Journal Issue: The Next Generation of Antipoverty Policies Volume 17 Number 2 Fall 2007
Gordon L. Berlin
Strategies That Work: Earnings Supplements as a Response to Low Wages
Given these discouraging labor market trends, the changing social norms that led to high rates of single parenting, and the distorted incentives resulting from the briar patch of overlapping benefit programs and cumulative high marginal tax rates, one might reasonably ask: can government successfully intervene to raise incomes and reduce poverty? Encouragingly, a reliable body of evidence demonstrates that work-based earnings supplements—such as the EITC—can be an effective strategy for boosting employment and earnings, and reducing poverty, without distorting work incentives.
The “Make Work Pay” Experiments
Concerned that low-wage work simply did not pay relative to welfare, the State of Minnesota, the New Hope community group in Milwaukee, and two provinces in Canada began to experiment during the 1980s with new approaches designed to increase the payoff from low-wage work. All provided work incentives in the form of monthly cash payments to supplement the earnings of lowwage workers. The payments were made only when people worked, and the amount of each month’s cash payment depended on the amount of each month’s earnings. Minnesota targeted welfare recipients, relied on the welfare benefit system to make payments, and supplemented both part-time and full-time work, while the Canadian and New Hope programs targeted welfare recipients and all low-income people, respectively, operated as independent entities, and rewarded only fulltime work of thirty hours a week or more.
The results were encouraging. The mostly single mothers who were offered earnings supplements in these large-scale, rigorous studies were more likely to work, earned more, had more income, and were less likely to be in poverty than those in control groups who were not offered supplements.26 At their peak, these employment, earnings, and income gains were large—reaching 12 to 14 percentage point increases in employment rates, about $200–$300 more per quarter in earnings, and $300–$500 more in quarterly income. The earnings supplements also had a secondary benefit for children. Preschool-age children of participating parents did better academically than like children in the control group, in large part because their parents had higher incomes and they were more likely to attend high-quality, center-based child care programs.27 The largest and only persistent effects on adults were found for the most disadvantaged participants, particularly high school dropouts without recent work history and with long spells on welfare. For this group, the employment and earnings effects continued through the end of the follow-up period—six years in the Minnesota project— implying that early work experience could provide a lasting leg up in the labor market for more disadvantaged populations.28 The pattern of results also suggests that income gains—and thus the poverty reduction—could be sustained by an ongoing program of supplements.
The findings from the programs in Minnesota and Canada speak primarily to the behavior of single mothers, raising the question of whether offering supplements to single men could have similar effects. The New Hope program did achieve modest, statistically significant gains in the number of quarters employed for men overall, as well as for single men, when cumulated over the full eight-year follow-up period—although the small number of men in the study sample (by design) makes these findings suggestive at best.29
Last, both the Minnesota and the New Hope programs also served two-parent families. In Minnesota, the offer of an earnings supplement led to modest reductions in quarterly employment rates and earnings, principally among the second earner, who could work less because the supplement offset the earnings loss. Cutbacks also occurred in the New Hope program initially, but these were trivial, concentrated among people who were working overtime hours that exceeded forty hours a week, and did not persist. Importantly, work reductions in the New Hope program were limited by the program’s thirty-hour full-time work requirement, a feature the Minnesota program did not share.30
The Earned Income Tax Credit
Recognizing the contradiction of remaining poor while working in a society that values work, policymakers have used employee subsidies as an integral part of the nation’s strategy for reducing poverty since the EITC was first passed in 1975 (to offset payroll taxes paid by the poor). The EITC was substantially expanded in 1986, 1990, and 1993, and today is available to all low-income workers who file tax returns. It is refundable, which means that its benefits are paid out even when the tax filer does not owe any income taxes. More than 20 million taxpayers take advantage of the EITC each year, at a cost exceeding $34 billion, making it by far the largest cash benefit program for the poor.31 By design, the overwhelming majority of beneficiaries are single parents supporting children.
The EITC’s distinguishing feature is its status as a safety net built around work—only people with earnings can claim the credit. The amount varies by both family type and earnings. Families with two or more children can receive a maximum credit of $4,400; those with one child, $2,662; and single adults with no children, $399.32 At its maximum, the credit provides an additional 40 cents for every dollar earned to a family with two children, effectively turning a $6.00 an hour job into an $8.40 an hour job. But this is the maximum credit for a family with two or more children, where the parent is able to earn between $11,000 and $14,400 a year. The average family receives about half of the theoretical maximum either because it earns too little to get the full credit or because it earns too much and is in the phase-down range.
Based on a comprehensive review of studies of the EITC, Steve Holt reports that it reduces family poverty by a tenth, reduces poverty among children by a fourth, and closes the poverty gap by a fifth.33 The Census Bureau, by using a measure of disposable income that relies on revised, and still controversial, definitions of income and poverty and includes all government cash transfers (but not Medicaid or Medicare), and by subtracting both taxes paid (but adding back EITC payments) and work expenses (but not child care expenses), estimates that the 2005 poverty rate falls to 10 percent, about 2 percentage points lower than the official rate.34 The after-tax value of the EITC probably accounts for about half of this reduction. But even so, someone who works full time (2,000 hours a year) at the 2006–07 minimum wage of $5.15 and who receives the maximum EITC credit would still have income below the 2005 poverty line of $15,577 for a family of three ($10,300 in wages plus $4,400 from the EITC, or $14,700).
Nonexperimental assessments find that the EITC affects work in two ways. First, it encourages job taking, especially among single mothers (a 3 percentage point increase in the labor force participation rate of single women with children).35 Several studies estimate that as much as a third of the increase in female labor force participation rates during the 1980s and 1990s was due to the expansion of the EITC.36 Second, in two-parent families, it might reduce by a small amount the hours that second earners work, but there is scant evidence of a reduction in hours worked among single parents.37
Because the bulk of EITC benefits go to families with children and because both parents’ earnings are counted when a couple is married, but only one parent’s earnings count when they are not, the EITC can penalize marriage when both partners work—even as it rewards marriage between a nonworking single parent and a working partner.38 These penalties can be large. According to Saul Hoffman and Lawrence Seidman, a single parent working full time at the minimum wage who marries another minimum-wage earner could stand to lose $1,600, while two full-time workers (each earning $14,000), both with two children, could lose as much as $6,700 in EITC benefits.39 Recently enacted provisions that increase the credit’s value for married couples by several hundred dollars a year attempt to offset those penalties. By 2008, when those changes are fully in effect, penalties would be eliminated for most cohabiting families with incomes below 200 percent of the poverty line, but substantial penalties (averaging $1,742) would still remain for 44 percent of all cohabiting couples, mostly those with incomes between $20,000 and $30,000 a year.40 Two-earner couples where both workers have similar earnings are especially hard hit by EITC reductions if they marry.