Should the Minimum Wage Be Raised to $9?—Posner

The President in his State of the Union address last week proposed increasing the federal minimum wage from $7.25 an hour to $9, and then indexing it by the rate of inflation. The proposal will not commend itself to most economists who study the economic consequences of minimum wages. They make three principal arguments: minimum wage laws reduce employment (and efficient resource allocation) by pricing labor above its market rate; the laws do not reduce poverty, because most beneficiaries of minimum wage laws are not poor; and as a means of reducing economic inequality, such laws are inferior to the Earned Income Tax Credit (i.e., the negative income tax). I will try to assess these arguments. 

Although there is some disagreement among economists, the majority of those who actually study the
effects of minimum wage laws agree that they have a modest disemployment effect concentrated on young persons. But the issue is the effect of a 24 percent increase ($1.75 ÷ $7.25) from the current minimum wage; it could be immodest. The effect will vary from state to state, depending on each state’s minimum wage law. A few states set the minimum wage well above $7.25 and one (Washington) has set it above $9, though only slightly ($9.13). In Connecticut and Illinois the state minimum wage is $8.25, in Oregon $8.95, and in Vermont $8.60. But in most states it is at the federal level and in some states it is below it—and some southern states have no minimum wage at all. 

The majority of economists also believe that the minimum wage laws have no effect on the poverty level—except perhaps to increase it. A minimum wage law has no effect on poor people who don’t work, unless they belong to a family that has workers whom the law affects. And because the application of the law depends on the individual’s wage rate rather than on family income, a sizable fraction of those whose wages are affected by such a law are not poor, because they are members of families that are not poor, Many of these beneficiaries of minimum wage laws enjoy family incomes that are twice the poverty level (and thus about $40,000). It has been estimated that only 11 percent of workers paid the minimum wage are actually poor people. 

As for the Earned Income Tax Credit, because eligibility depends on family income rather than on the wages of individual family members, the payments do not benefit the nonpoor, except that, to avoid a sharp cliff, eligibility extends beyond the poverty level. A married couple with two children and annual income of $7000 is entitled to an Earned Income Tax Credit of $2810, rising to $5036 if the couple earns $15,000 and falling to $2179 if it earns $35,000. 

In analyzing the case for and against a hike in the federal minimum wage, one should bear in mind that a minimum wage law is really a form of redistributive taxation. It’s effectively an earmarked tax on employers. Income is redistributed from businesses, and their customers (because a business hit with higher costs, labor or otherwise, will, if its competitors likewise are hit, be able to pass on some of the cost hike to consumers in the form of higher prices), to workers; additional costs are borne by workers who lose their jobs (or can’t find a job) because they are not worth the minimum wage to any employer. With the minimum wage understood as a form of taxation, the objection to a hike in the minimum wage that it will cause a distortion in the labor market falls away; all taxes create distortions. If as some critics of the President’s proposal advocate, the Earned Income Tax Credit is expanded, this will require an increase in federal taxes or borrowing, measures that also distort markets. Furthermore, the Earned Income Tax Credit is limited to families who have minor children living with them, and so provides no redistribution to poor people who are childless, or whose children are grown. 

The fact that the minimum wage mainly benefits workers who are not poor, because they are members of nonpoor families, is a less forceful criticism of the President’s proposal than may appear. The reason is that the poverty line is extremely low. It is $11,170 for a single person and only $23,050 for a family of four. At $7.25 an hour, a minimum wage worker makes only $14,500 in a year if he works 2000 hours a year. That is below the poverty line unless he's single, and if he has minor children and no working spouse he is earning way below the poverty line, although his total income in real terms will be higher because of food stamps, Medicaid, and other benefits available to the poor and the near-poor (though not to all of them; Medicaid for example has quite restrictive eligibility criteria). To recall my earlier example, a worker who makes only $14,500 a year and has two minor children will be eligible for about $5,000 in Earned Income Tax Credit, but his total income will still be below the poverty line for a family of four of $23,050. 

As I have argued in previous posts, income inequality has become a serious problem in the United States. The median income in the United States--$50,000—though far above the poverty level, is too low to enable optimal investments in the human capital of children in families whose total incomes are at or below that level, even with the various governmental benefits available to them. Increasing the minimum wage is an inefficient response to the problem, but what is the alternative? What the advocates of increasing the minimum wage have going for them is a widespread sense that people who work full time at menial jobs (as most minimum wage jobs are) should be paid a decent wage, and that $7.25 an hour is no longer a reasonable estimate of a minimally decent wage for such work. 

Still, a 24 percent increase is a big jump. A prudent compromise might be to increase the federal minimum wage to $8.25 and study the results over a period of a couple of years.

And I don’t think indexing the minimum wage to inflation is a good idea; should inflation surge, which is always a possibility though not (it seems) an imminent one, an equal increase in the minimum wage might contribute to an inflationary spiral.

Comments

[Jdwalton]

It's a red herring -- the White House prefers 1) having a demonizing issue which paints their opponents into a corner than 2) lower unemployment amongst women, teens and minorities.

Logical analysis? -- for the Chicago crowd now transplanted to Washington, it's like the line in "Treasure of the Sierra Madre": "Logic, we don't need no to show you no stinkin' logic".

[onfire]

Why is income inequality a serious problem in US?
Just something for the govt to "fix".

[onfire]

Median income (50,000) is too low to enable optimal investments in children of families at/below 50,000. I paraphrased (accurately I believe). What does that mean??
On the other hand thanks for this bit of clarity: " a minimum wage law is really a form of redistributive taxation."

[Thomas Rekdal]

If raising the minimum wage to $9 per hour results in a net economic benefit to the nation, it will be purely accidental. The notion that something like Posner's careful analysis preceded the president's decision to give it a ballyhoo position in his State of the Union address stretches one's most charitable inclinations.

[Account Deleted]

I think he means that there are still gains to be had for the children of families at or below median income.

Gains that can't be provided unless more resources (income) are brought to bear.

Gains that are supplemented by many of the govt programs (e.g., head start) out there targeting the children of low to middle income families.

With the prevalence of the internet most of the gains to society are to be had in redistributing resources to investing in the children of the below 100 IQ crowd. Those above can, more so than ever before, take care of themselves.

[Terry Bennett]

When all the lumber yards in town agree amongst themselves to charge $4 for an 8-foot 2x4, it's called price fixing. When all the laborers of an employer conspire to demand an artificially high price for their output, it's called a union. I am once again struck by the administration's disingenuous villification of employers, ruthless businessmen doing wrong for profit, taking advantage of the unskilled. This law is in effect telling employers, if you hire poor people, you are obligated to give them charity. I assert that the obligation to give charity, if it exists at all, exists for all of us, and not just those who actually interact with the poor.

Beyond that, as Judge Posner points out a 24% jump in a fragile economy could very well amount to a noticeable disincentive. If you currently pay 10 guys $7.25 it is costing $72.50 an hour to have that team in place. If if's about to cost $90, that extra $17.50 has to come from somewhere - raising prices, maybe laying off a skilled worker, or here's another approach:

There are people in the world whose productivity justifies $7.25 an hour, and there are people whose productivity justifies $7.26 an hour, etc., and there are people who are rightfully $9 workers. As a businessman seeking value for my money, if the minimum wage is $7.25 I am never going to retain a worker whose productivity does not justify at least $7.25, but I may choose to pay more and hire smarter people in some positions when their productivity does so justify. If the $9 law takes that choice out of my hands, I will act intelligently and go get $9 worth of productivity for my mandatory $9 expense. I will fire all those duds that are only worth $7.25, and replace them with people who are worth $9 - and I should only need about 8 of them to get the same output. It's not that complicated, except perhaps for a leader who's never actually worked a day of his life in the private sector.

[Jennifer Thall]

I'd just like to mention that childless workers are indeed eligible for the EITC, although the amount of the credit they are eligible for is quite modest. (Many experts, such as the Center on Budget and Policy Priorities, strongly support increasing the value of the EITC for these low-income childless workers.) Additionally, families with children are eligible for the credit until their children reach the age of 24, so long as they are full-time students.

It is my understanding that in order to truly combat poverty and income inequality, and to ensure that working full-time raises families above even the relatively low standard of the poverty line, it would require a balance of raising the minimum wage somewhat, AND improving the EITC, including increasing the credit amount for childless workers.

To you knowledge, has there been any work examining the potential market-wide effects of enacting improvements to BOTH policies simultaneously?

[richardatlegallyfit]

Just came across your blog and found it really interesting. I have just started a blog with a colleague and are looking for inspiration – keep up the good work – cheers!

Richard

[Scott Slick]

Judge Posner,

Apologies for another aside. But I was just watching one of your interviews on The Big Think. Great stuff. What a gift to have lived in an age where both you and Ronald Dworkin were alive, and able to exchange thoughts and trade criticisms. I actually believe in what Harold Berman used to call "integrative jurisprudence," and thus I derive great enjoyment from reading Dworkin, you, and Holmes.

Best Regards,

Scott

[Vaughn]

Judge Posner,

This detached economic analysis is helpful in framing the issue. But once we do, we should remember that minimum wage laws are intended to serve a purpose beyond merely "to enable optimal investments in the human capital of children," pressing as that objective may be. Like many of our interventions into the labor market, minimum wage laws seek to protect the poor from certain degradations that we deem to violate the baseline of human dignity which every American may expect, independent of his or her economic station. Here, that indignity might be described as the hopelessness and embarrassment of accepting that the value of one's efforts is less than the cost of his or her sustenance. And so even having identified an efficiency disadvantage of the minimum wage as compared to the EITC or other more direct subsidies, in promoting the economic well-being of the poor, the question becomes: is this relative efficiency disadvantage cost-justified in view of the social protection offered by minimum wage laws? The late Arthur Okun eloquently describes this calculus in "Equality and Efficiency: The Big Tradeoff."

How this question should be resolved, and even whether protecting this form of dignity is a worthwhile normative goal (and minimum wage laws an effective means to that end), are complicated policy questions. But to omit these variables from the debate fails to take full account of the proposal's costs and benefits.

Thanks for a thought-provoking post.

Best,
Vaughn

[Terry Bennett]

Vaughn's post posits an interesting predicament: "the value of one's efforts is less than the cost of his or her sustenance".

If the cost of our federal government is $3 trillion this year and we have 300 million people, each American's share of the bill is on the order of $10k. Anyone who pays less than that is freeriding - but none of them seems the least bit "embarrassed", though some do exhibit "hopelessness".

I think the American way is to call a spade a spade and treat everyone fairly, and what we specifically need in our time is for more people, not fewer, to be confronted with the fact that they don't pull their weight - and then we should demand that they either pull harder or lose weight.

[Karlajordan2012]

Employers are indecent to not pay a man a wage that pays their bills. Support the passage of legislation of $9.00 an hour. Hillary Clinton would have had the minimum wagers in the soup lines starving because the moment you get a raise..the company would lay off the entire crew and rehire at the minimum wage level to cut company expenses or send the job overseas to get their products made with $2.00 hour labor in China/Japan/India/ or Mexico!! Give us our pay to cover rent,utilities, food, auto ins, health ins, etc...and recreation.
Support my petition to the congress/senate.
Go to my site www.fightforlivingwages.org
Thanks for your support

[Terry Bennett]

Karla Jordan, your accusation is unfounded. Employers are not the indecent ones. EMPLOYEES are indecent, to demand a wage higher than their productivity justifies, and then when they cannot convince employers to pay it voluntarily, to use the law to bully employers into disadvantageous contracts.

[D]

I know of no definitive studies that show any impact on unemployment, either increasing it or decreasing it. But the chatter that raising the minimum wage increases unemployment continues with no supporting data. My best estimate is that unemployment changes due to mw hikes are lost in the noise caused by other economic impactors. We know that mw increases will be spent because they go to those paid the least--those struggling to get by. It's also likely that they will spend their money at businesses where the mw is paid. How is this a bad thing?

Minimum wage a redistributive tax? Maybe it is. But certainly SNAP and other benefits paid to mw earners now is a subsidy to the likes of Walmart and other businesses who pay their employees very low wages and cannot make a go of it w/o such assistance. How is that not a redistributive tax going to businesses??????

Let's go back to the 1967/1968 when the minimum wages were $1.40 and $1.60, respectively. Run either number through an inflation adjuster and one finds that the equivalent mw today would be $10.00+/- $0.50 There is nothing sacred about the mws of 1967 or 1968, but they seem like a reasonable baseline from the quaint old days when people gave a rat's behind about others.

There were no minimum wage increases during the Nixon years, none during the 8 years of Reagan, none from 1997 through the Bush 2 years until 2007 when the Democrats controlled the Congress. See the pattern here? This suggests that the refusal to grant increases in the minimum wage is purely ideologically driven. We know there is tremendous and increasing income disparity in this country, yet conservatives refuse to address the problem. They claim there are other ways to deal with the problem, which they will not support anyway. And yes, the EITC is just another subsidy for businesses at the government's expense. Why pay your employees more if the government will pick up the tab?

[D]

@Terry Bennett

Worker productivity has gone up at Paul Krugman notes at http://krugman.blogs.nytimes.com/2012/07/17/decoupled-and-divided/

I know. Krugman is a liberal, but the is CBO data that is is presenting. Per capita GDP increase more or less linearly from 1950 to present with a slowdown in the 1970s (oil embargo). Median family income keeps pace more or less until about 1980 where it loses a lot of ground to productivity.

So, you are wrong. Employees will get away with paying as low a wage as they possible can. And right now, they can offer as little in terms of wages and benefits as they choose.