Could a Direct Wage Subsidy Replace the EITC?

By Kate Skochdopole

Senator Marco Rubio (R-Fla.), like many of his fellow presidential hopefuls, has a plan for the Earned Income Tax Credit (EITC). But unlike many of his opponents, Rubio doesn’t want to expand the EITC. He wants to eliminate the credit entirely and replace it with a direct wage subsidy program for low-income workers – an idea that has been circulating since early 2014.

What form exactly this wage subsidy program would take is still unclear. But the proposal itself has drawn mixed reviews.

Oren Cass, a senior fellow at the Manhattan Institute, supports the idea as an alternative to both the EITC and an increased minimum wage – calling it “a better way to raise paychecks.” A wage subsidy plan that eliminates the EITC and instead gives lower-income workers more dollars-per-hour in each paycheck “is the best way to tackle poverty,” Cass writes in The New York Times. “It responds to the challenging economic landscape facing unskilled workers by raising their incomes, while increasing the incentive for those outside the labor force to step onto the first rung of the economic ladder.”

The benefit of this model, Cass says, is that it would feel like a minimum-wage increase to workers, but since the subsidies would come from the federal government and not from employers, it would interact with the economy like an EITC.

But would a direct wage subsidy be as effective as the EITC in reducing poverty and encouraging work? We asked Elaine Maag, Senior Research Associate in the Urban-Brookings Tax Policy Center.

While Maag acknowledged that both a wage subsidy and the EITC could provide substantial assistance to low-wage workers, she argued that the EITC is supported by years of research demonstrating its effectiveness at reducing poverty and encouraging work. By contrast, the effects of a direct wage subsidy are still unknown. Possibly, a low-income worker could have too high a wage rate to qualify for the wage subsidy, but still be low-income because he or she doesn’t work enough hours. And while a small portion of the EITC goes to employers, she noted that it “seems reasonable to assume that employers would usurp a larger share of the wage subsidy than they can with an EITC, making it a less effective policy.

“One of the reasons that many people favor EITCs over subsidies is that they are administratively simple to deliver,” said Maag. “Key components of the credit depend on information already received by the IRS – namely, earnings and number of children. A wage subsidy would require additional hours and wage reporting, which could be administratively difficult for employers. In addition, employers will have an incentive to over-report hours at under-reported wages in order for employees to appear eligible for the wage subsidy. This is not true with an EITC.”

As more details of Marco Rubio’s plans for the tax code emerge, we’ll continue to provide insights on the costs and benefits of a direct wage subsidy program versus the EITC. To learn more about other candidates’ tax reform proposals and the benefits of the EITC and other tax credits, visit our website.