Too Optimistic?

Robert M. Solow

If I could have Robert Haveman's program as a substitute for the status quo, I would grab it. And that goes double if I could have him to administer it. The tough monitoring that he emphasizes is an essential part of the scheme, just because the ethic of work and self-reliance is so deeply embedded in American culture (and no doubt elsewhere as well). The hard problem is to keep tough monitoring from spilling over into mere punitive resentment against transgressors and their children. Run by Professor Haveman, the plan offers a useful middle way between the accurately described extremes of Europe and North America. Run by your average Republican governor, the picture is less attractive.

With that understood, I can go on to say where I think the Haveman scheme may be inadequate or over-optimistic.

1. It needs to be insisted that the root of the problem lies in the enormous range of earning capacities generated by the interaction of modern technology (and other influences on the demand for unskilled labor) with the demographic and educational outcomes on the supply side of the labor market. There is no really good way for a market economy to deal humanely with that spread. That is the lesson to be drawn from Haveman's contrast between the European system that sets a floor to family incomes at the cost of unemployment and demoralization and the North American system that tries to maintain employment opportunities at the cost of poverty and demoralization.

The obvious implication is that an important part of any solution is to narrow the range of earning capacities. That means eliminating the long lower tail, not truncating the upper tail. (I am not now talking about the grotesque incomes at the very top of the scale. I mean that we need to raise earning power at the 5th percentile, not reduce earning power at the 95th percentile.) Without progress on the education and training front, Haveman's compromise is just a compromise between failed extremes. Professor Haveman knows this at least as well as I do. The trouble is that this more fundamental approach could hope to pay off in 10-15 years, if we knew where to start now. For the shorter run, there is probably nothing better than fine-tuning the sort of measures Haveman proposes. So I get back to that.

2. I am not sure that the article makes it sufficiently clear that the Basic Income Guarantee applies to everyone, everywhere along the earning scale, or at least sufficiently high up that taking it away will have no meaningful effect on incentives to produce. Otherwise we run into the Iron Law mentioned by Haveman: A basic guarantee at a decent level has to be taxed away at a fairly high marginal rate, unless we are prepared to subsidize those who are already in pretty good shape. But the high tax rate--to which many AFDC recipients are subject right now--is a disincentive to work. The implication is that the budgetary cost of the guarantee will be high.

3. A similar problem arises with the employment-based wage subsidy. I think that the part paid to the worker has to go on forever, if the incentive to work is not to be pulled out from under the low-wage earner after a short interval of benefits. This is not a fundamental difficulty of principle if the goal is to make work more attractive at any phase of life. But it adds to budgetary cost, and it goes against the rage for time limits on welfare receipt. Maybe we should think of this as a litmus test of purpose. If a society really wants to encourage work, the indefinite duration of a work-based subsidy should be no more than a budgetary problem. If the subtext of time limits is simply hostility to the poor, the indefinite duration will be a bigger stumbling block.

4. The same can be said of the employer-based subsidy, only more so. A time limit is an invitation to employers to lay off each subsidized worker at the end of the allowed duration and hire a fresh one to preserve the subsidy. Of course the accumulated experience of the incumbent workers will be a force in the other direction; at very low skills, however, it may not be much of a force.

There is a more fundamental problem with the employer-based subsidy, I think. As Haveman says, the arrangement does not target the employment of unskilled workers directly; the subsidy amounts to one-half of the first $10,000 of wages paid in a year to anyone. But he thinks it will be an indirect incentive to hire the low-skilled. I am not so sure. Suppose I am a marginal worker in the sense that I would cost the firm $10,000 in wages and add $10,000 to the value added by the firm. With the subsidy, the firm clears $5,000 and would gladly hire me. Now suppose I am a worker who usually earns $50,000 and would add $50,000 in value. With the subsidy, the firm still clears $5,000 and would hire me. Where is the bias toward the unskilled? Firms do not care about proportions; they care about dollars. Some more subtle targeting may be needed.

5. As long as we are being optimistic, I will try two constructive additions to the Haveman program, neither of them new. (At this stage of the game, there probably isn't anything new to talk about.) The first applies especially to Europe, but also to the United States. Most economists believe that the "social charges" on wages--health care costs, Social Security contributions, etc.--fall ultimately on the worker no matter who formally makes the payment. This is because the employer cares only about the full cost of an hour of labor, not about its composition. But this proposition breaks down at very low wages, because shifting costs to the worker would violate legal or customary minimum-wage limits. So these non-wage labor costs provide a bias against unskilled workers. The bias may be very large in Europe; and the popularity of part-time no-benefits employment suggests that it is meaningful in the United States, too. The remedy would be to transfer these costs from the employer to the general taxpayer.

The second thought I would like to inject goes back to the underlying source of the problem: the persistence of a long tail of people whose earning capacity is simply very low. Unskilled workers get very low wages because the demand for their services is weak and getting weaker. Anything that increased the demand for unskilled labor would diminish the problem Haveman is trying to ameliorate. William Julius Wilson has suggested a sort of WPA. The deliberate creation of jobs in the service sector might be more in sync with what is happening in the economy at large, and more suitable to welfare recipients as a source of supply.