.25 per hour would receive a $3,400 credit on annual income of $8,500. The tax credit is unchanged as incomes rise from $9,110 to $11,900, and then it phases out at a 21% rate as incomes increase until families with earnings of $29,000 and over receive no tax credit.

This approach has several advantages over minimum-wage legislation. A hike in the minimum wage raises unemployment by pricing inner-city teenagers and other persons with few skills out of jobs. It also raises costs and reduces profits of smaller companies, such as fast-food franchises, that employ workers with limited skills. This is why small business is the main lobby against hiking the minimum.

The EITC comes out of general tax revenue, so it does not affect the incentives of companies to employ workers with few skills. Empirical studies confirm the prediction of economic theory that the EITC increases the labor force participation and employment of people with low wages because they need to work in order to receive this credit.

FAMILY-FRIENDLY. Another advantage of the EITC is that it increases the incentives of the less skilled to get training, because the credit adds to the low incomes they receive while in training. In contrast, a higher minimum wage removes on-the-job training from the reach of many low-skilled workers. They are, in effect, prevented from paying for their training by accepting wages below the minimum while they are receiving training.

Even economists who support a higher minimum wage admit that it is not a good way to attack poverty. This is because workers who earn wages at or near the minimum, such as teens, frequently belong to households that have total incomes above the poverty line--sometimes well above. The EITC, however, depends on family, not individual, earnings.

Because it is unpopular to pay young, healthy women for not working, many states are beginning to force mothers on welfare under the Aid to Families with Dependent Children (AFDC) program to work. The EITC goes even further in this direction by helping families only if they are employed. Most families under AFDC could be merged into the EITC program and receive government support only when they work.

WIDE APPEAL. Unlike welfare, the Earned Income Tax Credit is fully available to families with both parents present, even when only one works and the other cares for their children. Perhaps the amount paid as a credit should be even greater for intact families, since the tax code should encourage families to stay together.

Studies show that because the tax credit is available only to families with dependent children, some families have falsely claimed dependents. The best solution is to drop the dependency requirement: The working poor should not be required to have dependent children before they qualify for help.

The EITC has been unpopular with some congressional budget-cutters because the federal government already spends $21 billion on this program to help more than 18 million families. However, it also spends $14 billion to help only 5 million families who received welfare under AFDC, and state governments spend an additional $12 billion.

Clearly, the tax credit approach helps many more families than welfare does at about the same total cost. The EITC program could be expanded without raising total government spending if welfare payments were eliminated to women who could work and replaced by government benefits under EITC that rise with earnings.

Congress can greatly reduce welfare "as we know it," and avoid raising the minimum wage, by reforming and even expanding the tax credit for earned income. This should appeal both to conservatives worried about the effects of welfare and minimum wages and liberals who want to help the working poor.

Before it's here, it's on the Bloomberg Terminal.