Tuesday, December 26, 2006

Working at Cross Purposes

Consider this policy aimed to help workers at the bottom of the income distribution:

1. A wage subsidy for unskilled workers, paid for by
2. A tax on employers who hire unskilled workers.

Now, if you think like an economist, you might wonder about the logic of part 2 of this proposal. You might say, "A tax on the hiring of unskilled workers would discourage their employment, offsetting some of the benefits they would get from the wage subsidy. It would be better to finance the wage subsidy with a more general tax, rather than with a tax targeted specifically on employers of unskilled workers."

I agree. So why did I bring up this proposal? Because a policy essentially the same looks likely to become law, having been advocated by Congressional leaders and, recently at his news conference, President Bush. Haven't heard of it? It is called an increase in the minimum wage.


Update: A commenter asked about the technical equivalence of minimum wages with taxes and subsidies. I will leave this issue as an exercise for the reader, but here are some hints about how to think about it in a competitive labor market using supply and demand curves. Let w be the market wage, and let W be the target wage of policymakers. Draw supply and demand curves for labor such that the equilibrium wage in the absence of any policy is below W. Now suppose the government tells suppliers of labor: Whenever w is less than W, you are paid a subsidy equal to W-w. Similarly, it tells demanders of labor: Whenever w is less than W, you are charged a tax equal to W-w. Calculate quantity supplied and quantity demanded as a function of the market wage w. Graph the new supply and demand curves, and I believe the equivalence should be clear.