The federal minimum wage increase didn’t survive the “Byrd bath” process in the Senate in the first budget bill this year because it wasn’t sufficiently related to the budget, but what if it was repackaged as a tax instead? That’s the question that economists Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley, raise in a recent paper suggesting a minimum wage tax.
A tax and credit combination designed to mimic a direct minimum wage increase might satisfy the budgetary procedural requirements under the reconciliation process. It would likely face the same political headwinds, which could have the same fatal result for the tax proposal as the Byrd rule did for the direct increase. But what's noteworthy about the proposal is the suggestion that the tax code should be used as a vehicle for enacting items through reconciliation that wouldn’t otherwise make it through the process. The animating idea is that instead of limiting what policies are enacted through the budget process, the budgetary impact requirement could be more or less eliminated.
“Taxes are powerful and versatile. This political moment requires designing policy through taxes and transfers,” Saez and Zucman conclude. They’re right about the versatility of tax laws, as both their proposal and the sheer variety of provisions in title 26 show. Congress isn't limited to using the tax code only for collecting the revenue needed to keep the federal government running. But there's an administrative cost to putting programs that aren’t about raising revenue in the tax code, and the proposal nods to that reality without really addressing the extra administrative burden it would create for the IRS.
The proposal is for a refundable tax credit that would go to employees and a payroll tax on their employers, both set at a fraction of the pay gap, or the difference between the aspirational wage and the actual wage. Congress would set the aspirational wage level. The employer would pay the new tax along with existing payroll taxes. The tax/credit rate presumably would be designed to increase over time.
Employees would probably receive their credit when they file their tax returns, but other provisions might be made for a more regular distribution. By mimicking a minimum wage increase through tax law, the proposal is meant to point out to senators the plasticity of the budgetary rules. “A direct minimum wage increase would be even simpler and hence preferable in principle,” wrote Saez and Zucman. But since the direct approach definitely runs afoul of the budget rules, would an indirect approach have a better shot?
Bypassing the Byrd Rule
The budget process established in the Congressional Budget Act of 1974 prohibits “extraneous matter” in reconciliation legislation. For an item of extraneous material to be excluded from a budget bill, a senator must make a point of order against it. Relevant to the minimum wage proposal, extraneous items are those that don’t produce a change in outlays or revenues, or changes in the terms and conditions under which outlays are made or revenues are required to be collected; do produce changes in outlays or revenues that are merely incidental to the non-budgetary components of the provision; and do increase net outlays or decrease revenues in fiscal years after the fiscal years covered by the reconciliation bill.
Saez and Zucman point out that their policy would increase tax revenues and outlays, which would get it over the hurdle to “produce a change in outlays or revenues” in 2 U.S.C. section 644(b)(1)(A). Because the employer tax and employee credit zero each other out, there shouldn't be a change in overall revenues or outlays — the proposal indicates that taxes and credits are supposed to be collected and distributed in basically equal amounts, or $333 billion in new taxes and $333 billion in new outlays.
A parenthetical in section 644(b)(1)(A) explains that “a provision in which outlay decreases or revenue increases exactly offset outlay increases or revenue decreases shall not be considered extraneous by virtue of this subparagraph.” Thus, a revenue increase that exactly offsets an outlay increase should be fine, as long as there are employers who pay the new tax and employees who receive the credit. If all employers choose to raise wages to the aspirational wage instead of pay the tax, there would be no change in revenue, or any outlays, so the proposal would violate the Byrd rule.
The tax rate is important for two reasons. As a policy matter, it determines how close wages get to the aspirational wage, and for compliance with reconciliation rules, the closer the tax rate gets to 100 percent, the more problematic it becomes. Saez and Zucman note that “a tax of 100% would correspond to an effective minimum wage of $15 but might run afoul of reconciliation rules (as a 100% tax entirely discourages pay below [the aspirational wage]).” They propose gradually increasing the tax rate, and their example ends with an 80 percent rate. But they note that “it is easy to adjust [the aspirational wage] up to target an effective minimum wage of $15 even with a tax rate less than 100%.”
Saez and Zucman also suggest initially including a safe harbor exemption for small employers, such as family-owned restaurants, to reduce their administrative burden. The proposal suggests that if a small employer pays all its employees a wage equal to or greater than the new effective minimum wage, it doesn't have to administer the tax and its employees are ineligible for the credit on their earnings.
Saez and Zucman write that adopting a more exclusive definition of small employer makes the proposal more likely to satisfy the Byrd rule because small employers would be expected largely to use the safe harbor, which would reduce tax collections and credit payments. If enough of them did that because of the broad definition of small employer, the budgetary impact might be too insignificant to pass the “merely incidental” test. However, a broader definition of small employer would reduce administrative costs overall.
If including a statutory safe harbor for small employers is deemed too problematic from a Byrd rule standpoint, Saez and Zucman propose delegating its design to Treasury by adding a statutory mandate, such as “the Treasury shall design a way to reduce the administrative cost on small employers without changing the economic substance of the Act.” But a delegation to write regulations might not withstand a challenge under the Byrd rule, either, because the act of writing regulations to reduce administrative costs wouldn’t produce a change in outlays or revenues.
Other Potential Issues
From the perspective of the credit recipients, a refundable credit might be less than ideal, because they would receive the payment only once a year when they file their tax returns, rather than regularly through paychecks. To avoid that, Saez and Zucman propose encouraging employers to provide the credit immediately to workers in their paychecks. They look to the advance earned income tax credit (AEITC) as a possible model for distributing the minimum wage tax credit through paychecks.
Saez and Zucman acknowledge that the AEITC was unsuccessful — barely any eligible taxpayers took advantage of it — but distinguish it from the minimum wage plan by noting that employers have the information they need for the latter because that information is only the employee’s wages and the amount of credit they would be entitled to for the minimum wage tax. However, the AEITC was complicated, and depending on how the minimum wage tax is structured, it might end up being rather complicated, too.
Unlike a direct minimum wage enacted at the federal level, the minimum wage tax credit would result in different effective minimum wages around the country, because although the rate of both the tax and the credit would be the same everywhere, the amount of the increase would depend on state minimum wages. States with minimum wages above the federal level would have a higher effective minimum wage under the minimum wage tax than states with minimum wages at the federal level. Employers in states with higher minimum wages would therefore pay more per employee in minimum wage taxes than employers in states with lower minimum wages, and employees in the higher minimum wage states would receive larger amounts of refundable credits than employees in lower minimum wage states.
Administrative Difficulties
Administering new programs like a minimum wage benefit would require increased IRS funding. If all employers decided to provide the benefit directly to employees in their paychecks instead of remitting the payroll tax to the IRS, then perhaps the administrative impact would be mostly limited to the agency's examination function, but regulatory guidance requiring IRS resources would still need to be issued.
And if legislators chose not to stick to a completely uniform tax and credit scheme, there could be added complications for the IRS to address. Saez and Zucman propose potentially delinking the tax and credit, at least in some circumstances. For example, the credit could be limited for some taxpayers, like secondary earners with a high-earning primary earner, or dependents of high-income earners. The tax on employers would stay the same, even if the credit amounts to employees differed. Alternatively, the proposal suggests that specific employers could be given a lower tax rate if they had specific characteristics, such as operating in disadvantaged areas. The difficulty with carveouts is that they add complexity. But Saez and Zucman suggest that these types of provisions might help the proposal comply with the Byrd rule by differentiating the policy from a direct minimum wage.