On Earning Subsidies (Part 2): What are the potential downsides of earning subsidies?

In my previous blog I explained earning subsidies and set out some of those who might react against such a proposal. The positions presented there are no doubt genuinely held and internally consistent ones, though I will not respond to those views in exactly those terms. I will pick out a few genuine concerns about earning subsidies and respond to them in this post.

Of course, when discussing policy options such as earning subsidies the important issue is what you compare them too—the appropriate baseline for comparison. One option is to compare any proposals to the idealised free-market situation in which a minimal state simply provides defence and enforces markets. Given that this imagined society is clearly not good for a large proportion of people—if not everyone—I don’t think I need to compare earning subsidies against this baseline. The two most appropriate comparisons are the following: i) a system which does less for the worst off in the name of economic efficiency and ii) a system which takes an alternative approach to helping the worst off such as “Predistributive” policies such as a reasonably high minimum wage along with other benefits at fairly generous levels. I covered much of the latter comparison in my previous blog on Predistribution.

However, there are some points in favour of Predistributive policies. A minimum wage would cost the government a much smaller amount in order implement; the cost of paying low-paid government workers more and enforcing the minimum wage regulation instead of the cost of topping-up the income of all low-paid workers.  Nevertheless, for the reasons I set out previously the advantages of earning subsidies should vastly outweigh this downside where there are sufficient tax revenues available to fund the earning subsidies.

I will therefore focus on the comparison with a more free-market approach—baseline i) above. The argument here might be that earnings subsidies would change the economy in ways that would make things worse overall and therefore undermine the advantages of the policy. I applied this strategy when arguing against the application of a high minimum wage and so it is only appropriate to consider this against earning subsidies.

I would certainly accept that generous earnings subsidies would change the job market. Just as with the minimum wage the higher net pay could be expected to induce some people to work more than they would have. These additional workers (or hours worked by existing workers) might displace other workers, though unlike the minimum wage the final result is less likely to be involuntary unemployment.

What might be the other changes to the job market? Some people may switch to lower paid employment which they prefer, for example because they enjoy the work more or find it more fulfilling. In this example the person will choose work that pays more, but earning subsidies might enable them to take the work they find more fulfilling. In this way earning subsidies might shift workers towards jobs that they find more enjoyable and away from jobs that provide others with goods and services they would prefer (where the wages people are paid tend to indicate that the work done is more highly valued by others—this is not always true but is enough of a tendency for the discussion here).

One argument against earning subsidies, then, is that they are going to help people who are not really economically unfortunate to do jobs that are less socially productive than the work they might do otherwise. Where this effect occurs society is made worse off while the worker in question has been made better off. In a sense I would accept this point, but my response is that I don’t see a big problem here—the person in question is happier and more fulfilled and the job they would have done is still available for someone else to do. People who have a passion for particular jobs may be more likely to obtain them and this will free up higher paid jobs for other people. Economic productivity may drop very slightly, but I would not think it would fall very much.

A relatively common complaint (usually by left-wingers) against earning subsidies is that employers will respond to them by reducing gross wages. As a result workers get the same pay as they would otherwise but employers save a lot of money on labour costs. The criticism is that government spending is therefore being used to support businesses which pay low wages rather than on other things.

I would not necessarily expect this effect to occur, as it implies that firms choose to pay more than they need to in order to ensure that their workers have a certain level of income, but let us assume that it does. In a competitive market the effect over time of the subsidy will be that the cost of the goods and services provided by these low-paid workers would fall. This is likely to have knock-on effects throughout the economy as the firms buying goods and services from these suppliers will also end up dropping their prices. Cheaper prices are no bad thing, as everyone—including low-paid workers—will benefit from these.

If like-for-like wage falls for low-earners were to occur as a result of earnings subsidies, then these would appear to be an expensive way to assist low-earners. Their effect would be to lower prices for all and hope that this helps low-earners as much as others. However, I do not think that employers would be in a position to drop wages for low-earners (particularly if my other proposal for a guaranteed work-programme were in place).

Indeed, perhaps generous earning subsidies and a generous guaranteed-work programme might provide low-paid workers who do unpleasant and unpopular work with additional wage bargaining power. The guaranteed work scheme would provide an alternative, and earning subsidies would ensure there were plenty of other low-paid alternatives. Employers might have to offer workers more than they would to undertake otherwise low-paid jobs.

I accept that in this scenario consumer prices for some goods and services could increase. However, this would occur in cases where the work is highly undesirable and wages are only kept low due to the desperate position of the workers doing the job. Redistributing towards people who do highly unpleasant jobs does not seem like a particularly bad outcome to me, even if some prices increase as a result.

In the above scenario, however, it is important to stress that not all prices would increase and that some would probably decrease as well. As I have said, my proposals, as with all earning subsidy proposals would change wages and prices compared to other policy-approaches.

Compared to other policies to help low-earners the economic downsides of earning subsidies are not nearly as serious. I do not think the effects on economic incentives are likely to be serious enough to cause us to give up on a powerful method to assist the worst off. Most importantly, a wage and price increase spiral is much less likely.

Is it futile to attempt to provide generous earning subsidies? However, the level of assistance available will depend on several factors. One is the amount of government revenue available for the programme. The other factor is the type of earning subsidy available, and in the following blog I will explain why my hourly averaging tax system provides an excellent method of providing an earning subsidy. 

On Earning Subsidies (Part 1): Why earning subsidies?

Earning subsidies are my preferred method to improve the situation of the economically worst off. The government provides a top up to the income of workers who earn a low amount. These are utilised often under the name of ‘tax credits,’ for example Working Tax Credits in the UK and Earned Income Tax Credits in the USA. The new Universal Credit in the UK is gradually replacing Working Tax Credits.  

Unlike the basic (or unconditional, or citizen’s) income this subsidy only goes to those who work. This is achieved by only taking account of income received as a result of working (earnedincome), or by taking a declaration of the fact that someone is working, or the number of hours which they have worked.

If earning subsidies directly assist the right people, why are they not universally accepted as a good idea? Some on the left think that employers should be paying their staff rather than leaving the government to pick up the tab. This is no doubt often because they want the state to do a lot of other things and money spent supporting workers leaves less money available for other projects. Many on the left are also heavily involved in the Trades Union movement, and Unions will also be sceptical of earning subsidies for similar reasons.

Those on the right might be sceptical of earning subsidies for several reasons. Some think that free markets produce the correct outcomes and that it is always wrong to interfere with them. Others may see earning subsidies as a disincentive for people to work harder or show ambition, and that this might have unwanted economic consequences. The left-wing characterisation of the right-wing view on this might be that they want workers to be desperate and have little choice but to take terrible jobs for very little pay. I hope that this characterisation would not be correct, but I fear there might be some terrible people who would hold this view.

I will consider the more sensible concerns about earning subsidies in the next part of this series of blogs. I should mention that despite the ideological opposition described above most pragmatic and centrist politicians and activists are supportive of earning subsidies. There is good reason after all—channelling government spending to people who are doing economically useful activities but getting paid very low wages for doing so. In the third part of the series I will explain why my hourly averaging system would provide a much more effective method of assisting the worst-off than existing earning subsidy proposals.