Feb 182014

Longbrake3by Bill Longbrake, Executive-in-Residence, Center for Financial Policy

This is an excerpt of the February 2014 Longbrake Letter. To read the letter in its entirety, click here.

President Obama in his 2014 State of the Union address, asked Congress to pass legislation introduced by Sen. Tom Harkin (D) of Iowa and Rep. George Miller (D) of California, which would raise the federal minimum wage from $7.25 per hour, where it has been stuck for years, to $10.10 in three steps over a two-year period and index it to inflation thereafter.

President Obama also announced that he would sign an executive order requiring these increases to be paid by federal contractors. So far in 2014, 13 states have raised the minimum wage.

Broad Public Support Exists for Raising the Minimum Wage

Americans overwhelming support the efficacy of a minimum wage. A recent Gallup poll indicated that 76 percent support raising the minimum wage to $9.00 per hour. This is not just a liberal issue – 57 percent of Republicans are supportive. Historically, surveys have indicated 60 to 70 percent support a minimum wage, but as income inequality has worsened, support has risen.

Congress Has Been Reluctant to Pass Legislation

In spite of broad public support, Congress has not given this issue serious attention. Why is that? Americans have a deep visceral commitment to “fairness” and an aversion to exploitation. Mandating a “living wage” through minimum wage legislation is viewed as a legitimate component of America’s social contract. Based on these values and the broad bi-partisan support, one would think that Congress would have acted long ago.

Lobbyists, such as those representing the restaurant industry, are partially responsible for the lack of action. Politics may be involved as well. Democrats actively advocate raising the minimum wage as evidenced by Sen. Harkin’s and Rep. Miller’s sponsorship of the current legislation. Since this hasn’t been an issue that Republicans have claimed as their own, there is little to nothing for them to gain politically by supporting legislation. Thus, there is little incentive for the Republican-controlled House of Representatives to consider minimum wage legislation.

Economic Arguments Opposing Increasing the Minimum Wage

Economic purists argue that fixing a minimum wage interferes with natural market processes and could lead to fewer jobs. However, most studies of the impact of increases in the minimum wage rate show no significant effect on employment levels. It appears that wage increases typically get passed through to consumers through higher prices. If demand is price inelastic, which means that changes in prices have limited to no impact on demand, then employment would not decline. Other research shows that modest increases in the minimum wage lower turnover and vacancies and this reduces aggregate employment costs and boosts worker productivity, which collectively offset higher direct wage costs.

Even though research shows that increases in the minimum wage rate have little impact on employment, there is some risk that a patchwork approach at the state and local level could have some consequences on a regional basis. This risk can be mitigated through federal legislation. Then, to the extent that higher wages are passed along to consumers through higher prices, this would lift inflation. But, this could be a welcome development at this time because the inflation rate is well below the FOMC’s long-term target level of 2 percent. More importantly, pulling up wages for lower income workers should boost consumption spending and reduce income inequality.

Arguments Favoring Increasing the Minimum Wage

Ron Unz, who is publisher of The American Conservative, is pouring a substantial amount of his personal wealth into a citizen initiative in California which would raise the minimum wage from $9.00 per hour to $10.00 in 2015 and further raise it to $12.00 in 2016. He cites many benefits.¹ For example, he argues that raising the minimum wage would help reduce government spending on social services. It would raise payroll tax revenues, which would improve the long-term solvency of Social Security, Medicare, and other government entitlement programs. It would increase sales tax receipts by enabling higher consumption – the propensity to consume is high for low wage earners and declines as income rises.

Raising the Minimum Wage Rate Is An Inefficient Way to Deal With Income Inequality

Some analysts argue that policy should focus on raising the earned income tax credit (EITC) rather than the minimum wage because the EITC is available only to low-income households and incentivizes employment; whereas, the minimum wage would apply across the board, including benefiting second wage earners in high-income households that do not qualify for the EITC, and, arguably, who are not necessarily victims of income inequality at the household level.One idea is to encourage firms to hire people at low wages, which might breach the minimum wage, and couple that with an expanded EITC for those individuals hired. This is an interesting idea but probably would be very hard to administer.Others argue that the taxpayer funded EITC distorts markets by enabling employers to benefit by paying low wages. An expanded EITC would also result in reduced tax revenues since the EITC works not just as a tax credit but also as a tax rebate for those owing no federal taxes.

Alternatives That Would Be Effective For Job Creation and Improving Income Equality

Ideally, the objective of employment policy should be to increase labor force participation and income equality. The risk of focusing only on income equality is that it will reduce labor force participation especially among those at the bottom end of the income distribution.

One idea is to combine a government-provided wage subsidy with a lower minimum wage requirement that would cover hiring of long-term unemployed workers.

Another idea would be to adopt the German program of job sharing in which rather than laying off workers, all workers in a business work fewer hours and the government makes up the difference in reduced wages. This is an alternative to unemployment insurance and, like unemployment insurance, would be paid for by employers over the business cycle by contributing to an insurance fund. Germany’s program has been highly effective in reducing unemployment volatility. It also weighs against the loss of skills and re-employment stigma that stems from long-term unemployment in the U.S.

Other ideas increasing participation and reducing unemployment faster include providing a cash bonus to people who find jobs and go off of unemployment, providing monthly rather than weekly unemployment benefits which would incent workers to accelerate job searches, and provide relocation subsidies.

While most of these proposals focus on increasing work force participation, a program to guarantee employment at a “decent wage” for anyone willing to work would address both the participation and income equality objectives. A job guarantee program could be run through the government or through non-profit institutions. Government already provides funds to many non-profit social service agencies that are frequently more efficient in delivering social services to the public than is possible through government. An increasing number of non-profit organizations are becoming social enterprises which are run with both a mission and a bottom-line focus.

A job guarantee program would be expensive, perhaps as much as one to two percent of GDP or about $175 to $350 billion annually and would increase federal government outlays by 5 to 10 percent. It would have to be paid for through higher taxes, but a good part of the cost would be covered naturally by higher tax revenues that would flow automatically from increased employment and income levels. A job guaranty program has been much discussed by liberals, but is not a favored approach among conservatives. Nonetheless, it seems an idea worthy of much more serious policy and economic analysis. People forget that the U.S. has engaged de facto in job guaranty programs in times of war. World War II, for example, resulted in full employment and enormous prosperity that was accompanied by rapid increases in the standard of living and a leveling of income inequality.

Concluding Comment

In summary, while as with most issues there is a plethora of views and opinions about raising the minimum wage rate. Although a higher minimum wage is likely to reduce income inequality to some extent, as explained in the November Longbrake Letter – Special Edition: Income Inequality, the forces driving increasing income inequality are deep and broad and solutions to reverse this trend will need to be equally deep and broad and extend well beyond simply raising the minimum wage.

1 Unz, Ron. “Raising American Wages by … Raising American Wages,” New American Foundation, October 2012. Also, see Medina, Jennifer. “Conservative Leads Effort to Raise Minimum Wage in California,” The New York Times, November 25, 2013.

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