Kyle Feinstein, Stanford University
The national minimum wage has remained unchanged in nominal terms for more than a decade, despite inflation and rising costs of living: It has stood at $7.25 per hour since 2009 when it was equivalent to $10.07 in today’s dollars. As shown in Figure 1, the real value of the minimum wage has since decreased below the historical average. Many local governments have set minimum wage floors that far surpass the national minimum wage, such as in Washington, D.C. and California.
Figure 1: Change in real value of the federal minimum wage, 1938-2021
Raising the national minimum wage to $15 per hour will significantly impact the personal finances of low-income employees and small business owners. Specifically, such measures would have mixed effects on laborers, benefiting laborers who receive wage increases and harming laborers who lose their jobs, while largely harming small business owners. Policy proposals to increase the national minimum wage to $15 per hour have become increasingly popular among labor advocates, labor unions, and progressive policymakers following the COVID-19 pandemic, spikes in costs of living, and periods of high inflation.
Raising the national minimum wage by 107% to $15 per hour would increase the wages of many jobs, particularly in rural communities where some employers have monopsony power. However, a minimum wage of $15 per hour would also contribute to unemployment, widen disparities in the labor market, and reduce the hours worked for small businesses. Because of these effects, it may be necessary to consider the alternative policies of setting the minimum wage as a percentage of a city’s average cost of living and expanding the Earned Income Tax Credit to assist low-income earners.
Recent History of the Federal Minimum Wage
Raising the minimum wage remains a controversial issue. Democratic leaders such as President Biden and Senator Bernie Sanders view a $15 minimum wage as a means to increase low-income workers’ wages. Republicans such as Senators Mitt Romney and Tom Cotton view a $15 minimum wage as an unreasonably high federal level. The national minimum wage was first introduced in the US under the Fair Labor Standards Act in 1938, and it has since been raised 22 times to adjust for rising costs of living. In 2021, the Senate voted 58-42 against an amendment to the 2021 COVID relief bill that would raise the federal minimum wage to $15. While legislative efforts to raise the federal minimum wage were unsuccessful, the Biden-Harris Administration issued an executive order to raise the minimum wage for federal contractors from $10.95 to $15. The directive has resulted in increased wages for 67,000 of 2.2 million government employees without significantly impacting employment.
Minimum wage laws have also reemerged as an important political issue with regard to their potential impacts on unemployment. It is not an optimal time for the US economy to experience an upsurge in unemployment. The US unemployment rate is 3.7% as of October 2022. During the COVID-19 pandemic, unemployment spiked to 14.7% in April 2020 from 3.5% in February 2020. The current unemployment rate marks a consistent recovery to pre-pandemic levels and could be sensitive to minimum wage hikes.
Figure 2: Approval of a $15 minimum wage across demographic groups
There is significant public support for raising the minimum wage. According to the Pew Research Center, sixty-two percent of US adults favor the idea of a $15 minimum wage, and 40% strongly approve of the idea. Conversely, 38% percent of US adults say they oppose proposals to raise the minimum wage to $15. Figure 2 indicates that certain demographic groups are more likely to strongly support a $15 minimum wage. Sixty-seven percent of women, 89% of black people, 76% of Hispanic people, 68% of people aged 18-29, and 72% of low-income individuals say they favor a $15 minimum wage. Notably, these groups that tend to support raising the minimum wage are statistically more likely to earn the minimum wage.
Although public support for raising the minimum wage has not translated into federal action, various states and localities have taken action to raise the minimum wage within their own jurisdictions. Thirty states and Washington, D.C. have instituted state minimum wages above the federal minimum wage, ranging from $8.75 in West Virginia to $15.20 in Washington, D.C. California and Washington, D.C. already have minimum wages of at least $15, and 9 other states have voted to approve a $15 minimum wage. Meanwhile, federal minimum wage applies in five states that have not adopted a state minimum wage and two states with minimum wages below the national minimum wage. Therefore, instituting a $15 national minimum wage would directly impact communities with lower wage requirements more than locations that have already adopted a $15 minimum wage.
The Minimum Wage and the Low-Income Population
The buying power of a minimum wage income varies depending on a worker’s location. Based on the standard 40-hour work week, an employee making $15 per hour earns a yearly income of about $31,200. The average annual cost of living for each state varies from $27,936 in Mississippi to $40,412 in Hawaii. This means that an individual making $15 per hour in Mississippi is effectively better off than someone in Hawaii making the same wage. There is also large variation in the costs of living across different cities in each state. For example, the annual cost of living in Los Angeles, California ($34,380) is 50% higher than in Garden Grove, California ($22,908). The cost of living in a state and city is influenced by many factors including production costs, housing demand, and fiscal policy.
Certain demographics have higher rates of minimum wage earners, including young people, women, and people without a college education. In 2021, 1.4% (1.1 million workers) of all hourly paid employees (76.1 million workers) earned federal minimum wage or less. Of those paid the federal minimum wage or less, 44% were under age 25, even though workers under 25 make up only about 20% of hourly-paid workers. 2% of women and 1% of men who earned hourly wages were paid federal minimum wage or less. Among hourly-paid workers aged 16 and older, 2% of workers with less than a bachelor’s degree and 1% of workers with a bachelor’s degree or higher made federal minimum wage or less.
Some occupations also positively correlate with the minimum wage earning rate. Three percent of part-time workers were paid federal minimum wage or less compared to 1 percent of full-time workers. About 8% of workers in the leisure and hospitality industry and 75% of service workers make national minimum wage or less although their wages are often supplemented by tips. Therefore, raising the minimum wage will likely most significantly impact industries such as leisure and hospitality, service work, and other industries with a high proportion of part-time workers.
Impacts of Raising the Minimum Wage on Workers
Increase wages and decrease poverty: If the minimum wage was increased to $15, the income of many workers in jobs making less than $15 per hour would increase. The Congressional Budget Office estimates that raising the national minimum wage to $15 will boost the wages of 17 million workers. Consequently, the number of people with an annual income below the poverty level will fall by 1.3 million by 2025.
Increase unemployment: As economist Thomas Sowell famously noted, “The real minimum wage is always zero.” If employers are forced to pay workers more at a higher minimum wage, businesses will not be able to afford to hire as many workers and a surplus of labor will result in the market. The Congressional Budget Office predicts that raising the minimum wage to $15 would cause 1.3 million workers to lose their jobs.
Empirically, cities with high minimum wages, such as Seattle, Washington, have observed such predictions. In 2013 with a standing minimum wage of $9.47, Seattle became one of the first cities to impose a $15 minimum wage, which was phased in over several years. One study by the University of Washington found that as the minimum wage increased from $11 to $13 in 2016, wages rose about 3% but the number of hours worked by employees in low-income jobs fell by about 9%. Another study by the University of California, Berkeley revealed that in the restaurant industry, wages rose less than 1% for every 10% the minimum wage rose, but there was no discernible effect on unemployment.
In the long run, raising the minimum wage above the market equilibrium cost of labor will also catalyze the development of automation to replace human labor. The displacement effect is an economic phenomenon by which a firm considers replacing workers with capital when the marginal cost of producing a good with capital is less than the cost of producing the same good with labor. If the costs of capital decrease as technology advances and the costs of labor increase as the minimum wage rises, automation will replace low-income workers at a fast rate. Twenty-five percent of US jobs are highly susceptible to automation and the displacement effect. By 2030, automation is predicted to displace 20 million manufacturing jobs (13% of current jobs) with the potential to eliminate 73 million jobs (46% of current jobs).
Automation will also create 58 million jobs, but most of these jobs will require high-skilled workers. Investment in technology could impact the economy positively by more efficiently producing goods and lowering consumer prices. For instance, the fast-food industry is undergoing major changes as restaurants are installing an increasing number of kiosks. This virtually eliminates the need for low-skilled workers to take orders but simultaneously creates job opportunities for high-skilled software engineers to upkeep the kiosks. Eventually, the customer costs for food may decrease due to lower variable costs for restaurants, but a net decrease in jobs will also result.
However, in the event of a minimum wage hike, unemployment could remain constant or decrease in the short run for certain economic sectors, such as the fast-food industry. Fast-food restaurants often have strict franchise requirements, meaning an individual store cannot independently change its operations or minimum number of employees. One study observed that employment rates in fast-food restaurants remained comparably high in New Jersey after the state minimum wage was raised from $4.25 to $5.05 in 1992. This finding suggests that raising the minimum wage could initially have a positive impact on employment in certain industries.
Impacts of Raising the Minimum Wage on Firms
Disadvantage small businesses: A $15 minimum wage would disproportionately lower the profit margins for small businesses and lead to store closures. Recent Gallup polls indicate that 60% of small-business owners believe that raising the minimum wage will hurt most small-business owners. A higher minimum wage will hamper small businesses’ ability to hire workers and expand. If the minimum wage is increased, 8% of small-business owners say they will need to lay off workers and 14% say they will have to cut worker hours. Correspondingly, 14% of small-business owners say a higher minimum wage will result in less revenue for their businesses and 22% say it will decrease profits.
Large businesses are generally better equipped to absorb the costs of a high minimum wage as they can raise the price of their goods marginally and spread the increased labor costs among a larger amount of sales to maintain positive profit margins. If the minimum wage becomes too high, large businesses also have more capital to outsource their factory production to other countries with less strict labor regulations.
Improve workforce productivity: Raising the minimum wage could have mixed effects on a company’s productivity. Some economists argue that forcing employers to pay workers an efficiency wage will increase worker productivity. An efficiency wage is a wage greater than the market equilibrium wage that encourages workers to be more efficient. Efficiency wages increase profit for businesses as they reduce employee training costs because turnover is lower and incentivize greater worker outputs because employees value their jobs more. Although raising the minimum wage may increase overall productivity in the economy, individual businesses would benefit more by raising their wages independently. A relative increase in wages incentivizes workers to produce greater output to retain their jobs and attracts higher-skilled workers. A $15 minimum wage may only increase worker output for certain supervised jobs. Productivity data from a major US retailer show that for high minimum wage locations, high monitoring led to a 6.6% increase in worker productivity, and low monitoring led to a 9.4% decrease in worker productivity.
Impacts of Raising the Minimum Wage on Equity
Widen economic disparities: When the minimum wage increases, the economic value of minimum wage jobs does not change, but the positions open up to a new pool of labor. The competition for formerly low-paying jobs will increase as people with higher educational attainment and greater skill sets will seek these jobs. Consequently, the first people to lose job opportunities and be shut out of the labor market will be young people, historically-disadvantaged minorities, and people with low educational attainment.
When jobs are scarce due to minimum wage hikes, the unemployment rate for young adults and teenagers tends to increase disproportionately. For example, many young people were shut out of the job market following the July 2009 increase in the federal minimum wage from $6.55 to $7.25. In the 3- month period from July 2009 to October 2009, the index of teen employment rate dropped 8%, whereas the previous decrease of 8% occurred over a yearlong period. People who experience unemployment at a young age are more likely to be unemployed or make lower earnings in the future. As a society, high unemployment rates among youth populations hinder the professional development of entire generations by setting back their careers and depriving them of valuable work experience needed for upward mobility to obtain high-paying jobs.
Raising the minimum wage could decrease the educational attainment of underprivileged groups and increase unemployment among people with low educational attainment. Increasing the minimum wage increases the opportunity costs for low-income individuals pursuing higher education. For people from low-income backgrounds, a higher minimum wage disincentivizes the acquisition of university degrees that lead to higher wages in the long run and incentivizes community college education that provides occupation-specific human capital. One study demonstrated that a 10% increase in the minimum wage results in a 5% decrease in university enrollment and a 6% increase in community college enrollment. Because the opportunity costs of not taking a high minimum wage job weigh more heavily on low-income individuals with limited capital assets, a high minimum wage strengthens the link between parental background and child educational attainment, thus perpetuating cycles of low incomes and undereducation. High school dropout rates follow a similar pattern, as research indicates that a long-term 10% increase in the earnings of low-skilled workers could decrease high school enrollment rates by 5-7%. Furthermore, since certain demographic variables correlate with educational attainment, raising the minimum wage may increase income inequality for historically underprivileged populations. Figure 3 shows that Black, Hispanic, Pacific Islander, and American Indian/Alaska Native populations had below-average rates of completing an associate’s degree or higher in 2021. Therefore, these underrepresented groups will have greater difficulty finding employment in the event of a minimum wage increase.
Ensure fair wages for rural workers: Small and rural communities tend to have highly concentrated labor markets with little competition among a few employers. This monopsony situation is why Southern states with higher proportions of their populations living in rural areas have the highest percentages of hourly-paid workers earning the federal minimum wage or less. Increasing the minimum wage to $15 could help correct this market failure by preventing employers with monopsony power from setting unfairly low wages.
Policy Recommendations
Instead of raising the federal minimum wage to $15 per hour, policymakers should consider a plan that adjusts the minimum wage based on costs of living and directly increases the income of low-income workers. To account for inflation and the diverse economies of each state and city, policymakers should move to set the national minimum wage as a percentage of the cost of living for each city. Setting the minimum wage slightly above the basic costs of living will ensure that workers receive a living wage, empower workers with disposable income to invest in their futures, and help workers care for any additional dependents. The new minimum wage should be recalculated annually to account for inflation and phased in over a five-year period to allow time for businesses to adjust operations accordingly.
There are various opinions on the optimal algorithm to calculate state and city costs of living. Policymakers often rely on the federal poverty level to determine an income that supports a given standard of living. However, the poverty level standard neglects prevalent costs of living beyond a basic food budget, such as childcare and healthcare. In 2004, Massachusetts Institute of Technology professor Dr. Amy K. Glasmeier developed a new way to calculate a living wage. Her project, the Living Wage Calculator, uses a market-based approach that considers state and local income and payroll taxes as well as an individual’s expenditures on minimum food, housing, childcare, health insurance, and other basic necessities. A multivariate analysis of a typical minimum wage worker in each state and city could offer a more accurate estimate of the average cost of living from which to determine the minimum wage.
In addition to minimum wage reform, policymakers should raise the Earned Income Tax Credit (EITC) to directly support low-income workers. The EITC is a refundable tax credit designed to supplement the wages of low-income workers and offset the costs of Social Security taxes. All US taxpayers making low to moderate wages qualify for the EITC. In 2021, the maximum income a recipient can earn from the program rose from $3,650 to $10,000. A study found that a $1,000 increase in EITC resulted in a 7.3 percentage point increase in employment and a 9.4 percentage point decrease in the percentage of families in poverty after tax and transfer income.
Figure 4: 2021 Earned Income Tax Credit amount for different numbers of dependents
The EITC is able to more effectively help low-income workers than raising the minimum wage because it has a positive impact on employment and accounts for recipient dependents. As illustrated in Figure 4, the EITC gradually phases out as a recipient’s income increases, which incentivizes participants to work and strive for upward mobility in income. The graph also shows that participants who have more children receive larger tax credits that phase in faster. Therefore, the EITC can more accurately distribute wealth to low-income workers with greater childcare expenditures without producing the negative effects on employment present during minimum wage hikes.
Conclusion
The cost of living increasing faster than the minimum wage is a perpetual issue for the working class. The minimum wage has historically been used as a policy tool to help low-income individuals with their personal finances but has proven to hurt the very people it is designed to assist in a multitude of ways. Amid the current period of high interest rates and inflation, a $15 minimum wage would further increase unemployment, decrease small-business profits, and widen pre-existing economic disparities. Instead, policymakers should support low-income workers by raising the EITC and reforming the minimum wage law to account for inflation and different state and city economies. Setting the minimum wage as a percentage of the average cost of living per city would ensure that workers are paid fair living wages while efficiently limiting unnecessary increases in unemployment.