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Bottom Line One of the most controversial economic debates in Washington today is the cause and effect of income inequality and the range of possible solutions. Against that backdrop, however, there’s surprisingly strong bipartisan agreement across America that the minimum hourly wage has failed to keep up with inflation, by some 50%. But making an immediate correction of that magnitude could have a severely deleterious impact on the economy, particularly end-market demand, labor, corporate profitability and financial-market wealth. The practical near-term solution would be to phase in a gradual right-sizing of the minimum wage over perhaps a five-year period, with subsequent inflation indexing, to minimize the possible damage to the economy. Longer term, the government needs to aggressively address and correct the root causes of income inequality, which are skill acquisition through improved education, more stable family units and mobility.
What’s the problem with the current minimum wage? Since Congress created it in 1938, the minimum wage has been raised 22 times, starting at 25 cents an hour to the most recent adjustment to $7.25 in 2009. According to the Bureau of Labor Statistics (BLS), the minimum wage adjusted for Consumer Price Index (CPI) inflation of about 5% peaked in February 1968 when it was $1.60, which translates to about $10.86 in today’s dollars. So had the federal government consistently indexed the federal minimum wage over the past 76 years, we’d be roughly 50% higher today.
What do the polls say? Americans overwhelmingly agree that the minimum wage should be higher. A New York Times/CBS News poll found that 62% of Americans favor a $10.10 minimum wage, while Public Policy Polling announced earlier this month that 74% of American—a majority of Democrats, Republicans and Independents—believe that someone who works full time should be paid enough to keep them out of poverty.
Cynics, however, would argue that supporting a higher minimum wage ranks right up there with supporting motherhood, apple pie and patriotism—it’s a free-lunch no-brainer. If the question was asked differently—with an associated cost—those polled might respond differently, i.e.:
No free lunch The Congressional Budget Office (CBO) reported that an increase in the minimum wage to $10.10 would eliminate 500,000 jobs. Such an immediate minimum-wage increase would transfer income from customers, shareholders, and small-businesses owners to workers, thus negatively impacting retailers and fast-restaurants that heavily depend on low-paid, unskilled labor.
What portion of the U.S. earns minimum wage? The U.S. employs 75.9 million paid hourly workers (16 years of age and older), roughly 58.8% of all 129 million wage and salary workers. Of these hourly workers, only 1.5 million workers are earning exactly the federal minimum wage of $7.25 an hour, while 1.8 million workers (such as restaurant wait staff who receive tips) are earning wages below the federal level. So only 4.3% of hourly paid workers are currently at or below the federal minimum wage, down from 4.7% in 2012 and 13.4% in 1979. But a prospective change in the minimum wage would likely also impact some of those earning above the minimum, perhaps to as high as $15.00 per hour.
What are the demographics of those earning minimum wage? Of the 4.3% of Americans earning minimum wage or below, 72% of them work full time (35 or more hours per week). Many are well educated—18% have a bachelor’s degree or higher. Importantly, teenagers (ages 16-19) constitute roughly 20% of minimum-wage earners, with young adults and teens (ages 16-24) making up 56% of minimum-wage employees. These young people are trying to get some early work experience to build career resumes, so perhaps there should be a special sub-minimum rate for younger, less-experienced workers. The good news is that only 2.7% of hourly paid workers earning the minimum wage or below are at or above the age of 25, which means that a relatively small fraction of the population depends on minimum-wage earnings to make a living and support a family.
How does the federal government stack up on this issue? Of the 26 developed countries that report minimum-wage data, the U.S. is in the middle of the pack, with the 12th highest minimum wage in real dollars, behind the U.K. (established in 1998 and now at $9.50 per hour) and Australia ($15.20).
As of Jan. 1, 2014, 21 states plus the District of Columbia have minimum wages above the current federal level of $7.25, and 11 of those states automatically adjust their minimum wage every year based on some index of inflation or cost of living. Additionally, California, Connecticut, Delaware and New York have discretionary increases in their minimum wage. Vermont plans to lift its minimum wage to $10.50 an hour by 2018, up from the current $8.37. Washington state, which uses an inflation index, currently has the highest minimum wage at $9.32 an hour, and on May 1, Seattle approved an eventual increase to $15.00 an hour. Businesses smaller than 500 employees can increase their wages to $15.00 an hour over seven years, while businesses with 500 or more employees have three years to comply. If health care is included in their calculations, they must raise wages within five years.
Could technology replace workers? Low-margin, high labor-cost businesses such as fast-food restaurants and retailers are watching these developments on minimum-wage pay with more than a passing interest. At the end of last year, Applebee’s announced a rollout of 100,000 iPad and Samsung devices to all 1,860 of their restaurant locations. The devices are equipped to order food and beverages, play computer games, settle the bill and even order that extra pickle. In this test, the restaurant chain wants to see if its business is more operationally and cost efficient with more technology and less human capital. Chili’s and IHOP are thinking about a similar technology upgrade.
Why can’t all businesses be like Costco? Costco—a specialty grocer and warehouse giant that caters to affluent, college-educated households earning more than $80,000 a year—has mastered employee efficiency while maintaining a high minimum wage, while retail competitors such as Target and Walmart struggle to meet Costco’s efficient business structure. For example, Costco’s revenue per employee is nearly triple that of Walmart, allowing Costco to pay higher wages than its lower-margin competitors. Gap and Ikea are setting a similar example, announcing 10% and 17% wage increases, respectively, resulting in a 10% surge in employment applications. Other profitable companies such as Disney and Anheuser-Busch have also recently announced wage increases.
What’s a possible near-term solution? A gradual increase in the federal minimum wage from $7.25 per hour now to perhaps $12 per hour by the end of 2019—that would represent a 10% rate of growth over the next five years—with inflation indexing beyond that point, so we don’t find ourselves at this point again later. We should also offer a sub-minimum wage for younger workers, to get them some early work experience, and some carve outs for smaller businesses.
What’s the longer-term solution? Education reform and skill acquisition, period. College graduates over 25 years of age have a 3.3% unemployment rate, while those with advanced degrees have a 1.5% unemployment rate, compared with a 6.1% national unemployment rate. Having marketable skills puts a worker on a higher-paying career trajectory, rendering this contentious minimum-wage debate moot.
Research support provided by Federated summer intern Grace Chmiel.