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.