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Abstract
Two primary wage-support policies help low-income families: the minimum wage and targeted tax credits. Since 1997, when Congress last raised the minimum wage, the real value of the minimum wage has fallen about 20 percent because of inflation, while the earned income tax credit (EITC) and child credit have been expanded. This brief illustrates how current tax rules interact with the minimum wage and considers whether increased tax credits could substitute for minimum-wage increases for those earning the federal minimum wage. Increasing tax credits enough to substitute for raising minimum wage is probably infeasible because of the cost and the high marginal tax rates required. A more direct route to helping low-wage workers is to raise the minimum wage and index it to inflation.
Introduction
Two primary wage-support policies help
low-income families: the minimum wage
and targeted tax credits. The minimum
wage serves as a floor on earnings for most
low-wage workers, regardless of their family
characteristics. The earned income tax
credit (EITC) and child tax credit target
benefits almost exclusively to families with
children and are based on a family’s total
income rather than an individual worker’s.
Congress sets the minimum wage; as of
December 2006, it had last been raised in
1997 to $5.15 an hour. Since that time, the
real value of the minimum wage has fallen
about 20 percent because of inflation. A
recent proposal would increase the minimum
wage to $7.25 an hour. While the
minimum wage stagnated, Congress
expanded both the EITC and the child
credit. Full-time minimum-wage workers
received no benefit from the EITC expansions
and only benefited from the child
credit expansions from 2001 through 2004.
The expansions helped workers with
higher—though still relatively low—wages
much more.
This brief illustrates how current tax
rules interact with the minimum wage and
considers whether increased tax credits
could substitute for minimum-wage increases
for those earning the federal minimum
wage. Raising the EITC enough to
offset the loss in purchasing power of the
minimum wage could prove costly. If
wages were held constant at $5.15 an hour
for a full-time worker,1 the maximum EITC
would have to increase by about $5,000
for a one-earner household to achieve the
same after-tax income as an increase in the
minimum wage to $7.25; the EITC would
have to increase about $6,500 for a twoearner
household to achieve the same
gains. In 2006, a family does not benefit
from the child credit until its earnings
exceed $11,300—or $5.43 an hour for one
full-time worker. Because that threshold
increases each year, families must increase
earnings to benefit in future years. To receive
the maximum $1,000 per child benefit
in 2006, a couple with one child must earn
at least $17,970; couples with two children
must earn at least $24,180.
This analysis shows that increasing tax
credits enough to substitute for raising
minimum wage is probably infeasible
because of both the cost and the high
marginal tax rates required. However,
relatively straightforward modifications
to the child credit could help households
earning near the minimum wage and
others that face a declining child credit
each year. A more direct route to helping
low-wage workers would be to raise
the minimum wage and index it to
inflation.
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