We liberals have been fighting the wrong battle with the Minimum Wage.  I am not sure whether liberals understand the economics of the minimum wage and choose to ignore them, or whether we just don’t understand basic principles of economics.  I can’t do much about the former, but I can at least shed some light on what actually happens when we raise the minimum wage.

We liberals all share a fundamental belief that government has the power and the resources to improve the standard of living of the poor and the middle class in this country.  Because we have the power and the resources, we have an obligation to take action to do so.  But we should also do no harm in the process, especially to those whose lives we are trying to improve.  The Earned Income Tax Credit is a more efficient way to accomplish our objectives, at a lower cost to society as a whole, with fewer unintended consequences that end up hurting poor people.

Let’s first agree on the reason people work at Walmart, Target, McDonalds, or any one of thousands of other low wage companies.  They work there because they do not have the education and skills to work anywhere else, and the social safety net is not generous enough to give them a pass to avoid work altogether.  That’s it.

We will decide to bear the burden of an unskilled and uneducated workforce in one manner or another.  We can raise the minimum wage, which subsidizes labor through increased prices (lower consumption and lower purchasing power), or we can subsidize the people directly through our taxes using tools like the Earned Income Tax Credit.  The latter is more efficient and less costly.

We liberals trumpeted the independence and competence of the Congressional Budget Office (CBO) when it scored the Affordable Care Act (ACA), and concluded it would not only provide health care access for millions of people previously denied, but would actually reduce the federal deficit.  The same CBO undertook a study on the Minimum Wage, using traditional classical economic theory to determine the impact on real income and employment.  If the minimum wage is the engine of change, here’s what the exhaust looks like, according to the CBO, and consistent with classical economic theory:

Real incomes for poor people, in the aggregate, will increase.

The demand for labor will fall, disproportionately impacting lower income families.

Prices will rise, and real incomes for the non-poor will fall.

A significant share of the benefit goes to the children of families well above anything close to the poverty level.

The first outcome makes progress towards our objective.  The next three simply claw back our gains.  We can look to all those empirical studies that show employment didn’t fall after a minimum wage hike.  And that’s exactly what the liberal machine is regurgitating.  Those studies, all of them, are deeply flawed.  Generally, the minimum wage is increased during expansion periods in the economy.  It may well be that employment grew after minimum wage hikes.  Unfortunately, we aren’t very good at considering counterfactuals.  What would have happened to employment if the minimum wage had not increased?  All other things being equal, the demand for labor would have been higher, and employment would have grown even more.  Data without sound theory is sophistry.  To my knowledge, and I’m open to any new ideas on the topic, there is no economic theory that describes how employment and demand for labor increase when higher wage rates are forced by government edict.

See Figure 3, on Page 50 of the CBO report.  You can download all this from the CBO’s web site, including the data behind the graphs http://www.cbo.gov/sites/default/files/cbofiles/attachments/44995-MinimumWage_OneColumn.pdf. 

At the end of the day, we’re talking about increasing real income (inflation adjusted) by a paltry $2 billion across the income spectrum.  Of the 45 million people living below the poverty line, the minimum wage boost to $10.10 would move 900,000 of them above the threshold (about 2%), and would increase their real incomes by an average of just 3% in the aggregate.

Who foots the bill?  Families earning more than 6X the poverty level (ie. $144,000 for a family of 4 or $112,000 for a family of 3) will see real incomes fall 0.4%, hardly the scale of income redistribution we need to make a dent in the standard of living of the poor and middle class.  By way of sacrifice and scale, the most pain will be experienced by the 500,000 workers who will no longer have a job.  That’s the midpoint of the range the CBO identified.

Yes, it’s true most people earning the minimum wage are not white suburban teenagers working at the mall, but age is a huge driver in the demographics of the minimum wage.  23% of workers under age 25 earn the minimum wage, while 97% of workers 25 and older earn more than the minimum wage.  Thus it should come as no surprise that CBO estimates a full 35% of the increased wages will go to families who are more than 3X above the poverty threshold (ie. $72,000 for a family of 4, $56,000 for a family of 3).  Of that, 6% is actually going to families above 6X the poverty level.

The family that tries to support itself on the minimum wage for decades is an image burned in our imagination.  It is a rare exception, and one that can be addressed with exceptional measures.  Using the minimum wage as a tool to help these families is like using a water cannon to extinguish a cigar.  It will work, but the clean-up won’t be pleasant.  While the CBO doesn’t directly quantify the results, we can infer from the data that 65% of the 500,000 workers who lose their jobs will be in families earning less than 3X the poverty level.  That’s 325,000 people out of work who are least in a position to weather a period of unemployment.  I do not know how we liberals can get square with the idea that the least fortunate among us are being asked to shoulder the most pain when it comes to our efforts to raise living standards for the poor and the middle class.  Based on CBO’s confidence intervals, there’s a one-third chance that number will actually exceed 650,000 people.

Remarkably, for as much heat as CBO is taking from the left, they likely understated the negative impacts felt by the poor and overstated the impacts felt by the rich.  The study applies an increase in the general price level of the CPI.  In reality, those economic sectors most heavily impacted by the minimum wage happen to be those sectors whose customers are disproportionately price sensitive.  The family down the street earning $30,000 a year likely spends more each year at McDonalds than the Gates or the Buffets.  Conversely, a minimum wage increase will have virtually no impact whatsoever on the price of corporate jets.

We liberals have a tendency to cut our noses to spite our faces.  It’s out of an innate sense of fairness, that Walmart should be forced to pay employees better….the feeling that society is subsidizing their company, and the $100 billion Walton family in the process.  But that’s all it is….a feeling.  We are not subsidizing Walmart by giving aid and comfort to people of little means.  We are helping people who need help, who are doing their level best, working hard to get by.  It is simply an economic truth.  We can choose to “tax” Walmart via a minimum wage to cure this problem, but be careful what you wish for.  Your sense of fairness ends up raising prices on those least able to afford it, and puts hundreds of thousands of the poorest workers out on the street.  Wouldn’t we be better served by taxing the Waltons instead?  

If you force a wage increase on Walmart, this is what will happen:

1. Prices will go up a little bit (because price is a function of marginal cost, and raising wage rates increases the marginal cost for the retailer).

2. Profit margin will go down a little bit (because Walmart cannot pass on the entire cost of the wage increase on to customers.  Walmart stockholders eat a portion of the “tax” in the form of lower sales).

3. Employment will go down a little bit (because the Quantity of Labor Demanded goes down when the cost of labor goes up).

4. The Labor Force will increase (because the Quantity of Labor Supplied goes up when the price of labor goes up).

5. Unemployment will go up (because Unemployment is 1-(Number Employed/Labor Force), and the numerator number employed goes down while Labor Force increases).

6. Walmart’s stock will fall to the level that relates to the new lower cash flow level.

7. A billionaire who buys Walmart stock after the adjustment will bear 0% of the cost of the increase in wage cost.

These last two points are the reason we liberals will forever frustrate ourselves by trying to get corporations to pay their fair share.  They should always be forced to pay their share of their external costs, such as the cost of cleaning up their pollution.  But welfare is NOT an external cost perpetrated by Walmart on the public.  On the contrary, every dollar they pay an employee is a dollar society saves.  As unsatisfying as that is, it is the truth.

The obvious long term solution is to devote more government resources to improve our education outcomes, and give people the skills they need to improve their own lives.  Since all of us liberals agree with that premise, and agree we should do that regardless of other steps we take, I’ll focus the remainder of this argument on the Earned Income Tax Credit.

The Earned Income Tax Credit (EITC) gives workers in low income families a subsidy, in the form of a refundable tax credit, based on the number of dependents and adult workers and their earnings.  First let’s dispel the myth of families trying to get by on the minimum wage.  It’s generally not the case.  The federal government spends as much on the EITC, about $80 billion, as it does on food stamps.  A single mother of two working 40 hours a week at $7.50 an hour makes $15,150 in wages.  But she also receives child care credits, food stamps, and an additional $5,460 in EITC.  Between EITC and wages, her effective wage rate is $10.20.

The CBO study points out another particularly counter-effective feature of the interaction between EITC and minimum wage.  For hundreds of thousands of families on the margin, the increase in the Minimum Wage will actually decrease the EITC the family currently receives.  The CBO study concludes:

“To achieve any given increase in the resources of lower-income families would require a greater shift of resources in the economy if done by increasing the minimum wage than if done by increasing the EITC.  The reason is that a minimum-wage increase would add to the resources of most families of low-wage workers regardless of those families’ income; for example, one-third of low-wage workers would be in families whose income was more than three times the federal poverty threshold in 2016, and many of those workers would see their earnings rise if the minimum wage rose. By contrast, an increase in the EITC would go almost entirely to lower-income families.”

Another promising aspect of the EITC is that it has the exact opposite impact on employment.  Rather than increasing the unemployment rate (by increasing Labor Supply and decreasing Labor Demand), an expansion of the EITC will increase the Labor Supply without reducing demand.  As the EITC credit rates and eligibility grow, more people on the margin enter the workforce, and many others choose to work more due to the expanded opportunity.  This has positive implications for the economy, including a reduction in demand for temporary social welfare spending and growing contributions to the Social Security Trust Fund.  Indeed, yet another CBO study (March 2012) projected that the EITC has a statistically positive relationship on the number of women who have sufficient lifetimes earnings to draw Social Security in retirement, while also increasing the average amount they will receive.

I count President Obama among us liberals, and his office issued a statement on the Federal Budget that applies equally well to the Minimum Wage debate.  “The president is not going to be in a position where is going to ask senior citizens and middle-class families to make sacrifices….and not ask the wealth, well-connected to make sacrifices, too.”  

 

Does it really make any sense for us to ask hundreds of thousands of low-skilled workers to pay the burden of increasing wages for the poor, in the form of unemployment and higher prices?  Does it make sense to use the Minimum Wage as an excuse to cut EITC benefits to low-income working families?  Not to this liberal, it doesn’t.  We should move the conversation toward increasing the EITC rates, and expanding eligibility.  Let’s target our nation’s resources efficiently to help the greatest number of people at the least possible cost.

CBO EITC Study:  http://www.cbo.gov/sites/default/files/cbofiles/attachments/WorkingPaper2012-06-EITC_and_SS_Retirement_Benefits.pdf

 

CBO Minimum Wage Study:  http://www.cbo.gov/sites/default/files/cbofiles/attachments/44995-MinimumWage_OneColumn.pdf