Minimum Interference – Elliot Eisenberg on Raising Minimum Wage

ElliotEisenbergSQIn his recent State of the Union address, President Obama suggested raising the federal minimum wage from $7.25/hour to $9.00/hour, an almost 25% increase. His argument: the minimum wage peaked in 1979 at about 48% of the median wage and has steadily declined to about 38% today, and working should be encouraged. Yet working full time for minimum wage one earns barely $14,500/year, just below the poverty threshold used by the Census Bureau for households of more than one. Unfortunately, stylized facts do not make good policy. Raising the minimum wage hurts those in most need of a job, and policy should be based on facts not feelings.

Proponents of raising the minimum wage suggest that a higher minimum wage makes work more attractive, which increases the supply of labor and reduces costs for absenteeism, shirking and monitoring. Were this truly the case, and if net labor costs actually fell as wages rise, we would see lots of employers voluntarily offering higher wages. But, that is not the case, putting the lie to this line of reasoning.

As for small businessmen like home builders and remodelers, a higher minimum creates bad dynamics. First, a number of low skilled workers will find themselves out a job as proprietors figure out more ways to substitute capital for labor. Second, all else equal, new house prices would rise and that would reduce affordability. And, with real median wages flat to declining, introducing a policy that puts housing out-of-reach of more households should be strenuously avoided. Lastly, the uncertainly surrounding this policy causes most small businesses to pull back and reduce risk taking. When our economy is weak, and GDP growth is lackluster, policy certainty and continuity are what is needed most.

The primary problem with raising the minimum wage is, outside of one questionable study there is no evidence to support the claim that higher wages raise household incomes. It turns out that the reduced employment and thus the loss of income suffered by some households more than offsets the higher incomes enjoyed by households that hold onto their now suddenly higher-paying jobs. Worse, as both these effects are primarily to be found in low-income households, increases in the minimum wage simply end up redistributing income between poor households.

The other big problem with this entire approach assumes that poverty is a result of low wages. It’s not. Low wages are the result of limited skills, which results in low productivity and thus low wages. The solution is to increase the skills of low wage workers, not raise their wages and keep them dependent on legislation for more money. For many workers, minimum wage jobs are the first jobs they hold and are therefore critical in helping them gain valuable work experience (and in the process increase their skillset) which will get them a higher future wage. Moreover, in many of the poorest households, no one works.

To raise low household incomes, a far better approach is the Earned Income Tax Credit (EITC). This is because the EITC does not raise the wage rate paid to workers by employers. Rather, it is a federal income tax credit for low to moderate income working individuals and families. In 2012, the income thresholds were $14,340 for a single person and $19,680 for a childless couple. Above that level no tax credit is available. Unlike raising the minimum wage, with the EITC employers are not encouraged to replacing low wage workers with technology, offshore jobs, or reduce non-monetary employee compensation such as free uniforms, holidays, time off, or break time. The easiest way to help more low-income families would be to raise EITC income thresholds.

Lastly, at present, teen unemployment is 22.7%. Worse, for blacks 16 to 19 it is 38.2% while for men 16 to 19 it is 25%. These are numbers that are roughly 30% to 40% higher than their historical averages. To now suggest that the solution is to make these workers even less appealing to employers boggles the mind.


Elliot F. Eisenberg, Ph.D.
GraphsandLaughs, LLC
Cell: 202.306.2731