Thursday, April 29, 2021

The Negative Income Tax Meets the Maximum Wage Ratio

As was discussed in the previous post in these pages, finding the right minimum wage for the entire United States is no easy task. I do think it is safe to conclude that what will amount to a living wage will differ according to circumstances and locality.

Now I have heard from those who suggest that a living, family wage shouldn’t even be the goal of a minimum wage. It is difficult to respond to such people, because it seems to your humble servant that a law that ratifies paying employees less than what is needed to support their families is simply irrational. The reason why people work is to support their families, or at least themselves if they have no family. Allowing businesses to pay less than a living, family wage defeats the whole purpose of work. And it’s no argument that wages should be decided by the market, because there is no market when it comes to wages. Adam Smith himself recognized that employers have a decided advantage when it comes to bargaining, and that they often collude among themselves to hold down employee compensation.

We have now the scandal of people who are gainfully employed full-time, but require the assistance of the government to live. Employers who take advantage of the social safety net, such as it is, to supplement what they pay to some of their workers are really receiving a public subsidy for their workforce. And while I’m hardly the first to mention that, it seems that the situation continues unabated. Legislators, by and large, don’t seem to consider people thus victimized a viable constituency.

Of course, there are those who would solve the problem by eliminating public assistance. I have to think, to hope, that such people aren’t thinking things through. Widespread malnutrition wouldn’t just be bad for those experiencing it; it would be bad for society as a whole. Those for whom human empathy is simply a stick thrown too far for the dog should consider how indefensible our country would become in the face of such a situation, and how much more crime would be engendered. Those for whom the law mandates starvation no longer have a stake in the welfare of the society promulgating that law.

But with the recognition that this plea will fall on some deaf ears, I will move on. For there is one objection to a living minimum wage that has some weight, and that is that it might serve as a discouragement to the start-up, or even the continuation, of some small businesses. We are considering, here, the possibility that there are people who would consider starting a business if they were required to pay X, but not if they were required to pay X+1. And it is certainly the case that large companies more often are able to pay better wages than smaller ones.

There is an extant idea that the minimum wage approach is not the best to ensure a decent standard of living for working people. The alternative suggested is something called a “maximum ratio.” I’ve discussed the ideas mentioned in this post previously, and have shamelessly plagiarized my own work. But it should be discussed in the present series of articles. So, without further ado, this is how it works:

The basic idea is that “the salaries of the top earners within a company” should not “be more than a stated multiple of the lowest salaries.” [1] This is an idea pioneered by Ben & Jerry’s, the ice cream maker, which had a company policy saying that no employee could earn more than seven times that of another.

Now this would not require the government to set a mandatory ratio between the highest and lowest paid employees. Instead, it could be implemented by basing a business’s tax rate on its compensation ratio; the wider the ratio in a company, the higher would be its tax. So a company that paid its CEO four-hundred times what it paid its lowest paid employee would pay at a higher tax rate than a company where the ratio was 20:1. The maximum ratio would be the point at which the tax rate reached one-hundred percent. The rates would be set in such a manner so as to discourage overly wide ratios.

Provided that the rates were properly set, this would help start-ups and other companies with fewer means by allowing them to pay wages they could afford, but would also disincentivize businesses paying their employees less than they are able to pay. Of course, to make it work humanely, there would have to be a sufficient system to supplement incomes where the wages were low. But it would be expected that, given that this system would be of assistance to start-ups and small businesses, total welfare expenditures could be reduced without hurting those who need the assistance.

We cannot assume that every business owner claiming that he or she cannot sustain a raise in the minimum wage is engaging in bad faith. The maximum wage approach, combined with a sufficient income supplement system, can relieve some of the labor cost burden of honest small business owners, while at the same time removing the scandal of people working for a living but still living in poverty.

When it comes to supplementing incomes, simplicity is key. And the simplest approach is what is called a “negative income tax,” or NIT.

The basic idea of the NIT is that an income threshold would be established. Only income above the threshold would be taxable. But if a person’s income fell below the threshold he would receive payment from the government to make up the difference. This approach would eliminate the need for the multitude of agencies that have proliferated under our current system. The “government could effectively ‘cut out the middleman,’ and transfer funds directly from taxpayers to welfare recipients at a substantially lower cost to taxpayers.” [2]

Now this is how the NIT could work in conjunction with the maximum ratio (MR) idea. The percentages and dollar amounts to be used are for illustration purposes only and are provisional. Others may turn out to be preferable upon further analysis. For example, I will be using the 2021 HHS Poverty Guidelines for the 48 contiguous states and the District of Columbia [3], even though those guidelines have been criticized for inadequately assessing a livable income. But the purpose will be to show how the NIT and the MR can interface and work together.

In 1965, during the “golden age of capitalism,” “the ratio between the CEO in a company and the average worker was a respectable 20:1.  For every dollar earned by an average employee, the CEO would rake in $20.” [4] Now this was the ratio between the CEO and a given company’s average employee. But I’m concerned about those receiving the least pay, so I want to establish tax rates for businesses based on the ratio between the pay of a given business’s CEO (or any other officer or owner most highly compensated) and the lowest paid employee. So let’s say that we will set a company’s tax at 20% if that ratio is 40:1. That means that if we start at zero tax if the ratio is 1:1, the tax will be 1% for a 2:1 ratio, 2% for a 4:1 ratio, and so on. The tax will reach 100% when there is a 200:1 ratio.

This will, obviously, keep CEO pay in line. But it will also help small businesses and start-ups by reducing their tax burden if only they narrow their wage ratios.

Now the maximum ratio is intended to replace the minimum wage. But we really don’t want people making $1.00 per hour, because they can’t live on that. So if a company can only afford to pay below what an employee needs to live on, the government will supplement employee pay according the HHS Poverty Guidelines. So if a given employee has a family of four, he needs to make $25,500.00 per year (in the 48 contiguous states and the District of Columbia) in order for his family to not be in poverty. So, under this plan, if the employee makes only $15,000.00 from his job, he will receive the difference in the form of a negative tax from the government (plus more, as I discuss below).

The NIT and the MR work in conjunction here. We don’t want companies that can afford to pay good wages cheating the system by paying low wages and having the rest supplemented by the taxpayers. The MR controls for this, because a company with a wide ratio will pay a higher tax than a company with a narrower one. A business owner, therefore, will not be incentivized to compensate himself at too greater a rate than what he pays his workers. What he pays his employees will limit how much he can pay himself.

But if a person is unemployed and has a family of four, the government will, under this plan, be sending him the entire $26,500.00. And we don’t want a situation where lower wage workers will have the same income whether they work or not. We don’t want a single individual to be in poverty, but we do want there to be an economic incentive to work in all cases.

The poverty line according to the guidelines increases by an amount of $4,540.00 for each person in the household. A person who is working, under the plan, would be treated as if he had one more person in his household than he actually has. A full-time employee with a household of four, would be treated as if he had a household of five. So our worker with a four person family would be brought up to the level of $31,040.00 instead of $26,500.00. Part-time employees would be so elevated according to their hours worked. So, for example, an employee with a four person household working half-time would be treated as if he had 4.5 people in his household, and have his amount brought up to $28,770.00.

Combining the NIT and the MR in this manner would ensure that no one was in poverty, that work was incentivized, that start-ups and small businesses could hire more people, and that unscrupulous employers would pay a tax to compensate for the burden they inflict on the community.

And that is how the plan would work.

Friday, April 16, 2021

What's a Minimum Wage?

In the last offering in these pages your humble servant promised to take a look at two regulatory efforts that have been implemented to ameliorate the ill effects that unregulated capitalism has on the compensation of labor, and one new suggestion that would effectively have the effect of abolishing the distinction between capital and labor. In this post, I will address the minimum wage.

This is a highly disputed area, with studies predicting different results from raising the minimum wage from the current federal level of $7.25 an hour, higher in many states and localities. The problem is that there are different minimum wages in different areas; and it is impossible to study the same area, with different minimums, for the same jobs. The reason why such studies are conducted is to predict what effect minimum wage levels will have on unemployment.

But there are doubtlessly a number of factors that go into an employer’s decision to hire people, the cost of labor being only one. Another is the number of employees it needs to operate its business efficiently. Yet another is the calculation of how much the employer can charge for the product or service it is selling, which is more directly determined by the market than the employer’s costs, a factor that is of no interest to customers.

As to the wages themselves. there is the question of how much people will be willing to accept for any given job; even without a social safety net, wages of a dollar for twelve hours of work would be a waste of time for any prospective employee in the United States. Further, an employer must consider the level of skill a prospective employee will need to bring to his job.

Still, we can take it as a conceptual verity that for the same job, in the same location, an employer’s desire to hire someone will diminish to the extent it has to compensate that person, disregarding other factors. At the same time, the more money people must spend, the better that will be for business generally. So, it isn’t as simple as saying that mandated higher wages will mean greater unemployment; there are other factors in the economy to consider.

Now even if it is agreed that there ought to be some sort of minimum wage, the next question is: how much should it be? I’m going to take it as a given that wages should be, at the very least, sufficient to support an employee and her family. After all, what is a job for?

There will be those who argue that some jobs are for young people who live at home, and that it would be senseless to require that those jobs pay enough to support a family. Those who speak like this usually have jobs like working in fast food establishments in mind. Of course, there are many people trying to support families working in fast food establishments. But we can’t allow such businesses to pay young people less, because that would provide an incentive to hire only young people, to the detriment of the unemployment rate of the adult population. For the same reason, we can’t permit businesses to declare themselves youth employers.

But what is an amount sufficient to support a family? What size family?

One possibility is to consider the fact that families must live someplace, and at the lower end of the wage scale (we’re talking about a minimum wage here) that will be in rented property. And since we’re talking about families, they should, in the United States, have at least one bedroom for the parents, and another for the children. So, we should consider what wage would be necessary to rent an average two-bedroom apartment in the U.S.

It is said that, generally, one’s mortgage payment shouldn’t be more than 28% of his gross income. [1] The median rent for a two-bedroom apartment in the United States in 2020 was, according to one source [2], nearly $1,370.00 per month, or $16,440.00 per year. $16,440.00 is 28% of $58,714.29. Now if we consider one who works 50 weeks per year (because, really, two weeks vacation per year isn’t really extravagant), with 40-hour work weeks, that amounts to $29.36 per hour. That’s a little more than $7.25.

Of course, median rent will vary in different parts of the country. $29.36 per hour will be more than enough in some parts of the country, and insufficient in other parts. And that is the problem with a minimum wage that is uniform for every state and every locality. We can use other criteria than how much it costs to rent apartments, but the same problem will emerge. A nationwide minimum wage turns out to be a blunt instrument for addressing the scandal of people working yet living in poverty.

But it is a problem that must be addressed, because, after all, people work to support themselves and their families; and if they can’t do that because of low wages, the whole purpose of work is defeated. I will make a couple of suggestions in the next offerings.