The “Fight For 15” is a nationwide protest by fast-food workers for raising the minimum wage to $15 from its current level of $7.25. In these tough economic times, it is not hard to understand why workers would take to the streets to ask for higher wages. As per the latest employment release from the Bureau of Labor Statistics, the labor market recovery remains weak. There are nearly 738,000 workers who are too discouraged to look for jobs, 2.6 million workers who remain long-term unemployed and another 6.7 million who are employed part-time only because they cannot find full-time jobs. Wage growth over the last year has averaged a meager 2 percent. A separate survey from the BLS shows that nearly 3 million workers earn wages at or below the federal minimum. If these workers work full-time year-round, their annual earnings would average $15,000. We need to think of ways to help low-income households dependent on these minimum wage jobs to supplement and increase their incomes. Unfortunately, hiking minimum wages may prove to be a risky strategy.
The reason minimum wages may not boost incomes at the bottom is because there is a significant probability that higher minimum wages could result in fewer jobs. Increases in the minimum wage mean an increase in costs for employers. Some employers may be able to absorb these costs, perhaps by passing them on in the form of higher prices for consumers. However, other employers may respond by reducing hours or eliminating entire positions. To use economists’ terms, the labor demand curve is downward sloping, so when the cost of a worker goes up, firms will hire fewer of them.
Minimum Wage Impacts
New research finds that the effect of increases in the minimum wage between 2007 and 2009 was to significantly reduce employment of low-skilled workers. Further, minimum wage hikes increased the likelihood that low-skilled individuals would work without pay, and this was true even for workers with some college education. Finally, this new research tracked workers over time and found that increases in minimum wages had negative medium-run effects on the ability of low-skilled workers to rise up the income ladder. The paper finds that during the late 2000s, effective minimum wages rose by nearly 30 percent and estimates these increases reduced the employment-to-population ratio of working age adults by 0.7 percentage points.
This is far from a one-off finding even though some earlier research finds no impact on employment. The fact that we need to account for negative employment effects shows up in a careful analysis done by the Congressional Budget Office last year on President Obama’s proposed minimum wage hike to $9 or $10.10. The CBO estimated that in the aggregate, employment losses could be as high as 500,000 or 1 million as a result of the hike in the minimum wage to $10.10.
It is true that our understanding of the employment effects of minimum wage hikes lacks consensus. However, what it does suggest is that following a hike, there is some significant probability that workers will lose jobs and face losses in income. The workers who retain jobs will be unambiguously better off than before but those who lose their jobs will be much worse off. This is a risky strategy.
Earned Income Tax Credit
To my mind, a risk-free strategy to boost incomes for minimum wage workers is to expand the Earned Income Tax Credit program. The federal EITC program is now the largest anti-poverty program for non-elderly workers in the United States. It does so by encouraging work and increasing the after-tax wage for those with low earnings. Since it is a refundable tax credit, it is available as a cash payment to those without a tax liability. As per a recent estimate, almost 28 million people received over $66 billion in EITC payments for tax year 2013. The EITC has lifted an estimated 6.5 million people above the poverty line including 3.3 million children. There are other programs that help low-income households as well, such as SNAP (food stamp program) and Temporary Assistance for Needy Families (TANF). However, these are not as effective as the EITC in helping people move out of poverty.
As opposed to minimum wage hikes which are potentially associated with losses in employment and less income mobility for low-skilled workers, a vast literature shows that the EITC increases employment of low-skilled adults while supplementing incomes. Studies suggest that the EITC was responsible for 60 percent of the 8.7 percentage point increase in labor force participation of single mothers between 1984 and 1996. The EITC is also associated with better health outcomes for children and mothers in households that receive EITC support.
The Less Risky Strategy
Under the current system, both minimum wages and the EITC help low-income workers. A worker on minimum wages of $7.25 would earn a full-time year round income of approximately $15,000. This obviously affords him a low standard of living by any measure. However, the participation in the labor force allows the worker to earn a tax credit through the EITC. For a worker with children earning approximately $15,000, the benefit of the EITC could vary from $3,300 to $6,143. Thus, in order to supplement incomes at the bottom, we have at least two instruments, the EITC and the minimum wage. However, the minimum wage is the more risky strategy since it could potentially have dis-employment effects. If a worker loses his job, he not only loses the minimum wage income from the job but also income from the EITC, and other government benefits that may have a work requirement. On the other hand, if we expand the EITC benefit levels and extend them to childless adults, the worker keeps his job, earns higher incomes, gains work experience and has the potential to continue to move up the income ladder, while providing for his family.
The choice seems pretty clear to me.
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