Are higher minimum-wage trade-offs worth it? Are higher minimum-wage trade-offs worth it?\images\insights\article\cash-register-small.jpg January 21 2020 July 12 2019

Are higher minimum-wage trade-offs worth it?

The benefits may not exceed the costs of raising the minimum wage.
Published July 12 2019
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Bottom line The Congressional Budget Office (CBO) knowingly waded into a political buzz saw this week, providing balanced analysis for a Democratic sponsored bill that would more than double the minimum wage to $15 per hour over the next six years. In coming weeks, the House of Representatives will vote on the bill, which also eliminates subminimum wages for tipped workers, young workers and those with disabilities. It is unclear whether the Republican-controlled Senate will vote on a similar bill. But according to the CBO’s analysis, the political trade-off for the “Raise the Wage Act of 2019” is that some minimum-wage workers will be raised out of poverty, while others will lose their jobs.

What’s the issue? Many Democrats—particularly presidential aspirants Bernie Sanders, Elizabeth Warren, Joe Biden and Kamala Harris—correctly believe that the current $7.25 per hour minimum wage set in 2009 is outdated. Congress created the minimum wage in 1938 at 25 cents an hour and has since raised 22 times over the next 71 years at an annualized rate of wage inflation of 4.86%. Over that same period of time, the nominal consumer price index (CPI) has risen at an annualized pace of 3.6%, so the minimum wage offered recipients growing purchasing power.

For whatever reason, however, Congress hasn’t adjusted the minimum wage over the past decade. If it had (at the same historical 4.86% rate of growth), the minimum wage today would be approximately $11.65 per hour. Meanwhile, CPI inflation has slowed to a 1.6% annualized rate over the past 10 years, so relative purchasing power would have grown at a much faster pace. The Democrats’ proposal is to adjust the minimum wage (at that same 4.86% rate of growth) to 2025. But they will need to play catch up and raise the minimum wage by about 13% in each of the next six years, at which point it would approximate $15 per hour. After that, future increases in the minimum wage would be indexed to inflation.

What are the trade-offs? According to a similar analysis the CBO conducted in 2014 at a proposed minimum wage of $10.10 per hour, one million workers would be pulled out of poverty, at a cost of 500,000 lost jobs. But a Bloomberg poll then found that 57% of Americans viewed that job-loss trade-off as unacceptable.

Today, studying a proposed $15 per hour minimum wage by 2025, the CBO concludes that 1.3 million people would be pulled out of poverty, it would boost the pay of 17 million workers who would otherwise earn less, and it also could raise the pay of 10 million other workers who would otherwise earn slightly more than $15 per hour. But job losses could total between 1.3 million to 3.7 million. That worse-case scenario is the equivalent of pushing the unemployment rate (U-3) up 2.3 points from 3.7% currently (just off a half-century low) to 6%. Real family income would be reduced by $9 billion, as the increase in worker pay was offset by this increased unemployment rate.

Child Tax Credit Bloomberg reports that the House bill would increase wages for poor families by an average of $600 per year, which is less than the increase in the Child Tax Credit that was part of President Trump’s 2017 tax cut. As an alternative strategy, by expanding the Child Tax Credit by another $1,000, we could offer more relief for poor families than an increase in the minimum wage, without potentially costing some of these workers their jobs.

Who’s most at risk? This plan would also eliminate the subminimum wage for tipped workers such as waiters and high school and college workers who are trying to build a resume and acquire marketable job skills, and for disabled workers such as young adults suffering from autism. These groups—along with small-business owners—would disproportionately shoulder most of the damage. Consequently, legislative set-asides for these groups should be considered.

Who benefits most from this transfer of wealth? Low-income and impoverished workers would be the big winners, at the expense of higher-income earners and businesses. Lower-paid workers would certainly see their incomes rise, while higher-income workers would see the prices of goods and services increase, businesses would generate smaller profits due to higher labor costs, and economic growth and equity share prices could stagnate or slip. But to counter this lost efficiency, many businesses may introduce more technology to lower labor costs and increase productivity.

29 states and counting To date, 29 states have already passed laws to raise their minimum wages above the federal level. Connecticut Gov. Ned Lamont recently passed a bill gradually increasing his state’s minimum wage to $15 by 2023, joining California, Maryland, Illinois, Massachusetts, New York, New Jersey, and Washington, D.C., at $15. Only 21 states still use the federal minimum wage; the others have implemented their own higher standard.

Currently, 89% of people working for minimum wage live in an area that enforces a higher rate. Minimum-wage workers in the U.S. have lost 16% of their purchasing power since 2009, so the only real question is to find a sensible, balanced solution to fix the problem.

On the margin In June, Bernie Sanders attended the annual shareholders meeting at Walmart to deride their “starvation wages.” Walmart pays an $11 minimum wage, which their CEO describes as “strategic.” Amazon has already increased their minimum wage to $15. But Amazon has a 7% net profit margin, compared with 3.3% at Walmart.

Kamala Harris joined protesters outside of a McDonald’s in Nevada advocating for “livable wages.” More than 80% of their locations are franchises, putting them in a unique situation. While their 30.6% profit margin is unusually high for the food industry, the majority of their income is generated by a franchising fee, a monthly service fee (percentage of sales) and rent. So McDonald’s is essentially a real estate company that also sells hamburgers, although the higher minimum wages would affect them indirectly if their franchises struggle.

Bring in the robots Large corporations are under financial pressure, and robots are their not-so-secret weapon. Amazon has more than 125,000 robots working in their warehouses, McDonald’s is currently testing machines that can make fries and flip hamburgers, and Walmart has robots that monitor inventory, count cash and sweep the floor. Unloading a truck requires half the workers, thanks to automated conveyor belts.

Banks make their move Questioned about why their CEO’s earn 700 times more than their bank tellers, banks are making an effort. Bank of America and JP Morgan Chase will raise their minimum wage to $20 and $18, respectively, by 2021. But the six largest banks, including Citibank, Wells Fargo, Goldman Sachs and Morgan Stanley, laid off more than 3,000 workers in 2018, compared to just 349 the year prior. The banks had record high annual profits, after replacing low wage workers with higher-level financial advisors.

Restaurant recession in NYC Overall employment in New York rose 2% in 2018, but the food service industry fell 3.7% to a 3-year low due to their $15 minimum wage hike. The New York Hospitality Alliance surveyed 324 full service eateries and found that 47% plan to eliminate jobs, 75% expect to cut employee hours and 87% will raise menu prices in 2019 to combat higher labor costs.

Global concept Typically, the U.S. minimum wage approximates the 10th percentile of wages nationwide, meaning that 90% of the population made more than the federal minimum wage. But the House bill to increase wages to $15 would generously raise the minimum wage to the 20th percentile. In 2002, Hungary jumped from 36% to 57% of their median, by increasing wages 50%. The result was 10% of people losing their jobs.

Research support provided by Federated summer intern Michael Ware.


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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Consumer Price Index (CPI): A measure of inflation at the retail level.

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