Minimum Wage

Update 3/28/2016: California legislators have agreed to an incremental minimum wage increase to be introduced in the legislature. This will likely supersede the competing ballot initiatives backed by unions. The bill passed both houses, and the Governor signed. Now, the process of incrementally raising the minimum wage will begin. I still believe quite fervently that my tax cut proposal for small- and medium-sized businesses would be a vitally important feature to add.

My Policy Prescription in Brief: I support an incremental minimum wage increase up to $15 per hour, statewide. I base this upon the great preponderance of empirical evidence compiled and examined by economists over the course of the past three-plus decades studying the consequences of prior minimum wage hikes. The data demonstrate that the economic benefits of a minimum wage increase far outweigh any predicted, real or claimed economic costs. What's more, I believe a statewide progression toward a $15 an hour minimum wage is important for the sake of economic stability; it is vital that both firms and workers have a consistent minimum wage level with which to work and for which to plan across the entire state.

However, proper safeguards for small- to medium-sized businesses will need to be built-in to the legislation to mitigate the initial costs of implementing a statewide minimum wage. CLEARLY, not all small- and medium-sized businesses can just absorb these increases in labor costs. Specifically, a short term tax credit would be made available for one year to 18 months for which any and all businesses that employ five to 100 minimum wage workers could apply (the exact numbers will obviously need to be hammered out among interested parties; my rationale for these numbers is explained below).

There is no “us versus them” here. Businesses ARE the lifeblood of our communities. We need to assist businesses as we mandate them to do what most business owners would already do voluntarily if they felt they could afford it—give their lowest paid workers a raise to a living wage.

Once the $15 per hour threshold is met statewide by, ideally, around 2020, I would be in favor of legislation that would index the minimum wage to the national inflation rate for a 10 year period, to be sunsetted in 2030 or 2032, for reevaluation before renewal by the legislature.

Below, I address these positions with much greater detail, and I add some empirical data to back up my positions:

Rationale: Arguments for Minimum Wage from Four Perspectives

The debate over the minimum wage really centers on four, fundamental questions—I will answer each below to elucidate my policy prescription:

  1. On balance, does raising the minimum wage help workers (especially the low skilled and the very young) or hurt the large majority of them?

    This question is more complex than it seems, because we must take into account predominant economic theory first and foremost:

    The Economic Theory on Instituting a Minimum Wage: While recipients of a higher minimum wage instantaneously and undeniably benefit from greater purchasing power, economic orthodoxy tells us quite plainly that an “artificially” mandated higher wage (in other words, a governmentally instituted minimum wage that comes from outside of the market itself) should simultaneously create:

    1. greater demand for the jobs at the higher wage level, while it concomitantly should

    2. reduce the number of jobs offered or available due to the higher cost of labor for employers.

Thus, the economic orthodoxy tells us that an “artificial” minimum wage (again, instituted by the government, rather than set by the market) benefits only a few workers, and makes both businesses and most other workers suffer from a skewed market that reduces available jobs just when more are desired. What’s more, the workers that do keep or receive the higher paying available jobs are forced to work harder; they must be more productive because there are fewer workers overall at each firm, and the same amount of overall output is still required by these firms as they compete for business in the market….

This economic theory is the basis for those who say that “raising the minimum wage is a ‘job killer’ and will harm the economy.” It is a fundamental reason why many well-meaning people oppose raising the minimum wage. Further, any sensible business owner wants to keep costs down in all facets of their business. Such desire elicits an immediate, negative reaction by many business owners to the concept.

Thankfully, however, economic theory does not always demonstrate itself to be true when applied to real life—and there is growing evidence that the economic theory on the detriments of raising the minimum wage is flawed.

Why? Most fundamentally because we don’t see the predicted results actually materialize on an aggregate economic level when the minimum wage is actually raised. How can we say this so confidently? According to a literature review of the relevant, rigorously peer-reviewed economic studies on the effects of minimum wage hikes (studies of municipal, county and statewide hikes as well as national adjustments to minimum wage) over the last 30+ years undertaken by the Center for Economic Policy Research (CEPR), there is no discernible evidence from any instance that demonstrates these harmful overall economic effects in any significant way—not for workers, not for businesses, not for consumers and not for the economy as a whole. These data demonstrate the negative perceptions to be inaccurate in reflecting the overall picture. Certainly, as demonstrated below, some of the above mentioned negative effects do occur. However, the literature tells us that, in the aggregate, these negative effects are not by any means the dominant outcome. Anecdotes will always exist reflecting specific situations, but the evidence tells us that anecdotes do not represent the whole market in the case of minimum wage.

With regard to workers, the data demonstrate that “the minimum wage has little or no discernible effect on the employment prospects of low-wage workers.” (Schmitt, pg. 22) What’s more, the review clarifies that,“[a]cross all of the empirical research that has investigated the issue, minimum-wage increases are consistently associated with statistically significant and economically meaningful increases in the wages of affected workers.” (Schmitt, pg. 22)

Thus, from the workers’ perspective, the benefits come through. The predicted downside does not seem to materialize.

2. But, on balance, doesn’t raising the minimum wage hurt businesses, even if it does benefit workers?

The data tell us that raising the minimum wage—though undoubtedly disruptive and perhaps alarming to employers—does not actually hurt employers in the aggregate. There is some pain to be absorbed, to be sure (see below my proposition to help small- and medium-sized businesses in this transition), but what the accumulated data actually demonstrate is that employers adjust to minimum wage increases much the same way they respond to other rising costs of doing business—with a multifaceted approach that does not solely concentrate on eliminating minimum wage or other workers. And, because of such multifaceted approaches, the strategies that do have negative effects on individual workers and businesses do not translate to ill effects across the economy (which is good).

Some of the admittedly undesirable strategies are (1) laying off/eliminating employees; (2) cutting back on benefits; (3) cutting wages and/or benefits for other, higher paid workers; (4) raising prices for consumers; or (5) settling for lower profits, and thus eating the cost. Each of these reactions individually can be quite harmful. But, employed in some combination, the ill effects of these strategies can be somewhat muted.

What also can mute these ill effects is the more positive adjustments and consequences pointed out in the studies. These include firms (1) becoming more efficient in order to reduce costs to offset increased labor costs; (2) experiencing less employee turnover thanks to the better wages; (3) and gaining more productivity and hard work from workers in response to the wage increase. (Schmitt, pp. 22-23)

The combination of these possible responses by business to a minimum wage hike offset each other—albeit imperfectly. There are still overall costs with which to contend. That is where government must come in. By making a minimum wage a statewide reality, it puts all regions of the state on an even playing field and solves competitive differences that can emerge among municipalities and regions that have different minimum wage levels. That will help, rather than hinder implementation and help to mitigate the source of a key objection. (Namely: “How do I compete with my neighbors if they pay their employees less for the same production?") By putting the entire state on the same footing, businesses do not have to worry about being at a competitive disadvantage for labor costs, and quantity and quality of workers in the labor pool.

But, government must also treat businesses as partners in this matter—because they are the lifeblood of California's economy. The state cannot mandate a wage increase upon them, and then simply say, "live with it." CLEARLY, not all small- and medium-sized businesses can just absorb these increases in labor costs. Government needs to offer assistance to ease the blow for small- and medium-sized businesses.

In such cases, I propose a short term tax credit of, say, 60% of each added increment of the minimum wage, at each additional interval of minimum wage increase, up to a certain ceiling to be determined in the legislature, available at the conclusion of each interval. Any and all businesses that employ (let's say) five to 100 minimum wage workers could apply. (Why have a low end number? It might offer an incentive to a business that employs, say, two minimum wage workers to hire three more—because it may actually be more economically lucrative thanks to a tax break.) Businesses employing more than 100 minimum wage workers can still take advantage of the break for their first 100 workers.

To be eligible for the credit, a company would have to demonstrate that (1) it did not eliminate the total number of positions that were eligible to be considered minimum wage over the course of the prior 12 or 18 month increment of the minimum wage hike period, nor (2) reduced a current employee's wages down to minimum wage. In that way, companies can be rewarded for not laying off employees in the face of additional minimum wage costs. By the end of each eligibility period, it would be assumed that the business has been able to adjust to the “new normal” of wage levels and the credit would sunset. A new credit would become available for the next incremental increase, to be applied for at that interval's conclusion.

In this manner, the minimum wage would not be a zero-sum game. Businesses could count on economic assistance, which would be an incentive to not downsize in the face of increased labor costs.

This approach follows my economic policy philosophy: California, as a high tax state, can incentivize or make more palatable societally beneficial behaviors by employing tax incentives. In this case, the government acts, but the action's potential maleffects are offset by a tax break. In turn, the lost revenue from such a tax break for the state would theoretically be largely offset by the increase in economic activity that results from more workers having more money—money that on balance they will likely spend.

3. On balance, does raising the minimum wage cause inflation—and doesn’t that hurt the economy?

If a minimum wage increase is having a real economic effect, then the answer is yes—it can initiate what would amount to a bump in inflation. But, that does not actually indicate harm to the economy. On the contrary, it would indicate increased demand, which would obviously be a net benefit for all. Keep in mind, a certain rate of inflation is essential for real economic growth. And, the economy is presently experiencing inflation levels below the Federal Reserve’s target of 2% inflation, despite three massive rounds of quantitative easing by the Fed since the financial crisis to capitalize banks so they would lend more to spur economic activity (inflation is 0.7% nationally for 2015; 2% in the LA metro area for 2015). By spurring consumption, the minimum wage could not only energize the economy in a way it currently isn’t being energized, but would also raise living standards in a time where many are lagging behind in our economy.

As you well know, inflation is simply the rate of the general loss of purchasing power in a currency over a specific period of time; it is reflected in and measured by the rate of the general rise in prices across the economy during such a time period. Though a dollar is a dollar across time, what or how much a dollar can purchase ideally diminishes slowly over a given period of time, all things equal, due to inflation. This is not a bad thing: Average prices in an economy should be rising at a reasonable, sustained level (say 2% to 3% annually). But, this does not mean that ALL prices are rising at an equal rate—inflation is only an average. An increase in minimum wage will not increase demand for all items in an economy, only certain ones; it will contribute to the average level of inflation, but not in any massive way.

Moderate inflation is nearly always a strong indication that an economy is growing. Additionally, adding more consumer spending to the system would actually help to mitigate to a certain degree the short term difficulties many businesses would anticipate for their bottom line due to increasing labor costs—more demand means more business.

For an even more detailed analysis of the effects of a minimum wage hike on inflation—by an economist no less—click here.

4. On balance, should the minimum wage—once raised—be indexed to inflation? If so, does that hurt businesses by forcing them to raise wages based upon a lagging indicator such as inflation that may run counter to present economic reality (such as a downturn)?

Some argue that tying the minimum wage to inflation will destine businesses to perpetual wage increases, not allowing them to get ahead.

One counter to that argument is that such a pegging to the inflation rate would provide certitude to businesses about what prevailing wage rates will be across the state’s economy, keeping them all on a level playing field when it comes to minimum wage rates. They would all know what to expect because they could roughly predict and plan for the next, incremental increase, rather than be uncertain as to when the next wage debate will come.

I also argue here that inflation becomes a bit of a red herring in a claim such as this. The argument, intentionally or not, miscategorizes inflation itself. The inflation rate can be described as a lagging indicator—that is, it is an indicator of what has already occurred and is occurring on the ground. It is a reflection of a rise in prices already evident to those who have had to raise those prices, or because they can see their monetary costs of production going up (due to accelerating inflation). To say that the inflation rate will cause an increase to wages and would be a "surprise" to employers seems a bit of a hollow argument to me.

One caveat does exist. Does pegging the minimum wage to inflation mean that—if God forbid we hit a deflationary period (a period of aggregate prices dropping rather than rising)—workers will have to see their pay cut in the face of a deflationary cycle? The answer to that would probably have to be "yes." If we do peg minimum wage to inflation, we may have to either take the good with the bad, or build-in automatic tax credits--probably for employers--to undergird a policy of not allowing the wage to come back down.

Conclusion: On balance, the minimum wage increase will benefit society, not hurt it—provided we do this responsibly, keeping everyone on the same playing field and assisting those businesses that may need a helping hand during the transitional period. I have plainly laid out my reasons for it and backed it with evidence collected by economists. I invite your feedback on this matter.

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