The Minimum Wage STILL Isn’t a Good Idea

“Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full-time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour.” – President Barack Obama, State of the Union Address, February 13, 2013

No matter how big the stage you’re standing on when you make arguments for it, the minimum wage still isn’t a good idea.  Ostensibly, the minimum wage is a policy which is supposed to help the lowest wage earners by protecting them from earning less than a living wage from an employer.  In practice, the minimum wage does nothing more than set a minimum on what a worker can sell their talents for – well, short of an unpaid internship (or running a blog!).

So, our goal is to stamp out the poor and ensure that all households earn a living wage, right?  Just like the CAFE standards are a suboptimal way of reducing vehicle emissions, the minimum wage takes a backseat to another policy which is much better at eliminating poverty while spreading the burden equitably – negative income taxes.  We’ll touch on that later, briefly.

Pay Attention to Effects – Not Titles

Lisa: His name doesn’t matter, a rose by any other name would smell as sweet.
Bart: Not if you called him Stench Blossom.
Homer: Or Crap Weed.

-The Simpsons Episode 4F23, The Principle and the Pauper

The Simpsons had it backwards – if you took Stench Blossoms and called them Roses, that wouldn’t make them smell any better.  They would still smell like (and be) Stench Blossoms.  Back in Washington, D.C. or any of the 50 state capitols, coming up with palatable names for things is like a second career for the political subset:  “PATRIOT Act”,  “Pro-Life”,  “Pro-Choice”, “Gun Control”,  “Climate Change”,  “Marriage Equality”.

Putting politically favored labels on movements is big business.

What’s really going on once you strip off all the labels?  Simple – you’re raising the cost of labor.  We go into the whole argument against minimum wages in the archives – but Economics 101 tells you what happens when you raise the cost of something, artificially or otherwise.  In this case there is a subset of employees who would work for less than the price floor but cannot due to the policy.

Labor Supply and Demand Meet the Price Floor

Labor Supply and Demand Meet the Price Floor

Incidence of the Minimum Wage

Incidence, in economics, refers to the group that the effects of some policy would fall upon.  Generally, ‘Tax Incidence’ is the topic – but today we’re going to talk about ‘Minimum Wage Incidence’.

It’s impossible to argue that a minimum wage doesn’t increase the cost of labor.  In the case of the mimum wage, there is the immediate rise in minimum wage costs to $9 an hour in addition to compliance costs, payroll taxes, and other costs (including health insurance – an additional service that all employers will now have to offer or pay a fine).

For the sake of argument, let’s say that the $9 an hour employee now costs $15 to employ, up from $12 previously.  At the most basic level, that means that the employee must be in a role that is worth more than $15 an hour to the company.  If the job was worth $13 and an employer could previously justify the employee?  Well, let’s just say that companies aren’t in the business of losing $2 an hour to keep people employed.

So, in the immediate term, the employer can either lay off employees or raise prices.  This is where it gets interesting… I assume that some of the cost will fall on employers in the form of shrinking margins (say, a $17 / hour role, previously a $12 / hour employee, now a $15.)  The rest?  Passed on to customers through higher prices.

And who tends to bear the increased costs of goods and services from employers that employ minimum wage employees?

Well, let’s just toss up the demographics of two well known chains which have employees who might be affected by an increase in the minimum wage.  One: McDonald’s, where a majority of customers make under $60,000 a year and best fit the category “lower-income households living in city neighborhoods in the South.”  (Inferred from website demographics).  Two: Walmart, with average customer household incomes between $30,000 and $60,000.

So, best guess is the incidence would fall partway between the employers and their customer bases – generally of similar demographics to their employees.  Logically, this makes sense, but also anecdotally – remember the threatened Walmart strike on Black Friday?  Since the people that were in favor of the strike didn’t tend to shop at Walmart, it was more of a hiccup than a major disruption.

Logically, anecdotally, how about academically?  One very famous paper by David Neumark and William Wascher does show that the effect of the minimum wage might be redistribution among poor and almost poor families, just like in our simplified model.  Not the desired effect, I’m afraid.

Where Should the Burden Fall?

I’d argue that the responsibility to ensure a living wage falls on, well, all of us.  It’s one thing to observe an ecosystem in which you don’t participate and be in favor of it changing – it’s another to help change things yourself.  If you never shop at stores with minimum wage employees you might not care if there is inflation among necessities on the low end, however, it’s much better to spread the burden of providing for the lower earners among a larger population – like, say, a whole country.

Think of a puddle, perhaps one foot wide by one foot wide.  That’s the universe of people who work and shop at minimum wage employing stores and business.  Imagine the costs of the minimum wage increase is represented by a small bottle of food coloring.  If you dump the whole bottle into a puddle, what happens?

Now, same analogy, except think of a swimming pool.  The swimming pool is the tax base of the United States – all of us, including the expensive store only shoppers (Whole Foods, Costco and Ikea, at a minimum, here in the Bay Area).  Now if you dump the whole bottle of food coloring into the pool… it doesn’t affect it as much, does it?

Dumping the food coloring into the pool is the negative income tax, a refundable tax credit which can be used to set a living wage.  We’re way too deep into this article (I sort of talk about it here) to discuss a good structure, but the only program we’ve got today which fits most of the requirements is the Earned Income Tax Credit.

Expand the Earned Income Tax

I think it’s unfortunate that the Negative Income Tax is so out of vogue in Washington today.  A well designed NIT set up to properly reward increasing incomes could replace all of the non-health related welfare transfer payments we make today (that’s right – including Social Security).

Of course, even though the EITC was a Republican policy (thank the late Milton Friedman for that), it’s been all but abandoned.  The Democratic alternative, the minimum wage, isn’t good at fixing the problem it attempts to fix, and is likely making things worse.

Anyone think there is a good chance the EITC gets a new look in this environment?

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Comments

    • says

      Is there a reason Nunavut doesn’t have any additional links? I didn’t know that Canada has minimum wages, let alone higher ones than the US.

      • says

        Nunavut is a Territory, not a province. What links/info do you want to find out about?

        Yeah, Canada has always had minimum wages. The last time I was paid $7.65 was about 15 years ago, working in fast food.

        That’s why I had such a culture shock going to the U.S. and realizing what your minimum wages were.

        • says

          Canada, however, is also showing signs of a disconnect near the bottom of the job market. Statistics Canada has the official rate at 7%, but amongst teens (teens are most likely to be paid minimum wage) 13.5%.

          Unfortunately (otherwise it would work universally), minimum wage doesn’t set demand. There are some adjustments to react to a shift, but demographic groups close to the minimum wage often suffer in new job gains (that’s what the study link says – it’s not so much layoffs as lack of new hiring).

          • says

            Canada is just like the U.S., but milder. We experience the same ups and downs, in addition to carrying 165% of our income in debt alone.

            We are learning from the U.S. however, and I heard that Canadians are starting to slow down on taking on debt. A small drop from last year, but we’re slowing down before we crash too badly.

          • says

            Oh no doubt; your demographics might be different, but Canada faces the same Frist World Problems as the Unite States. Also, you have a better home ownership rate despite not allowing commoners to write off mortgage debt. There’s a ton the US could steal from Canada and improve upon – but as for NIT vs. Minimum Wage, I’m staying in the NIT corner, despite the fact it’s a political orphan.

            When I run for President I’ll revive the beast, haha!

  1. Jose says

    I have mixed feelings about the minimum wage. I’m basically a fiscal conservative and fully grasp the economic impact of raising the minimum wage. But I can’t help of thinking back when I worked for the minimum wage and eagerly anticipated the next increase. I also can’t help but think of my kids hitting the workforce. The odds are that their first jobs will probably be minimum wage and quite frankly, I don’t think they can survive on it,

    • says

      I hope you check out some literature on the Negative Income Tax – it’s sort of an orphan right now, but in terms of a poverty reducing policy… well, I can’t think of a better one, haha.

      • Jose says

        I haven’t but I will check it out. I’m a “Fair Tax” supporter but don’t think it ever stands a chance. I’ll look up the negative income tax. It’s probably something I won’t like :D

  2. John S @ Frugal Rules says

    Good post! I just had to shake my head when I heard Obama made this statement. It sounds great (which is why he said it), but once you scratch the surface it really is not all it’s cracked up to be. It’ll affect smaller businesses and also cause increased prices for many. I don’t know if the EITC gets any further look, but who knows with the clowns we have in D.C.

    • says

      It’s probably a wave. I hate to be cynical, but a reformed/pumped up EITC takes a lot of issues off the table, which both parties like to have in order to position themselves as polar opposites.

  3. Bichon says

    Another option, for employers who would be able to pull off such a maneuver, is that those “higher compensated employees” don’t get as large of a raise anymore. I think this is what Obama hopes happens everywhere. NPR Planet Money did an interesting podcast on an underpaid LeBron…and while that deals more with ceilings rather than floors, I still believe there will be a little of everything – more unemployment, more price increases and “sacrifices” by fellow employees to accommodate a higher minimum wage.

    http://www.npr.org/blogs/money/2013/01/04/168627825/episode-427-lebron-james-is-underpaid

    • says

      I suppose the issue in my mind is what the study was citing – what if the HCEs that get hit are the people who make slightly more than minimum wage right now? The reason I’m skeptical is the 2007/2009 experience – I think I hear more complaints about CEO and executive pay today than I did in 2006 (there was no Occupy Wall Street, etc. back then.)

      I had read the reasoning on Lebron, but I’m not sold… firstly because I think how sports are funded in the United States is a bit ridiculous. Publicly funded stadiums and tax breaks for continuing operations, anti-trust exemptions, and tons of politics. Additionally, if he brings $40,000,000 in franchise value – shouldn’t that mean that he should make up to $39,999,999 in a career?

      If I bring my employer $20,000,000 in business, NPV or not, I’m not going to make $19,000,000 for it, haha.

      All that said, if there was no anti-trust exemption it would probably be more like soccer, right? In that case Lebron would definitely be paid more. He and Kobe are the 2 best (current; I’d rather have Durant than Kobe though)) athletes in the NBA, and Lebron has (likely) more healthy years ahead of him. I’m of the opinion athletes, especially in Basketball and Football, are paid too little (I need to update that article). I think Lebron would have been better off as a baseball player (see: Alex Rodriguez), soccer player (see: David Beckham, Lionel Messi), racing (Kimi Räikkönen) or a few other sports.

  4. freeby50 says

    First, I think people make too much out of the minimum wage. Right now we’ve got about 3% of the population working at federal minimum wage. A large % of them are part time employees and teeenagers. So if the minimum age is increased the net impact to the economy is not going to be that much.

    Given how few people actually earn minimum wage Id tend to agree that increasing it won’t reduce poverty much. EITC on the other hand has a direct impact on poverty. So I’d agree there that if you want to cut poverty then EITC is more effective.

    On the other hand, what if we didn’t have a minimum wage? It seems the minimum wage really sets the floor for wages. Its not just what poor people make. Its also the amount that everyone else makes more than. Get my drift? I mean what if minimum wage was $1. Would Starbucks pay $10 or $6? Consider China. Average wages there are around $1-2 an hour. But engineers there don’t make 6 figures they make mid 5 figures. Wages are relative. Also I kind of doubt theres many people who would actually work for less than minimum wage there in the US. (excluding illegal immigrants)

    In short, I think the impact here is much less than people seem to make of it. overall I think the minimum wage is a good thing. I think its sets a reasonable floor for wages that every other wage is built on.

    p.s. I live on the west coast where high minimum wage and inflation adjustments are the norm, plus servers get FULL minimum plus tips. We don’t seem to be hurting from it.

    • Joe says

      Re: minimal impact — I think that’s exactly why it’s being proposed. It’s a carefully-calculated political ploy by Obama to win huge points with his supporters on the hard left “anti-poverty” “community organizer” type people while not actually doing very much. The incidence will fall upon the American consumer in the form of price inflation (after a couple years when it’s worked through the entire system), but Obama expects nobody to notice or care. I don’t think it’ll pump NAIRU (as much as I respectfully defer to microeconomics and charts on most matters). I agree strongly with your earned income tax proposal. People making low incomes just shouldn’t pay taxes and if the American fed gov is serious about “poverty reduction” this is what they need to target. Rather than making it easier to earn more money (at the cost of inflation for everybody), let people KEEP more of the money they earn. It also incentivizes WORK relative to welfare. Finally, I would comment that most of these fools don’t seem to understand the economy is money-neutral in the long run. Raising prices doesn’t create more wealth. It might raise nominal GDP but certainly not real GDP. In the end, prices adjust, a certain segment of the population will continue to make poor choices, and poverty will continue to exist.

      • says

        Wait, back up! So you’re saying it’s possible that politicians don’t want this issue to go away so they can continue to wedge their respective bases around this issue? What is this conspiracy theory?

        I agree on the EITC. Why do we take 7+% in payroll taxes from the lowest income earners (I’d argue, 14+% since the employer pays too) just to give it back to them in 1-45 years? Just replace the whole Robe Goldberg machine with a refundable tax credit. I really think I need to do this article and try to get it amplified/shared a bit – it’s absurd that we are ignoring a program that actually works, heh.

    • says

      I think 3% understates the number of people whose jobs would be affected by this change – only Washington currently has a higher minimum wage than $9, and a number of states have it encoded into law that their minimum wage is “Federal + $x” (off the top of my head, Massachusetts – I used to work there, although never for Minimum Wage. I just remember from the posters on the wall.)

      The issue with those states, including China vs. the United States in aggregate? Cost of living. Setting aside taxes, look at the costs of necessities like food in a state with a higher minimum wage like California, vs., say, Oklahoma. I wouldn’t argue that the entire reason for a higher COL is a minimum wage higher than the average, (in CA? Taxes, Property Values, Energy Costs…) but I certainly think labor costs have an effect effect on the price floor of goods, including necessary goods.

      How about this – which policy would you enforce if you were in charge? I know that I’d go for the EITC. It has probably no political support right now, but you could craft it to replace everything from Welfare to the Minimum Wage to Social Security. I might just have to write an article doing some math on it, but my gut says it would be cheaper to guarantee a minimum household income than to administrate the current system – I’ve read there are something like 50 -70 welfare programs depending on your state.

      “Also I kind of doubt theres many people who would actually work for less than minimum wage there in the US.” – DQYDJ 2012 income: ~ $2,300 (yeah, I bought a bunch of stuff like podcasting equipment.). 7.5 hours in an average week x 52 = $5.89 an hour, haha! (I kid, I’d do this for free!).

      • freeby50 says

        Yes undoubtedly minimum wage does impact prices to some degree. Hard to say how much in general. If you look at McDonalds then its clear that higher minimum wage costs will directly impact the price of their foods. Their labor costs are relatively large % of their costs. I found one source that said that labor is 40% of McD revenues. If you raised minimum wage by 25% then one might expect McD costs to go up 10% directly… maybe. Its not as if McD controls prices and fi their competition didn’t raise prices or the market didn’t want to pay 10% more for a burger then they might not be able to raise their prices by 10%. But one could assume that higher minimum wage leads to higher burger costs in general.

        Its really hard to say what the impact of minimum wage is on prices in general. I can find data for the cost of gasoline and individual grocery staples but those vary for other reasons like proximity to oil & refineries or distance from farms. e.g. Apples are cheaper on the West cost probably because they’re grown in Washington.

        What would I do? Probably not much. If I were a politican I’d probably win some easy points with a large % of the population by lobbying for minimum wage increases. I guess I would support indexing minimum wage to inflation at least so it would be automatic.

        • freeby50 says

          Additional, I found a news article that said the White House claimed that 15 million people would be impacted by an increase to $9. The 3% is of course just the people making the current $7.25 and theres obviously more people that make $7.26 to 8.99 today.

          • says

            I’ll try to figure out people who are at/near minimum wage. I wonder about people who make immediately more, too – $9.50? $10.00?

            If there was a hierarchy of desirable jobs before, how do you think this would affect jobs which are considered ‘above’ minimum wage jobs? It might make a difference in some cases – someone would only take some job if it paid more than an easier minimum wage job elsewhere? I wonder…

        • says

          I think with companies that employ minimum wage workers you might want to look at the margins. Theoretically (if I’m an equality warrior), margins are where I can take money from directly in order to pay workers without raising my prices. Obviously, that’s a dubious argument, since lower margins affect everything from competitor strategy to stock price, but, hey, it’s there. (I’ve seen some arguments about Executive Pay. Same idea, though – if public opinion forces lower executive salaries at MCD and WMT, executives could work elsewhere).

          Yeah, price of food, especially, also has an element of transportation cost. I just try to look at things holistically – if COL is higher in general, it means something. I look at, say, the cost of energy in CA, which is mostly attributable to us importing our energy from other states (‘Transportation Costs’ is broken out by our utility, ha).

          I should have said “If you were dictator and there was no way to get rid of you”, haha. I recognize the general public likes the idea of the minimum wage, and probably is conditioned not to like a program where it’s possible to get credits for not working. Political viability – I’ll work on that.

  5. 101 Centavos says

    I just looked through a series of craigslist ads for my area, at jobs in the lower income range. Except for tips-only jobs (set @ $2.13/hr), and fast-food service, most start at $9, $10 and up to $13 an hour. I know it’s anecdotal, but most full-service restaurants have help-wanted signs. Granted, this is in a suburban area and doesn’t reflect wages paid in more rural settings, but does setting a price floor even matter, when the floor is below the going market rate?

    • says

      Nope, not in that case – not unless there was a shock to the economy where the prevailing ‘minimum’ wage fell – like another recession?

      Best to think about it like something apolitical – like the price of toothbrushes. If the cheapest toothbrush is $3 and the Government says “minimum: $1″, there won’t be any effects – except maybe on toothbrush buyer psychology? Haha – no comment on that part.

  6. says

    I live in a really weird economic region that has a bimodal income distribution. The inflationary aspect of raising minimum wage is terrible for… minimum wage employees. Other than rent, most minimum wage employee friends of mine spend their dollars on … other places that employ minimum wage workers. Examples: bars/restaurants, groceries, liquor store, ski passes (I live in a ski town). So, yes, their income goes up, but their basket of goods is FULL of inflationary goods. So while they take it in the teeth, people like me with higher incomes spend less on the very discretionary goods that employ them, like bars and restaurants. Losing situation. The min wage here jumped $2.25 over two years and I am REALLY looking forward to seeing some economic analysis done, now that it’s implemented and has been around for a little while.

    • says

      It’s funny you mention that – Economic policies are sometimes best seen through the lens of hard to access areas (see: Tobacco Tax in Hawaii vs. Tax Stamp smuggling in the Lower-48).

      I do think the Bay Area (where I live) has really started to have the same income distribution. The East Bay has more of the cheaper to rent homes and apartments, while the South Bay and Peninsula (and, of course, San Francisco and Marin) have inflated to some pretty absurd prices.

      There is no “real” middle class, just an upper middle class consisting of white collar engineers and professionals, and a lower middle class of service professionals.

      That isn’t a comment on the MW so much as something your comment spurred – but if you ever see any literature on the subject definitely send it my way.

  7. says

    Really liked this article and I agree that minimum wage is a bad idea. My one question is about the proposed earned tax credits system. Wouldn’t it change your labor supply curve? For example, say someone is willing to work for $15,000 per year but with the earned tax credits they can take home $15,000 by accepting a salary of $12,000 per year. Wouldn’t that person now work at $12,000 per year which would not address the problem that the program is trying to solve which is increasing peoples wages to a living wage. All it would do is shift some of the salary burden from employers onto the government/taxpayers.

    • says

      Yes, absolutely – once you starting changing the incentives you’re going to change the supply end of the curve, and that’s the subject of a lot of research. I didn’t want to get into the weeds in this piece. (uhh… yet. I think I’ll do something eventually) There’s a lot of interesting literature on the subject, starting with this BLS research review: http://www.bls.gov/opub/mlr/1981/04/art3full.pdf . In it, the researchers found some reduction in supply of hours worked based on the pure NIT scheme (the EITC only pays for earned income, a true NIT would pay regardless of hours worked. Note that a true NIT could replace Social Security if done correctly.)

      The way a NIT is generally done is with a linear reduction in benefits based on dollars earned – so, in some way, it would impose a ‘tax’ on the first dollar of income, but it would be netted out by benefits earned. Let’s pretend we have an absolute floor of $10,000. If you earn $1, we don’t want to reduce the benefit by $1 – because, why work? So, let’s say we impose a 25% ‘tax’, for arguments sake. So, then, you’ll make $10,000.75. (Benefit = $10,000 – .25*Income). $10,000 in income? $17,500 total. All the way to $40,000.

      Obviously, to come up with the right rate you need to have a ton of variables at hand, including the disincentive to work, distributions earned in the US, etc… but that’s the basic idea.

      So, in short, yes. It reduces the incentive to work through the same mechanism that the regular income tax reduces the incentive to work.

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