What your waitress can teach us about the EITC

I've already written about the inefficiencies and perverse incentives associated with the EITC. However, while commenting on Greg Mankiw's recent post, in which he favors the EITC as an alternative to the minimum wage, I came across a splendid analogy to illustrate my point:

If you decided to give your waitress a particularly generous tip, it it would probably bring a smile to her face. "Gee, Mr.," she might say, "I wish everybody tipped like this." However, if all the customers everywhere in America really did start tipping as much as you did, the same tip will probably no longer bring the same pleased reaction. Is it because the waitress got greedy and entitled? No. It's because as soon as the increased tippage started to make her lot appreciably better, her job became more desirable, and her employer would soon be able to decrease the base wage for her position and still be able to field plenty of applicants. Thus despite getting more in tips, our waitress' overall financial position is not much improved. Right now, the base wage for waitstaff in the U.S. is what, three dollars something on average? Even lower in some establishments. I feel compelled to tip even if the service is on the bad side of mediocre, because if I don't, I'm taking bread out of the server's mouth -- his tip is his pay.

The EITC, in effect is our government attempt to re-destribute income by "tipping" low-waged workers out of the tax-payer's purse in an effort to alleviate poverty. One can see how a analogous, though not entirely similar, dynamic might be at play. Since a certain amount of unemployment has always been with us, and probably will be until the end of time, there is always competition for jobs. The employers will be able to drive the wage of the least-skilled worker down to what the worker needs to live on. However, with the EITC supporting part of the worker's expenses, the amount of wage he or she needs to live on just went down. In the short-run, this means the worker has a surplus of money. In the long-run, her wage will tend to adjust down until she is not really much better off. All on the government's dollar.

But what do I know, right? Greg Mankiw is the guy who literally wrote the book I used in the only class in economics I've ever taken. And he thinks the EITC is the most targeted and efficient way of distributing income. I guess I'm just glad that he feels enough of the egalitarian impulse to keep some form of income redistribution on the table.

I obviously think that the minimum wage would be a better solution, so stay tuned for "What Starbucks can teach us about the Minimum wage". Hint: the lesson is not going to be what you think it might be.