Wage Subsidies

What’s the difference between a wage subsidy and a minimum wage? What is the cost of a wage subsidy to taxpayers? We take a look at the earned income tax credit and how it affects low-skilled workers. We also discuss Nobel Prize-winning economist Edmund Phelps' work on wage subsidies.

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- [Alex] In our final lecture
on taxes and subsidies,

we're going to take a look
at wage subsidies

and compare them
to the minimum wage.

Suppose that we are especially
interested in increasing the number

of jobs for low-skilled workers.

That is, we think that the value
of these jobs exceeds the wage,

the value, to consumers.

Perhaps because we believe
that there's a special duty

to reduce poverty,
or that an increase in number

of low-skilled jobs
would reduce welfare payments,

or perhaps reduce crime
or inequality

or increase social cohesion.

There may be a variety of reasons.

If that's what we're interested in,
then Edmund Phelps argues

that one of the best means
of doing this

is through a wage subsidy.

So let's take a look.

Well imagine that the market wage
starts out here at $10.50,

and here's the quantity
of labor exchanged

at that market wage.

Our wage subsidy is given
by this wage wedge.

Let's call this a $4 wage wedge.

As usual, we drive it
into the diagram

and that will give us
the wage received by workers

as well as the wage paid by firms.

So notice what
the wage subsidy does.

It reduces the wage to firms
so the firms want

to hire more workers,
and at the same time,

it increases the wage to workers.

And the division is, as usual,
is going to be determined

by the relative elasticities
of demand and supply.

For the same reasons
that a wage tax probably falls

mostly on workers,
a wage subsidy will fall mostly

on workers, as well,
though I've drawn it

more evenly here.

Now what's the cost
of a wage subsidy?

Well the wage subsidy
could have a big cost

to tax payers,
namely the per job cost,

the $4 cost, or this could be
per hour cost,

times the total number of hours.

So the cost of the subsidies given

by this entire blue area
right here.

Now, Edmund Phelps argues
that the cost would actually

be less than this
because of savings on crime

and welfare payments
and other things like that.

So it may be worth doing.

It's also worthwhile to compare
a wage subsidy

with a minimum wage.

Now we haven't actually talked
about the minimum wage yet

and we're going to do so
in a future chapter.

So consider this bonus material.

This maybe material
you may want to come back to

at a later time.

But let's imagine that we
have a minimum wage

at the same level
as would be created

by the wage subsidy.

In this case a minimum wage
of let's say, $12.

Key point --
there are two key points

about the minimum wage.

First, it doesn't cost
the government anything,

which is one reason
why taxpayers may like it

better than the wage subsidy.

It does cost employers.

And what we can see
is that at this minimum wage,

the demand for labor
would be much less.

The demand for labor
would only be Qd.

So a big difference
between a wage subsidy

and a minimum wage
is that the wage subsidy increases

the demand for labor.

It increases the number
of low-skilled jobs.

While a minimum wage
decreases the demand

for labor and decreases
the number of low-skilled jobs.

That's one reason why economists
tend to be more in favor

of wage subsidies than they do
of minimum wages.

We actually have an extensive
wage subsidy program

in the United States
that's very large.

It's not talked about as much
as the minimum wage.

It's called the Earned Income
Tax Credit.

And a lot of economists,
such as Edmund Phelps,

Nobel Prize winner,
argue that a better way

of helping low-skilled workers
is to expand

the Earned Income Tax Credit,
make it available to more workers,

and this in fact would be
superior to a minimum wage.

Okay, we'll be talking more
about these issues later on.

That's enough for today. Thanks.

- [Narrator] If you want
to test yourself

click "Practice Questions."

Or, if you're ready to move on,
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