On Earning Subsidies (Part 3) Why is hourly averaging a better than alternative forms of earning subsidy?

There are several types of earning subsidy and I will explain why using my hourly averaging tax proposal as an earning subsidy scheme is much more effective than rival approaches. I will start out by expressing some concerns with existing subsidy schemes, and then highlight why hourly subsidies are more effective. Then I will explain why hourly averaging would be more effective than Edmund Phelps’ alternative hour-based proposal.

Earning subsidy schemes that are based solely on earned income, such as the US system, may encourage people to work fewer hours than they might otherwise. To counteract this, the policy tends to be focused on those with children, and with limited generosity to discourage people from reducing their paid employment. The policy therefore offers little assistance to people without children who work very long hours for low wages.

If it were more generous, in a way that would make a really significant difference to the lives of low-paid people, then it might induce people to work fewer hours as a result. Some people with higher earnings but a desire for more leisure could switch to part-time employment where the subsidy would make up for some of their lost income. These people would consider the remaining reduction their income to be worthwhile given the additional leisure they would obtain, though they would not have done without the subsidy. This would mean that some of the resources in the scheme will be assisting relatively fortunate people in order to enable them to work less. This reduces the resources available to assist others (or increases the expense of the scheme).

One way to increase the generosity of earning subsidies without encouraging people to take more leisure is to add a requirement for the adults in a family to work a certain number of hours each week in order to qualify for the scheme. This is the approach taken with working tax credits in the UK, where people are required to work either 16, 24, or 30 hours in order to qualify (depending on the number of adults and children in the household).

The problem with this approach is that the threshold is going to be somewhat arbitrarily set and will not be suitable for many people. Some people who we would want to assist will not meet the threshold and therefore miss out. The main point is that the threshold will have to be set with the aim of either assisting full-time or part-time low-earners. However, both of these groups could be among the less economically fortunate.

Furthermore, the introduction of a threshold will change people’s behaviour. Some may ensure that they work the numbers of hours required in order to meet the threshold, despite the fact that they and/or their employers would have preferred them to work fewer hours. It will thereby alter the amount of work done in society, potentially providing disincentives for some people to work and extra incentives to others.

Finally, if you add an hour requirement into the system in order to make the tax credits more effective and targeted, then there should be a means to monitor the number of hours worked by those claiming for hour credits. After all, it might appear sensible to introduce several thresholds with each qualifying someone for a different subsidy scheme. However, the more nuanced the scheme the greater the degree of monitoring that will be required. If the number of hours is potentially going to be monitored then my challenge is to ask why not go the whole hog and make good use of this information to generate a more effective system?

This is a challenge I would present to an interesting earning subsidy proposal from economist Edmund Phelps in his book Rewarding Work. Phelps proposes a subsidy that would be paid to employers for each low paid employee with the greatest payments for the workers with the lowest hourly pay. This proposal is the closest in intent to my hourly subsidy proposal, in that the subsidy would lead to higher pay for low-paid workers. However, Phelps proposes that only full-time workers should be eligible. This makes the scheme much less flexible around people’s requirements. If someone has caring or other responsibilities, or simply wants to work fewer hours, they will not receive any support in order to do so. Again this is setting an overly restrictive hours threshold, as part of a system which requires hours to be monitored anyway. 

In summary, earning subsidies are a popular proposal among economists as a way to help the low-paid without discouraging them from working as much as a basic income or negative income tax would. However, the tax credits in place tend not to be generous because this might encourage people to work fewer hours. Some people and governments have realised that earnings subsidies are much more effective if they can be applied on a per-hour basis. However, if account is being taken of the number of hours worked then I would suggest that it is much better to do this properly and provide the subsidy on a lifetime hourly basis. This would target payments to those who have a consistently low income, which is the best available unobtrusive indication of poor economic fortune.