August 2, 2006


So, a commenter (and soon-to-be UChicago applicant) brought up a very good point to my earlier post on the Earned Income Tax Credit. His claim is that while the EITC does increase the supply of labor, the supply shock it induces results in a wage decrease, holding everything else constant. That is true. If you hold everything else constant and increase the supply of labor, the equilibrium wage will drop. But in real life, not everything remains constant.In the long-run, increasing the supply of labor hasn't led to the drop in wages everyone from Malthus to our mysterious commenter both predicted. This is why a sudden influx of immigrants doesn't make everyone in the country poorer (here is a discussion and paper on the matter), or even unskilled labor getting screwed by simple population growth. This is because there is no limit to the number of possible jobs an economy can support (think of the PPF moving out over and over again). Getting the unemployed to enter the workforce allows firms substitute unskilled labor in for more expensive substitutes like technology or capital. This increases efficiency and pushes the PPF out quicker than it would otherwise be pushed out, leading to greater social gains, i.e. increased wages for everyone, which this paper finds the EITC causes.On top of that, the EITC is an replacement for something much more inefficient, government welfare checks. A welfare system only hurts the people on the government rolls and hurts the people whose income is redistributed to the poor. This has huge economic costs associated with it in terms of social welfare. The beauty of the EITC is that it essentially is a way for businesses to pay people welfare checks and increase productivity and social welfare--not harm it.Now compare this to the minimum wage, which the author of the EITC study that the commenter cites finds does lead to cuts in employment. The minimum wage puts people out of jobs and prevents long-run economic growth. Everybody loses with it. Everybody wins with the EITC. The EITC, of course, isn't perfect, but it's silly for "progressives" to prop up the minimum wage as the savior of the American poor.