Standard positions / Critics of minimum wage hikes have pointed to the mountain of econometric studies undertaken over the last half-century that show tens if not hundreds of thousands of job losses among covered low-wage workers from even a modest — say, 10% — minimum wage increase.
In making their statistical arguments, critics have inadvertently fortified proponents’ case. Proponents have realized that the critics’ estimated job losses across scores of studies are only a small percentage of the covered jobs — no more than 3% — with many studies reporting losses of under 1%. This has enabled minimum wage proponents to stress that for a 10% wage hike, more than 97% of the covered workers (which can easily be in the millions) will not only keep their jobs but get a raise.
Accordingly, the Congressional Budget Office (CBO) reported in early 2021 that the Biden proposal will give a pay raise to 27 million covered workers while killing off 1.4 million low-wage jobs, which represents only 5% of the total covered jobs. Given the proposed 107% minimum wage increase, this is in line with the findings of past studies.
The proponents can then ask the obvious policy question: How else can the federal government give so many low-wage workers an income boost and raise so many out of poverty (nearly a million Americans, according to the CBO) with so little economic damage? Good point — but only if the proponents have their labor-market economics right.
Increased work demands, cut benefits / Unfortunately, many minimum wage proponents and critics alike have long misconstrued how competitive low-wage labor markets work under wage mandates. Both sides seem to understand that those workers receive low wages because of competitive labor-market pressures they face. But both sides also seem to overlook the fact that those competitive pressures on both workers and employers don’t evaporate with mandated wage hikes. The pressures are simply redirected toward non-money forms of worker compensation.
As economists have conventionally argued, a minimum wage hike will price some low-wage workers out of the market, while attracting relatively more productive workers to the covered labor markets. The result? The emergence of a “labor-market surplus,” which gives employers an ability to replace less-productive workers with automated equipment and processes and with the more productive workers attracted to the covered labor market (increasing job losses among original workers in the covered markets).
Employers need not stop there. With more job applicants than jobs, employers can do what comes naturally, especially under competitive product and labor-market pressures: cut or eliminate whatever fringe benefits they provide (say, discounts on merchandise, full-time work, training, minimal health benefits, flexible scheduling, working conditions, and on-the-job treatment). In addition, employers can increase work demands on covered workers, speeding up their assembly lines or otherwise requiring more output per hour for continued employment. With the emergence of the labor-market surplus, workers must concede because they can be easily replaced. Moreover, as noted, employers will be pressed by competitors to check their labor costs in whatever ways they can to stay competitive on the prices of their products.
Econometric studies have found the predicted effects: Workers covered by the hikes are provided less on-the-job training and health-care coverage, worse working conditions, and fewer opportunities for full-time jobs. Many employees have been asked to do the same work in fewer hours and with fewer coworkers. This means that the job-loss percentages have been minor, but not because the demand for low-wage workers is “inelastic,” as some minimum wage proponents and opponents have contended. Rather, employers have been able to largely offset modest money-wage hikes through reductions in the cost of fringe benefits and with increased revenues from greater work demands and greater worker productivity than otherwise.
That is, a $1 per hour money-wage increase might only lead to, say, a 10¢ increase in employers’ total labor cost per hour. On balance, jobs will still be lost, but only by a small percentage, in line not with the increase in the minimum-money-wage increase, but with the modest increase in employers’ net labor costs per hour.
And it should be noted that claims that low-wage workers’ labor-market demand is highly “inelastic” is problematic at best. A highly inelastic demand means that employers must have few substitutes for low-wage workers. The fact is that low-wage workers earn what they do because (in addition to low-wage workers being relatively unproductive), employers have many substitutes — not the least of which are more productive workers at higher market wages, automated machines and processes, and outsourced production to other firms in lower-wage areas of the country and world.
Lost compensation / Moreover, with a money-wage increase, many retained workers are, on balance, made worse off by forced wage hikes, contrary to what both proponents and critics suggest. Employers provide fringe benefits for a simple reason: they attract more workers at lower labor costs from added benefits and relaxed work demands than would be the case with a commensurate money-wage increase. Also, their workers value the benefits and relaxed work demands more than any resulting money-wage-rate loss that can be expected when jobs are made more attractive. More attractive jobs can lead to an influx of added workers who will drive the money-wage-rate down. If that were not the case, employers would not offer the fringes or lower work demands in the first place.
With an increase in the minimum-money-wage and resulting reduced fringes and greater work demands, the analysis reverses: the value of workers’ lost fringes and the lost value from greater work demands will be greater than their mandated money-wage hike. (For example, a $1 minimum wage hike can lead to $1.10 in lost non-money compensation.).
Econometric studies have uncovered these types of worker loss. North Carolina State University labor economist Walter Wessels found that with a 10% increase in the minimum wage, workers experience a 12% reduction in the overall value of their total compensation packages. In addition, if a minimum wage hike truly made workers better off on balance, then the “quit rate” among covered workers should fall, but Wessel found that it increased.
Increased taxes and reduced government benefits / The foregoing conventional lines of minimum wage analysis overlook the fact that many low-wage workers receive various combinations of government welfare benefits that are “means tested,” or tied to their earned income. This means that hikes in workers’ money income from a higher minimum wage can be expected to lower their welfare benefits — to a surprising extent!
If the federal minimum wage is raised from $7.25 to $15 an hour (meaning that annual income will rise from $15,080 to $31,200 for the typical full-time worker), those workers will pay more in income and sales taxes, and lose a variety of welfare benefits such as food stamps, child-care subsidies, health care, and rental assistance (among many other programs). Craig Richardson of Winston-Salem State University estimates that the so-called “implicit marginal tax rate” for welfare recipients earning less than $38,000 annually can be as high as 95%, which means that for each additional $1,000 in money income from a higher minimum wage, low-wage workers can lose as much as $950 in welfare benefits. Even worse, those implicit tax rates can spike to 1,400% (the so-called “welfare cliff”) when an individual’s annual earnings rise above $43,000.
The proposed increase would do little to raise the net spendable incomes of many low-wage families but would boost the incomes of much-higher-income families.
Richardson recently developed an online “Social Benefits Calculator” (www.forsythfutures.org/benefits-calculator-intro/) to compute welfare benefit losses from money-income increases for North Carolina residents. Using that calculator, he estimated the effects Biden’s proposed minimum wage increase would have for a single mother with two children. If she works full time, her annual money income would rise by $16,120 but she would lose $11,502 in annual welfare benefits and her taxes would rise by $3,178. Her net gain in total annual benefits (added money income minus lost welfare benefits and added taxes) would be just $1,435. Her implicit marginal tax rate on the added minimum wage income would be 91.1%. Her reduced benefits and higher taxes would mean that her hourly $7.75 minimum wage increase would largely evaporate, falling to just 69¢, which would surely dampen her incentive to take a minimum wage job even at $15 an hour.
Backers of the $15 federal minimum wage stress how much low-income families with members now making the current wage of $7.25 need and deserve a pay raise. Ironically, the proposed wage would do very little to increase the net spendable incomes of many low-income families with multiple streams of welfare benefits. The increase would, however, increase the spendable incomes of much-higher-income families that are not eligible for welfare programs, with members (say, teenagers) who would receive the proposed $15 an hour.
Conclusion / The Biden administration’s envisioned doubling of the minimum wage over four years would be far above the “modest” increases of the past, which have been the subject of previous econometric work. This means that the job losses from the Biden proposal could be substantially greater than what was experienced in the past, given that employers may not be able to lower fringe benefits and raise work demands enough to offset a substantial portion of the minimum wage increase.
My University of California, Irvine colleagues David Neumark and Peter Shirley have estimated that Biden’s proposal could reduce covered jobs by 16%. But don’t count on the reduction being that large. Past marginal increases in the minimum wage may not apply to Biden’s proposed “structural” increase.
Also, given that the federal minimum wage has not risen since 2009, employers of low-wage workers could have, in the interim, been adding benefits and reducing work demands (in many unnoticed ways) to attract and retain workers and remain competitive in their labor markets. Those workers’ non-money-wage gains could now be reversed when the minimum wage goes to $15 an hour, lowering the net predicted job losses but also leaving retained workers less well off (and maybe worse off) than proponents and critics now imagine. This is especially true for many low-wage workers who have been able to tap several welfare programs because of their low incomes.
Finally, this should dampen the enthusiasm of those who see the proposed hike as a way to get low-wage workers off “the dole.” Because of the high implicit marginal tax rates, many current welfare recipients will be little better off because of the increase. And as the CBO has recognized, a $15 minimum wage can drive up the labor costs and prices in health care and childcare, causing many American low-wage and high-wage workers to lose health care and childcare benefits.
Readings
- “Benefits Cliffs, Disincentive Deserts, and Economic Mobility,” by Craig J. Richardson and Zachary Blizard. Journal of Poverty, forthcoming.
- “Effects of Minimum Wages on Human Capital Formation,” by Linda Leighton and Jacob Mincer. In The Economics of Legal Minimum Wages, edited by Simon Rothenberg; AEI Press, 2004.
- “Minimum Wage Effects on Training to the Job,” by Masanoto Hashimoto. American Economic Review 72(5): 1070–1087 (1982).
- Minimum Wages, by David Neumark and William L. Wascher. MIT Press, 2008.
- “Minimum Wages and Fringe Benefits,” by Mindy Marks. Washington University at St. Louis working paper, 2004.
- “Minimum Wages: Are Workers Really Better Off?” by Walter J. Wessels. National Chamber Foundation conference paper (Washington, DC), 1987.
- Minimum Wages, Fringe Benefits, and Working Conditions, by Walter J. Wessels. AEI Press, 1987.
- The Budgetary Effects of the Raise the Wage Act of 2021, published by the Congressional Budget Office, February 2021.
- “The Labor-Market Effects of Minimum Wage Laws: A New Perspective,” by Richard B. McKenzie. Journal of Labor Research 1: 255–264 (1980).
