Minimum wage hot potato
Minimum wage is too low, but strategy to raise it should be bipartisan.
As the Senate’s nonpartisan parliamentarian ruled President Biden can’t change the federal minimum wage in the proposed coronavirus relief package that passed the House over the weekend, Congress will need to iron out legislative differences to address it in a separate bill. Because at least three Democratic Senators—Joe Manchin (W. Va.), Jon Tester (Mont.) and Kyrsten Sinema (Ariz.)—oppose the $15-an-hour proposal, that stand-alone bill likely will require a 60-vote supermajority to pass, so it will need to be bipartisan. Here's our thinking about the controversial measure.
Current minimum wage is too low Congress created the minimum wage in 1938 at 25 cents an hour, which it has since raised 22 times over the next 71 years at an annualized rate of 4.86%, to $7.25 an hour in 2009. Over that same period, the nominal consumer price index (CPI) rose at an annualized pace of 3.9%, so the minimum wage offered recipients growing purchasing power of about 1% annually.
But Congress hasn’t adjusted the minimum wage over the past 12 years. If it had (at the same historical 4.86% growth rate), it would approximate $12.80 today and $15.50 in 2025.
Nominal CPI inflation, however, has slowed sharply to a 1.5% annualized rate over the past 12 years, so the recipient’s relative purchasing power would have grown at a significantly outsized pace. The Democrats’ proposal is to adjust the minimum wage (at that same 4.86% rate of growth) to $15 by 2025. After that, increases would be indexed to inflation.
However, using the more moderate recent pace of CPI growth of 1.5%—but also tacking on the same 1% inflation purchasing-power bonus—the minimum wage would be adjusted to $9.75 today and to $10.75 in 2025.
They’re both right That’s a pretty wide chasm, but Democrats and Republicans are both right on this issue. The minimum wage is clearly too low, but the critical question is the pace and eventual level of correction. If Biden’s proposal wins approval, the minimum wage would need to increase about 20% per year over the next four years, which could have a significantly deleterious impact on inflation, economic growth, profitability, stock prices and the labor market.
Seeds of a bipartisan compromise? Republican Senators Mitt Romney (Utah) and Tom Cotton (Ariz.) proposed raising the minimum wage to $10 by 2025 (an 8.4% annual growth), indexing it for inflation thereafter, and requiring employers to verify the immigration status of their workers. Lengthening the phase-in to $15 by 2030, using Romney and Cotton’s 8.4% rate of growth, might get the bipartisan negotiation ball rolling.
Winners and losers According to a recent nonpartisan Congressional Budget Office study, raising the minimum wage to $15 by 2025 would increase wages for 17 million minimum-wage workers (about 10% of the labor force) and an additional 10 million workers who earn slightly more than $15 now. The higher minimum wage also would lift an estimated 900,000 people out of poverty, but it would cost at least 1.4 million people their jobs.
Three-quarters of low-wage workers who would be potentially affected by this legislation come from: leisure & hospitality (37% of minimum-wage workers); retail (23%); and education & health care (14%). These groups were also disproportionately harmed by the massive job losses in the wake of Covid-19.
The District of Columbia (D.C.) and 29 states (mostly on the east and west coasts) currently have higher minimum wages, and seven states plus D.C. are already phasing in $15 minimums. Only 21 states (mostly in the south and the middle of the country) still use the federal minimum wage.
Who’s at risk? Biden’s plan also would eliminate the subminimum wage for tipped workers such as waiters, for high school and college workers who are trying to build a resume and acquire some marketable job skills, and for disabled workers such as young adults with autism. These groups, along with small-business owners, would disproportionately shoulder most of the damage. Regional differences should also be considered, as the cost of living in New York and San Francisco, for example, is very different than in Tupelo, Mississippi. Consequently, we believe that legislative set-asides for these disadvantaged groups should be considered, to exclude them from a potential damaging increase in the minimum wage.
But aren’t some companies already paying $15? To be sure, several large, profitable, high-volume and high-margin companies already are paying their employees a much higher wage with no adverse consequences. Costco, for example, announced last week it will raise starting pay to $16 per hour. Amazon, Target and Best Buy are already paying their people $15. Walmart, the nation’s largest employer with 1.5 million hourly workers, is keeping its starting wage at $11, but announced it will raise the average wage by $1 to $15. While Walmart supports an increase in the minimum wage, it also believes that the increases should be paced out further to allow businesses more time to adapt, with appropriate regional differences. Small businesses, however, are the backbone of the job-creation engine in the U.S., and these successful monoliths have different business models from the local mom-and-pop pizzeria or nail salon.
What are the downside risks? In our view, more than doubling the minimum wage too quickly with no legislative set-asides introduces several risks to the economy, equities and the labor market:
- Higher consumer prices If a company’s labor costs have doubled over a short period of time, it may be tempted to pass on those higher costs in the form of higher prices, forcing inflation higher and likely resulting in marginally softer economic growth, as some customers will opt to consume less of the company’s product or service at the new higher price.
- Lower profit margins If a company is operating in a price-competitive industry, it may not feel comfortable raising its prices, for fear of losing market share. It may grudgingly absorb the higher labor costs, resulting in fewer profits, slower economic growth, and lower stock prices.
- Increased unemployment Alternatively, faced with the prospect of higher labor costs, a company may decide to increase its investment in technology to boost productivity and reduce its investment in human capital. The unintended consequence is a rise in unemployment, if a worker inadvertently has been priced out of the labor market due to the sharp increase in the minimum wage.