Minimum Wage: Should it be Increased?

The $1.9 trillion American Rescue Plan recently signed into law by President Biden originally had a provision to increase the federal minimum wage to $15/hour. This was one of the few provisions ultimately removed from the final bill because it was not deemed to be a feature that could be approved by a simple majority of the Senate. As you might recall, the $1.9 trillion fiscal stimulus plan received a rather unusual and streamlined approval under a provision known as “Reconciliation”, which required only a simple majority of the Senate (rather than a super majority), identical to the methodology used by the Trump Administration to approve the Tax Cuts and Jobs Act of 2017. Nonetheless, the Biden stimulus plan did move the minimum wage topic back to centre stage. Of course, the US is not alone - there is an active debate in many countries about a minimum wage, the appropriate level of such a wage, and the positives and negatives associated with increases in the minimum wage.

Let me begin this article with a few succinct bullet points:

• The US federal minimum wage is currently $7.25 hour. It was last increased in 2009

• 30 or so states have minimum wages that are higher than the federal minimum wage

• The median US hourly income is $24.98/hour

• 1.1 million workers (full-time & part-time), or 1.5% of workers paid by the hour rather than by salaries (77.4 million), earn $7.25/hour or less

• 39 million workers, or 26% of all employed workers in the US in February 2021, earn less than the proposed new minimum wage of $15/hour

• The national poverty level for a family of four (two children) is $26,246/annum

• The living wage minimum for a family of four (two children) is $68,808/annum

• There are wide variations of wages, poverty levels and living wage levels across the US, with urban areas and the Northeast and Western US having the highest, and rural/suburban areas and the Midwestern and Southern US having the lowest

There are arguments ­– plenty on both sides ­– for and against increasing the minimum wage. Politically, it would seem short-sighted not to increase the federal minimum wage given it has not been increased since 2009. However, fine tuning should be left in the hands of states or even smaller catchments which are in a better position to manage the trade-off between a higher minimum wage and its benefits, and the potential detrimental effects on businesses and the broader economy of increasing the minimum wage.

The Minimum Wage Today

In the US, the current federal minimum wage is $7.25/hour, which was last increased in July 2009, 12 years ago. Since 2009, inflation has been 23% in the US, meaning that it would take $1.23 today to buy what $1.00 would have bought in 2009. Clearly, the federal minimum wage has not kept up even with inflation since it was last increased in 2009. I will return to

the US minimum wage in a moment. However, for context (and for my UK followers), UK minimum wage levels are interesting to view for comparison. The minimum wage in the UK varies by age, with those over 23 entitled to what is described as a minimum living wage. The revised thresholds for the minimum wage in the UK, which will come into effect on April 1st, 2021, are in the table above / to the right (source: www.gov.uk). As you can see, employees in the UK over age 18 have a higher equivalent minimum wage ($9.12 equivalent/hour) than the federally-mandated level in the US, and this is rather significantly higher for those workers that are 23 or older ($12.40/hour).

Let’s move back to the discussion about the US minimum wage and the ongoing debate about increasing it. Although the federally mandated minimum wage in the US is currently $7.25/hour, I counted 30 states and the District of Columbia that actually have a minimum wage that is higher than the federal minimum wage, based on data from paycor.com (here). The median wage of the 111.6 million full-time workers in the US (quarterly data, seasonally adjusted) in 4Q2020 was $983/week, according to the Bureau of Labor Statistics (BLS). Assuming a 40 hour work week, this means each US worker earned a median hourly wage of $24.58, more than three times the current federally mandated minimum wage/hour, and well above the proposed $15/hour ($31,200/annum or so) currently under discussion. If you wish to dig deeper, you can find more detail on median salaries in the BLS publication “Usual Weekly Earnings of Wage and Salary Workers: Fourth Quarter 2020”, which stratifies wage data by sex, age, ethnicity, etc. The table below, extracted from a different BLS report, shows that only two sectors – retail and hospitality – have an average per hour wage of less than $25/hour (source: here). It isn’t really surprising to see these two sectors with the lowest wages.

There are around 73.3 million full-time and part-time workers in the US that are paid hourly (as opposed to being paid a salary), which is 55.5% of total full-time and part-time workers according to the BLS. There are 247,000 hourly workers aged 16 or over in the US who are paid the US federal minimum wage of $7.25/hour, and another 865,000 hourly workers aged 16 or over who are paid less than the US federal minimum wage for reasons that I will not discuss in this article. In total, these 1.1 million hourly workers at or below the minimum wage represent 1.5% of total hourly paid workers. To complete the picture of current wages in the US and provide some context for the proposed $15/hour federal minimum wage, The Washington Post (article here) reported that there are 38 million full-time and part-time workers aged 16 and over who earn more than the federally mandated $7.25/hour but less than the proposed $15/hour. This means that a total of around 39 million workers, or 26% of the total workforce of 150.2 million workers (BLS at Feb 2021, includes full-time and part-time, hourly and salaried), earn less than $15/hour.

Although the minimum wage has not been increased for many years, the number of employees earning less that the new proposed $15/hour has been increasing anyway, due to a combination of states (and localities) stepping in with their own (higher) minimum wages but also due to reactions by companies to maintain their labour base under increasingly competitive circumstances. Below is an interesting graph from The Washington Post article showing the trend in workers earning less than $15/hour since the turn of the century.

Of course, the average or median hourly wage is far from the full story. The reasons are twofold. Firstly, regardless of the average wage, the misery is concentrated amongst low wage earners that are struggling just to scrape by, and this tier of workers and their families are very much affected by their low wages which are often at or just above the federally-mandated level. Secondly, wages cannot be considered in isolation, because they need to be considered in the context of what it costs a person or family to meet their minimum needs, and this varies throughout the country. For example, $15/hour – significantly above the federal minimum – might work fine in a rural area in the Midwest, but might not be adequate at all in a city in the Northeast.

According to the US Census Bureau, poverty threshold levels by family size in the US are as follows:

A family of four with two children under the age of 18 years old, earning less than $26,246/year (ignoring government benefits), would be considered to be living in poverty. It is hard to imagine any family surviving off of such a low amount of income under any circumstances, and fortunately at these levels, individuals and families qualify for state and / or federal assistance albeit inadequate in the minds of many. In 2019, 10.5% of Americans were living in poverty according to the United States Census Bureau (here), arguably way too many but still the lowest percentage since the US Census Bureau started recording this data in 1959. The initial stages of the pandemic saw the number of people in poverty decline further due to the CARES Act, but this soon reversed and economists predict that 2020 will see the first increase in poverty as a percentage of the US population for many years. In December 2020, the poverty rate was estimated to be 11.8%. The graph below from a Bloomberg article (here) provides a recent trend line for the US poverty rate.

Perhaps more relevant than the poverty thresholds are what are referred to as “living wages”, or the amount necessary for a family to meet its basic needs whilst being self- sufficient. These thresholds are significantly above the poverty level thresholds. Dr. Amy K. Glasmeier of MIT and her team calculate the living wage throughout the US each year and have done so since 2004. There is an excellent introduction (short) to the definition of living wage which you can find here, and the technical specs of a living wage can be found here. An extract from the introductory piece from MIT describing the living wage is below:

“Establishing a living wage, an approximate income needed to meet a family’s basic needs, would enable the working poor to achieve financial independence while maintaining housing and food security. When coupled with lowered expenses, for childcare and housing in particular, the living wage might also free up resources for savings, investment, and/or for the purchase of capital assets (e.g. provisions for retirement or home purchases) that build wealth and ensure long-term financial security.”

The MIT study reports that the living wage in the United States is $68,808 per year in 2019, before taxes, for a family of four (two working adults, two children). This equates to $16.54/hour (assuming both adults work 40 hours/week), compared to $16.14/hour in 2018. This of course varies rather dramatically by location, perhaps not surprisingly with urban areas having significantly higher living wage thresholds compared to suburban / rural areas. In general, the Northeast and Western states have the highest living wage requirements, and the Midwest and Southern states the lowest. As far as cities, this table below from the 2019 study shows the highest five and lowest five metropolitan areas, ranked by living wages for a family of four.

Should the Federal Minimum Wage be Increased?

Advocates of a minimum wage point mainly to the fact that workers in any country deserve a minimum standard of living, an assertion with which I agree. In the US, $13,465 is considered poverty level for a single person, and $26,246 is considered poverty level for a family of four (two working adults, two children), both of which imply earnings/hour that are below the current federal minimum wage of $7.25/hour. Rather than poverty levels, the more appropriate levels on which to focus are probably those of a living wage, and these levels – as mentioned earlier – imply earnings just above the proposed higher federal minimum wage of $15/hour. Proponents of a minimum wage increase would therefore not only like to see the minimum wage be increased to a level that reduces the percentage of Americans living in poverty, but to a level that enables families to receive a living wage, so that they can enjoy a lower middle-class existence.

Also, the federal minimum wage has not been increased since 2009, which makes little sense given that nearly all government entitlement programmes (e.g. social security) receive annual cost-of-living increases. During this period, inflation has been 23% and the minimum wage has not increased at all. Since the median wage in the US is already well above $15/hour, an increase in the minimum wage to $15/hour would seem easily justified on the basis or addressing inequality even if it comes at a modest cost.

There is just an equally strong case and vocal community against a minimum wage based on several economic theories. Firstly, imposition of a higher minimum wage for a company that might have some employees being paid less than the new minimum wage will obviously increase the company’s cost base. This, in turn, will garner one of three responses, or some combination. Firstly, depending on the industry and competitive dynamics, the company might not be able to do anything at all except absorb the higher costs and see its profits decrease. Secondly, the company might be fortunate enough to be able to raise the prices of its goods or services to protect its profit margin by offsetting the higher wage costs. Or lastly, the company might restructure its worker base to reduce the hours worked so mitigating the cost base increase, albeit likely with a trade-off in output, and hence, revenues. The reality is probably some combination of these responses, but there is a chance that some workers could be laid off or, less onerous, see their hours reduced. This is normally the most sighted criticism of an increase in the minimum wage, which is an increase in unemployment. The topic was taken up by the Congressional Budgetary Office (COB) in a report released last month entitled “The Budgetary Effects of the Raise the Wage Act of 2021”, which you can find here. This report is worth scanning, but its general conclusions are that an increase in the US minimum wage would put 1.4 million (0.9%) of workers out of work and would increase the US deficit, but it would also raise 900,000 people out of poverty. In essence, let’s call it what it is, which is a measure that would result in income redistribution.

Secondly, assuming at least some of the higher costs due to minimum wage get factored into higher sales prices of companies, an increase in the minimum wage might be inflationary. This is referred to as wage inflation, normally associated imbalances in the supply-demand of labour, not a higher minimum wage, although the effect can be the same. However, I believe that should such an increase in inflation occur because of higher wage costs, the increase would be temporary because a new equilibrium should be found quickly that mitigates further price rises. Moreover, there is an argument that the US economy would benefit from higher inflation, especially if it were to be temporary. I believe the US economy easily has the capacity to absorb this slack.

Thirdly, as with any operating cost or expense that increases, people or businesses are encouraged to find a way to address the higher costs. What does this mean for a business? It’s simple – higher wages that cannot be passed through will encourage companies to look for other ways to control their overall cost base. This could come for example in overt things like reducing employee benefits (to the extent allowed), or in less obvious and more longer-term measures that reduce the employee base gradually over time. This, in turn, could occur by management improving productivity by making manufacturing processes more efficient, introducing robotics, moving labour off-shore, employing illegal aliens at below-minimum wage levels, etc. There will almost certainly be some of this as a response, perhaps acceptable as a trade-off so long as more severe longer-term effects can be avoided, like businesses moving large swaths of lower wage jobs off-shore (to cheaper jurisdictions) or even entire companies disappearing simply because they cannot make the economics of their business work at a higher wage level.

My personal view is that for a country the size of the United States that has so many economic sub-regions, an increase in the federal minimum wage is just as much of a political statement as an economic argument. The US minimum wage has not been increased since 2009 – an increase is long overdue. Having said this, the US is such a large country with such a diverse labour market and different costs-of-living depending on where you live, which brings the entire question of the relevancy of a federally-mandated minimum wage level into question. Wouldn’t a series of minimum wages best be determined at state or local levels to reflect the difference in cost of living around the country? A family of four living in the New York City metropolitan area needs to earn $90,765/year as a living wage, according to the MIT study, whilst a family of four living in Knoxville, TN needs to only earn $58,314/year as a living wage. As a result, I would argue that a series of local, state and / or regional minimum wage levels would make more sense because these would better reflect the differences in cost of living in different parts of the US.

Knowing that this is not the focus of the Biden Administration at the moment, and in spite of a federal minimum wage having a lower utility than more localised levels of minimum wages, I think it is time that the federal minimum wage is increased. Much like the recently-passed stimulus act, I doubt many Americans would go against this, mainly because the increases in the federal deficit caused by a higher minimum wage – not dis-similar to the recent helicopter cheques – does not filter through to most people as a real cost. That will be someone else’s problem down the road.

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