Keeping people in poverty by trying to bring them out of it

In nearly all 34 countries with modern economies, inequality is rising, a new study by the Organization for Economic Cooperation and Development shows. The gap is especially pronounced in the United States where the country's largest program to alleviate poverty may be adding to the problem, not alleviating it.

The United States ranks fourth in income inequality after Chile, Mexico and Turkey. In the U.S. the best-off 10 percent make on average 15 times the incomes of the poorest 10th, compared to a six to one ratio in the Nordic countries, Austria, Hungary and Switzerland.

The OECD report cites the U.S. earned income tax credit as an explanation for a sharp increase in the hours worked by low-wage Americans.

The tax credit, the largest U.S. program to alleviate poverty, is meant to be an incentive to work, but it may also contribute to poverty, effectively holding down wages of all low-skilled workers. Now how is that?

Imagine that more people whose skills limit them to low-paid work decide to work more hours so they can get the credit. Add in people who have the skills for better-paid work but cannot find it and so take lower-paid jobs because of the implicit supplement to their wages provided by the earned income tax credit.

The result is more workers seeking more work, allowing employers to hold back wage increases or even reduce wages because of the enlarged supply of labor. The employers benefit. The American median wage, in 2011 dollars, has hovered at just above $500 per week for more than a decade.

Add in the elimination of America's largest welfare program 15 years ago, Aid to Families with Dependent Children, and the labor market is flooded with single mothers with few job skills. This not only holds down their pay, it also tends to depress the wages of all low-skilled workers.

DECENT LIFE UNAFFORDABLE

A pernicious problem in America is people who work but whose wages are too low for them to afford a decent life.

One in four Americans earns low wages — less than $11 an hour. Among modern countries only South Korea has a larger share of its workers in low-wage jobs and then only by a smidgen, according to a new study by John Schmitt of the Center for Economic and Policy Research, a liberal leaning economics policy organization in Washington.

Schmitt's work shows that the share of American workers earning less than two-thirds of the median wage has been slowly increasing since 1980, a trend that also goes to the decline of unions due to anti-worker laws enacted by Congress.

The problem is not indolence, the OECD report shows.

America's lowest paid workers, the bottom fifth, are working far more than they once did. In 1986 they put in 1,030 hours, a bit more than half time. By 2004 they were up to 1,300 hours. That is an increase of 26 percent.

Significantly, in almost every other country in the OECD study, hours worked by the poor fell.

DEPRESSED WAGES

The data indeed show that the flood of low-income workers, especially single mothers, is depressing the wages of all low-skill workers. One of four Americans with a job earns less than $15,000 and average income is less than half that.

Research by Professor Bruce Meyer of the University of Chicago Harris School of Public Policies shows that the largest increase in low-wage work was among single mothers with three or more children. In place of AFDC, as it was known, Congress in 1996 adopted Temporary Assistance to Needy Families with a maximum of 60 months of assistance.

Providing day care for children or poor working mothers has become a growing subsidy expense borne heavily by federal and state governments. In many cases the cost of child care, especially when a single mother has two or more children, exceeds what she can earn even working fulltime.

The earned income tax credit has grown rapidly and now benefits 26 million low-income individuals and families, primarily single parent households. The annual cost is approaching $60 billion.

Milton Friedman, the Nobel prize-winning Chicago School economist, proposed what became the EITC, a form of negative income tax, to encourage people to work. He noted that many people on welfare faced marginal tax rates of more than 100 percent if they left the dole for low-wage jobs. President Ronald Reagan championed the EITC because it required people to work to get benefits.

The credit provides its greatest benefits to people making from about $10,000 to $14,000. Earn more and the credit falls off. Work 1,300 hours at $10 an hour and you are in the sweet spot to get the biggest tax credit. Work an extra week and benefits slip.

If the earned income tax credit, combined with the end of welfare as we knew it, hold down wages for low-skill workers then it is time to find smarter ways than Chicago School theories to reduce poverty for those who work.

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David Cay Johnston is a Reuters columnist.