I previously blogged about how there is a natural price of unskilled labor, which is the amount of money it costs to sustain the laborer and allow him to reproduce and raise children thus maintaining the labor pool. (This is also known as the Iron Law of Wages.)
It therefore follows that when the government gives out benefits to poor people, this means they require less additional money to sustain themselves, so as a result of government benefits wages will decrease.
But I also blogged about the idea of an inheritance dividend in which every adult citizen is given an equal share of government profits such that everyone would be able to sustain themselves without having to work at all. The inheritance dividend would lower that natural price of labor to zero. Does it follow that wages would be reduced to zero? This wouldn’t happen because no one would work for free. Most people assume that the inheritance dividend would raise wages because higher wages would be required to lure people away from enjoying life without work.
I therefore conclude that there is an Upside Down Laffer Curve for labor:
When government benefits increase, wages decline because this lowers the natural price of labor. However, there comes a point where wages reach their minimum level and after that point additional government benefits cause wages to rise because workers don’t see the point of working for such low wages when they’re getting such good benefits.
Examples of benefits on the right side of the Upside Down Laffer Curve are Aid to Families with Dependent Children and Unemployment Insurance. These benefits are so good that people can live off them. If the goal is to encourage people to work and contribute to the economy, than these premium-level benefits provide bad incentives.
On the other hand, benefits to the working poor such as Earned Income Tax Credits and Medicaid are on the left side of the Upside Down Laffer Curve. Government benefits for the working poor are bad policy because they lower the natural price of labor and cause lower wages. The end result is a taxpayer subsidy to employers. This distorts the free market by encouraging an economically inefficient over-reliance on unskilled labor.