Friday, November 23, 2012

Minimum Wage vs. EITC

Trying to write from tablet so please forgive typos/grammar.

I've been mulling over a post on Am. Conservative on raising the minimum wage for a while now. My first impression is to largely agree with it. However, the problems this would cause small employers is nontrivial and I don't find Noah Millman's solution of a payroll tax cut all that convincing.

The essential problem I'm seeing is that any free market system necessarily institutionalizes so many advantages for large incumbents* that I fear this shift would primarily disadvantage newer challengers against less creative incumbents who would have advantages such as cheap financing and more short term flexibility in labor/capital tradeoffs.

A different way of achieving some, though not all, of the benefits of an increased minimum wage would be to increase the EITC, and smooth its phase out, and pay for this through increased taxation on high incomes(both corporate and individual). This strategy would reduce incumbency advantages while strengthening the position of those in weaker positions.

*This seems to me to be the big issue ignored by small government proponents. Left to its own operation the market tends to increasing rewards for previous winners while making it progressively more difficult for losers to turn things around, regardless of individual merit. This operates through mechanisms such as cheaper financing, network effects, bargaining power, reputation, flexibility with regards to current capital, ability to wait out downturns/time investments, etc. (all of these things occur simply as a result of inter-firm or individual interaction without any reference to the existence of a state). This should reduce innovation as current incumbents gain systemic advantages allowing them to outcompete otherwise stronger, more innovative firms/individuals that lack these advantages (very simple example, an individual able to finance a startup off a home equity loan can succeed with a much lower return then someone financing off an unsecured loan, leading to situations where the better execution still fails due to finance costs).

The solution to this is for the state to put its thumb on the scale to partially offset the advantages held by incumbents do to properties of free markets. To preserve incentives it is necessary that incumbency advantages not be completely offset, but since most studies show that the magnitude of incentives makes little difference to behavior it is simply necessary to retain some small advantage. This tends to make me feel that programs paid for out of marginal taxation tend to be optimal, incentives are left largely unchanged their magnitude is simply reduced. The problem comes with a too complex tax code which can create new incentives not apparent under a simple marginal tax rate.

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