The truth about the minimum wage

Raising the minimum wage is a well-intended way to hurt low-income workers.

Photo: Associated Press

WASHINGTON, January 2, 2013 — The new year brought raises for millions of Americans working for minimum wage, which is set at $7.25 nationally. From the Pacific Northwest, where Washington state hiked its minimum wage to $9.32 per hour, to the Southeast, where Florida bumped its to $7.93, thirteen state legislatures rebuffed the federal standard in favor of one that nips more closely on the heels of inflation.

A crescendo of voices has called for Congress to address the minimum wage over the past year, spawning a House bill, a fast-food worker strike, and a national debate over the efficacy and role of our minimum wage. Predictably, the discussion has devolved into a partisan struggle, with Democrats taking up the mantle of the low-income worker and Republicans shielding small businesses. But what does a federal minimum wage actually accomplish? And why shouldn’t the government just guarantee a high paycheck for every American?


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The minimum wage dates back to 1938, when President Franklin D. Roosevelt signed the Fair Labor Standards Act (FLSA) into law amid judicial opposition. At the time, the law did not even apply to the majority of the workforce, and fixed what was essentially a “wage floor” at just 25 cents an hour. Even at a time when the country was in the throes of the Great Depression, the FLSA drew criticism for its unprecedented oversight.

The idea behind the minimum wage is that the federal government can increase the earning power of all individuals by decree. By that logic, why would the government stop at $10.10 per hour (the current rate on the table), or $15, or even $150, if congressional edicts can unilaterally raise real wages? Minimum wage legislation assumes all business would engage in exploitation if left to price labor themselves, and that Washington knows best what workers in all industries are really worth.

Politicians trot out “better pay” arguments behind a mask of concern for the unfortunate souls trapped in minimum wage jobs. Democrats accuse opponents of a minimum wage hike as obstinate, inhumane capitalists blocking a painless salve for the poor. What they fail to realize, is that raising the minimum wage even just a little reverberates across the economy in damaging ways.

Democrats argue that too many Americans are “trapped” in their minimum wage positions. They claim that increasing the minimum wage will improve the standard of living of these workers. They claim that, since large corporations employ most minimum wage workers, employers could easily absorb a small hike. Finally, they argue that unemployment increases caused by minimum wage hikes are negligible and acceptable when compared with the benefit of higher minimum pay.


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The truth is that two-thirds of minimum wage workers receive a raise within one year of being hired — a far cry from being “trapped” in a low-paying job. This occurs because most minimum wage positions are entry level, and after a worker learns the workings of his industry, he can move up to a higher-paying job. Raising the minimum wage effectively removes the lowest entry-level positions, crippling workers’ chances at climbing a career ladder.

While simple linear logic would agree that raising a worker’s pay will raise his standard of living, this is not always the case. The clumsy patchwork of government assistance programs prevents the poorest Americans from seeing much benefit from a wage increase. SNAP (aka food stamps), the Earned Income Tax Credit (EITC), temporary assistance for needy families (TANF), housing vouchers, child-care subsidies, Medicaid, and more overlap in ways that actually hurt low-income workers as they begin to earn more. Because the programs phase out at different rates as individual incomes rise, workers end up paying very high effective tax rates.

To borrow an example from the Heritage Foundation’s James Sherk, consider a worker whose income is suddenly increased from $7.25 to $10.10. For each additional dollar of earnings, he will pay 15 cents in additional payroll taxes, 15 cents in income taxes, an additional chunk for state income taxes (the average is about 5 cents), and will lose 21 cents of his EITC and 24 cents of his SNAP benefits (again, for each additional dollar earned). Taken together, this forces him to pay an effective marginal tax rate of 80 percent. Simply put, many minimum wage workers will keep just two dimes for every extra dollar they’ll earn thanks to a federal pay bump.

Pat Garofalo at the liberal ThinkProgress blog argues that, since big corporations, which have supposedly made a full recovery from the recession, employ two-thirds of minimum wage workers, they can afford to pay their workers more. This notion would be great — an easy fix — if it were true, but it betrays a shallow understanding of the way the business world works. When variables in the market change, such as price increases due to inflation or a wage increase due to new legislation, a company’s margins remain the same.


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The public berated big oil when gas prices soared several years ago, claiming those companies were price gouging and that they could afford to charge less. However, these criticisms ignore the fact that big oil’s profit margins never changed, and that when the costs for their good went up, so did the prices they charged in accordance with the most basic precepts of capitalism.

Consider the most reviled big retailer in the land, Wal-Mart. “Wally World” has a razor-thin profit margin in such a competitive market; it hovers around 3 percent, which means the company pockets just three pennies for every dollar it takes in. What would be the impact if labor made up 50 percent of Wal-Mart’s costs and the federal minimum wage were bumped from $7.25 to $7.75 an hour, roughly a 7 percent increase?

That hike would eat up an additional 3.5 percent of Wal-Mart’s revenues, swallowing up every penny of profits and putting the company in the red. There is no extra pile of cash stored up in a room somewhere, maliciously being withheld from Wal-Mart employees. If nothing else were done, Wal-Mart would eventually go under. Of course, the only thing the company could do to save itself in that situation would be to cut labor costs — that is, lay off workers. That is exactly the situation that every business faces when the minimum wage is increased, even the big ones.

Many proponents of a minimum wage hike argue that data shows that the employment losses incurred by a higher national minimum wage will be minimal enough to justify it. Disadvantaged workers, such as unskilled workers and those who come from poor communities, are disproportionately priced out of the market when the minimum wage rises. Ironically, it is these very people that the minimum wage increase is supposed to help. If Congress bumped the minimum wage to $10.10 per hour, middle class teenagers and college students who won’t depend on their earnings to live will be attracted to the labor market in greater numbers and crowd out urban teens and older adults who need such jobs to survive.

Congress recently attempted to force the national rate of $7.25 an hour on the American territory of Samoa, which had long enjoyed a separate minimum wage. The tuna canning industry makes up most of American Samoa’s private economy, and in 2007 when the meddling began, almost all Samoans made less than $7.25 per hour, especially in that industry. In 2007, the American Samoan minimum wage, in the canning market, was $3.26 per hour. By 2009, according to time-scheduled rate increases, the minimum wage had jumped to $4.76 per hour.

Rather than stimulate demand and put more money in the hands of families, the wage increases forced one of the only two canneries on the island to shut its doors. The remaining cannery laid off workers and cut benefits, and could not afford to hire any new employees. The Government Accountability Office (GAO) reported that, between 2006 and 2009 when the minimum wage was lifted, employment fell by 14 percent and inflation-adjusted wages actually fell by 11 percent overall. Even in the face of these staggering figures, the governor of American Samoa pilloried the GAO for understating the conditions in the territory. Congress, seeing the damage done by their policy and responding to the public outcry, eventually waived future minimum wage hikes.

Simple economic theory can explain why arbitrary minimum wage increases, such as the one currently being discussed on Capitol Hill, inflict pain: Raising the price of labor reduces the demand for it. Other sources of economic aches come from many varied and nuanced consequences of hiking the minimum wage, but they all boil down to the unshakeable law of supply and demand. In this economic climate, when the surplus of labor is a constant source of strife for Americans, nothing should be done to diminish what little demand remains.


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