During recent minimum wage and living wage debates, it is often heard that there is no job loss attached to a mandated wage increase. A majority of economists question the “no displacement” theory, but many policymakers and their constituents believe this theory to be true. Contrary to popular opinion, mandating a higher minimum wage comes at a cost.
But what if, despite a credible body of economic research to the contrary, there is no job loss following a mandated wage hike?
In this study, economists Thomas MaCurdy and Frank McIntyre of Stanford University answer that question. They find that the cost does not disappear. In fact, by some measures, it hurts the poor the most. Moreover, a vast majority of poor families pay this cost despite receiving no benefits from the wage hikes.
MaCurdy and McIntyre simulate the effects of a minimum wage increase in a world with no job loss or decreased profit margins. Their research shows that while 1 in 4 of the poorest workers gain from an increase in the minimum wage, 3 in 4 of the poorest workers lose from shouldering the costs of higher prices resulting from the wage increase. The authors find that when these benefits and costs are considered, the minimum wage is ineffective as an anti-poverty policy. Specifically, they conclude that
- “[L]ow-wage families are not necessarily low-income families. So, contrary to conventional wisdom, raising minimum wages poorly targets the poor”; and
- “when minimum wage increases are paid for by higher prices, … prices rise in a way that implies a burden more regressive [i.e., taking a larger fraction from the poor] than a sales tax.”
The authors project the impacts on families by income class, inferring which families receive higher earnings from an increase in the minimum wage and which pay for this increase through higher prices for goods produced by low-wage labor. They examine the effects of a hypothetical increase of the minimum wage from $4.25 to $5.75 in 1996. A wage of $5.75 in 1996 dollars is about $6.25 in 2000 dollars, which is comparable to the $6.15 minimum recently considered by Congress.
Benefits and Costs of a Minimum Wage Increase
If minimum wages were truly costless, then it would be a simple matter to eliminate poverty by having the government mandate higher wages for all. However, minimum wages, like all forms of price controls, impose costs on society and reduce the welfare of some workers and consumers. These costs range from the hard-to-miss layoffs or cutbacks in benefits or hours, to more subtle effects such as increases in prices of goods and services. Although minimum wage advocates often cite helping poor families as the primary justification for raising the minimum wage, this study finds that the majority of the poor can actually lose from such wage hikes even if they do not lose jobs, work opportunities or benefits.
Policymakers ought to ask such fundamental questions as: Do the benefits go to the intended target — poor families? What are the costs, and how much is borne by rich families as opposed to poor families? Are minimum wages a sensible anti-poverty measure? Or are better, cheaper and more effective measures available?
When the minimum wage is increased, employers of affected low-wage workers face increases in their labor costs including not just wages, but also associated costs such as payroll taxes. The authors consider several ways in which an employer can respond to the increased labor costs.
- First, a business can cut back the number of hours of labor it uses by reducing hours per employee and/or the number of employees. Either way, the employees bear the cost for the higher wages in their reduced work. The authors note that many other researchers have studied and measured such losses.
- Second, if the firm is sufficiently profitable an employer may accept lower profits. However, the authors note that this is unlikely because the employers of low-wage workers are typically in highly competitive industries and have relatively low profit rates.
- Third, an employer can raise prices and accept the risk of consequently losing customers or business.
Other possible responses include reducing fringe benefits and requiring more work effort. In practice, employers are likely to respond in more than one way. For example, even if employers pass costs on to their customers in higher prices, they may also be driven by competition to minimize costs by substituting capital or higher-skilled labor for low-wage labor.
In their study, MaCurdy and McIntyre consider how much minimum wage workers’ earnings would rise if businesses raised wages but did not alter either hours of work or workers’ other benefits. They also consider how much prices for the goods and services produced by minimum wage labor would rise if employers raised prices rather than reducing hours or accepting profit losses. Using economic input-output relationships, they then consider how these price increases would ripple through the economy. They track businesses purchasing these higher priced goods and services, and in turn passing these cost increases on to consumers and other businesses. This allows them finally to use data on family consumption patterns to assess how the price increases affect families in various income groups.
Impacts of an Increase in the Federal Minimum Wage
Their results show just how few of the benefits from an increase in the federal minimum wage would flow to the poorest families. While all low-income families would pay for minimum wage hikes through higher prices, Figure 1 shows that only about 1 in 4 would benefit from an increase by having a worker who receives higher earnings. Moreover, the authors find that after taxes only about 24 percent of the mandated wage increases would go to earners in the poorest 20 percent of families. This share going to the poorest families is significantly lower than the after-tax share going to the richest 40 percent, which receives about 35 percent of the wage increases after taxes. As shown in Figure 2, families in poverty would receive only 17 percent of the increases in earnings after taxes. Consequently, raising the minimum wage is an inefficient way of targeting the poor.
What’s even worse for the poor is that they end up paying for benefits that go to the non-poor. Expressed as a percentage of families’ total nondurable consumption, the extra cost in higher prices is slightly above 1 percent for families of all income groups. If equivalent revenue were raised from families by the imposition of a federal sales tax, the analysis demonstrates that poor families would pay a higher tax rate to finance the costs of minimum wages than more affluent families. As shown in Figure 3, families with incomes in the lowest 20 percent would pay the equivalent of a 2.4 percent sales tax, whereas families with incomes in the top 20 and top 40 percent would pay the equivalent of a 1.7 percent sales tax. Thus, the lowest income group would pay at a higher rate than the top income groups.
Economists consider a tax “regressive” if low-income taxpayers pay the same or a greater fraction of their income in tax as higher-income taxpayers, and “progressive” if low-income taxpayers pay a lower fraction than higher-income taxpayers. According to the authors, the cost of living increases produced by raising the minimum wage impose a burden on poor families that is more regressive than a sales tax.
Impacts of an Increase in the State Minimum Wage
The authors also studied the benefits and costs of a comparable increase in a state minimum wage imposed individually in the states of California, Florida, New York and Texas. The families benefiting from a minimum wage hike are the same regardless of whether the wage increase is mandated by the federal or state governments. Thus, the benefits from a state minimum wage increase are just as poorly targeted to those in poverty as the benefits from a federal increase. The authors also find that the distribution of costs across income groups from a state increase is similar to that for a federal increase. As shown in Figure 3, when a state minimum wage hike is compared to a sales tax, the lowest 20 percent income group would pay at a rate higher than the highest 20 percent (and 40 percent) income group in all four of the states considered.
Conclusion
The authors liken a minimum wage hike that is paid for through higher prices to a public program that “taxes” all families to transfer income almost evenly across the income distribution. In view of this, it is fair to ask whether public support for raising the minimum wage relies on misconceptions about the resulting distribution of costs and benefits. As the authors put it:
“it seems certain that there would be little public support for a national sales tax levied only on selective commodities and used to transfer income in nearly equal amounts to 1 out of every 4 wealthy families as well as to 1 in 4 poorer families. Yet, when one considers passing the costs of the minimum wage through prices, this is the effective outcome of a minimum wage increase.”
If we are to accept the “no job loss” arguments of wage hike proponents we should also recognize the economic truism that there is no free lunch. This research convincingly shows that most of those in the lowest income brackets would be hurt by higher prices while getting no help from the wage increase. Meanwhile, only about 1 in 4 poor families would receive any benefits at all from the wage hikes.