A Smarter Alternative to Raising the Minimum Wage

Josh Barro explains why raising the earned-income tax credit is preferable to increasing the minimum wage. 

One of President Barack Obama's biggest proposals in yesterday's State of the Union Address was a big minimum wage increase, from $7.25 per hour to $9. The trade-off with any minimum wage increase is that it reduces inequality and poverty, but may raise unemployment. As Evan Soltas wrote for the Ticker last month, within the wage range that is on the table, the former effect should be substantial and the latter effect small, if existent. So, raising the minimum wage is a better idea than doing nothing.

But while a higher minimum wage is a way to address poverty, it's not the best way. It would be preferable to increase the Earned Income Tax Credit, a government program that makes payments to workers in low-income households. Unlike a higher minimum wage, a larger EITC would not create any disincentive to hire; and while some of the benefits of a minimum wage hike will go to teenagers in middle-class households, everyone who benefits from the EITC is poor.

So why are we talking about a minimum wage hike instead of a bigger EITC? The big reason is that a bigger EITC would grow the federal budget deficit, while a minimum wage increase is "free." Of course, it's not really free -- just like the EITC, it's a transfer to low-wage workers, though instead of being financed with taxes it will come mostly out of business profits; some of the transfer will come from consumers in the form of higher prices.

But the transfer is done off the government's books, which is what counts in Washington. Slate's Matt Yglesias recently wroteabout this problem in the context of both a federal spending cap and the President's health care reform: When the government is under pressure not to spend, it is likely to pursue inferior regulatory alternatives as a way to hide true economic costs.

So that's why we're left talking about a minimum wage hike. It's not the worst idea -- but there is a better one that would be available if both parties were not arbitrarily focused on hitting a short-term deficit target.

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