Last night, President Obama proposed increasing the minimum wage from $7.25 to $9, and then indexing it to inflation. That's a 25 percent initial boost, and a boost of 1 percent to 2 percent, at a minimum, every year going forward. Here are four things to know about proposals like this.
1) Economists are sharply divided about whether the minimum wage increases unemployment
A debate on this topic within the economics profession was kicked off by work done by Berkeley’s David Card and Princeton’s Alan Krueger. Card and Krueger studied employment changes following minimum-wage increases, notably a 1992 increase in New Jersey and a 1988 increase in California, and found no evidence that they caused a fall in employment, if you compare trends to areas that did not see increases.
That finding, which flagrantly contradicts Econ 101, caused a firestorm so large that Card has stated it “cost me a lot of friends.” UC Irvine’s David Neumark and the Fed’s William Wauscher conducted a literature review in 2007 that found a majority of studies found negative effects on employment — that is, a higher minimum wage meant fewer jobs. They found this was particularly true among low-skilled workers.
A more recent study from economists at the London School of Economics and the central bank of Turkey found higher minimum wages increased unemployment. But that finding is far from unanimous, with Berkeley’s Laura Giuliano finding no statistically significant effects on employment, and Arindrajit Dube of the University of Massachusetts finding no effects as well. So, if you believe one set of literature, Obama’s plan will increase wages without reducing employment. But many labor economists think the plan has real costs.
2) It's less cost-effective than just giving poor people money
Forget the economic debate about whether the minimum wage destroys jobs. Does raising it improve the plight of the worst off, at a reasonable price?
A lot depends on your definitions, but economist Adam Ozimek makes a smart point. According to a 2007 study by the CBO, an increase in the minimum wage to $7.25, like that eventually passed that year, would increase wages by $11 billion, of which $1.6 billion went to poor families.
By contrast, increasing the Earned Income Tax Credit for large families (as happened in the stimulus bill) and for single people would cost $2.4 billion, of which $1.4 billion would go to poor families. The EITC option costs one fifth as much to society but does about as much good for poor families. That suggests that if you want to help families escape poverty, wage subsidies are a more cost-effective option than the minimum wage.
Minimum wage increases at the federal level only take effect if the federal minimum is above that passed in states. So if every state already had a statewide minimum wage of at least $9, then Obama's proposal would do nothing. But as Brad pointed out last night, only Washington has a minimum wage above $9 at the moment, although Oregon's $8.95 minimum isn't that much lower: