If Your Minimum Wage Increase Doesn't Raise Unemployment, You Didn't Raise The Minimum Wage Enough

Today, the Congressional Budget Office released a report on President Obama’s proposed minimum wage increase.

CBO estimates the proposal (raising the minimum wage from $US7.25 to $US10.10) would:

  1. Raise wages for 16 million workers making under $US10.10 and millions more making slightly above that,
  2. Increase family income by $US2 billion overall and $US17 billion for people earning less than three times the poverty line (about $US72,000 for a family of four),
  3. Lift 900,000 people out of poverty, and
  4. Reduce employment by 500,000.

So of course our discussion is focusing around the employment number.

The White House insists the CBO number is wrong. In a conference call this afternoon, Council of Economic Advisers members Jason Furman and Betsey Stevenson argued that up-to-date economic research points to near zero employment effect from a minimum wage hike to $US10.10.

Economists are divided on the question, but fortunately it doesn’t matter very much. As economist Richard Thaler puts it, “All methods of helping the poor cause distortions”; a minimum wage increase can cause a modest rise in unemployment and still be a good policy idea, so long as it has more than offsetting positive effects.

And the minimum wage trade-off presented by CBO looks awfully favourable. For every person put out of work by the minimum wage increase, more than 30 will see rises in income, often on the order of several dollars an hour. Low- and moderate-income families will get an extra $US17 billion a year in income, even after accounting for people who get put out of work; for reference, that’s roughly equivalent to a 25% increase in the Earned Income Tax Credit.

The higher you set the minimum wage, the greater its positive effects on family income (for the bottom half of the income distribution) and poverty. In fact, the effects snowball; a $US2 increase in the minimum wage does more than twice as much to augment incomes as a $US1 increase does, because it affects more workers.

On the other hand, higher and higher minimum wages also have snowballing negative effects on employment. At modest levels, economists are increasingly convinced these effects are very small or zero; the added cost of employment gets offset by things like higher consumption and higher productivity. But that doesn’t go on forever; a minimum wage of, say, $US100 per hour would obviously reduce employment.

The policy challenge is to raise the minimum wage to the point where once cent more would produce more important negative effects on employment than positive effects on poverty and family income, and then stop. I don’t know what that point is, but I do know that if the minimum wage isn’t putting any downward pressure at all on employment, we haven’t reached it yet.

So if the White House really believes a minimum wage of $US10.10 would have no negative effects on employment, they are leaving an opportunity for poverty alleviation on the table, and should be pushing for a higher minimum wage than $US10.10.

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