SOCIAL WELFARE:
The Minimum Wage Was High in the First Place

By Thomas E. MaCurdy and John F. Cogan

Hoover fellows John F. Cogan and Thomas E. MaCurdy argue that when Congress and the president hiked the minimum wage last summer, they were making a dumb mistake. The hike hurt those it was intended to help and helped those who didn't need it. And the effective minimum wage rate was already at a historic high in the first place.

Who would have imagined that putting Republicans in control of Congress for the first time in forty years would produce a tax hike on small business--a tax primarily borne by middle- and low-income families? Yet last summer Congress approved legislation raising the federal minimum wage from $4.25 to $5.15. This 21 percent increase in the minimum wage is a testament to the level of confusion about who benefits from the higher minimum wage and who bears its burdens.

Advocates of the higher minimum wage base their case on a caricature--family heads who work at the minimum wage at a full-time, year-round job. These advocates argue that such family breadwinners earn too little to support a family with children. Furthermore, the argument goes, the plight of such families has worsened over time because the minimum wage compared with the average wage of all workers has fallen to its lowest level in decades.

Just the opposite is true. Since the early 1970s, the relative hourly earnings of minimum wage breadwinners have never been higher--and this was true even before last summer's increase. Consider the graph on the next page, where we plot three measures of the relative hourly earnings received by these workers.

The lowest curve shows the evidence commonly cited by the minimum wage advocates. It displays the minimum wage, before it was increased, as a percentage of the average wage in the United States. According to this curve, the minimum wage relative to the average wage had indeed fallen to it lowest level in decades.

However, none of the minimum wage breadwinners or their families must live solely on this wage. All these families are eligible to receive the earned income tax credit (EITC), a wage subsidy provided by the federal government as part of the regular tax system. The EITC was established twenty years ago as a way of supplementing low wages, and, with the filing of a simple form, it can now be paid to workers through their employers as part of their regular paycheck. The EITC creates a difference between the wage paid by employers and the average hourly earnings received by the eligible worker. In 1996, for every $1.00 that our hypothetical low-wage breadwinner earns from his or her employer, the worker receives an additional $0.40 from the EITC (assuming two children in the worker's family). Thus, although the minimum wage paid was only $4.25 per hour, the EITC raised the "effective minimum wage" received by a sole family breadwinner to $5.95 per hour. The middle curve in our graph adds the supplemental income provided by the EITC to the minimum wage paid by employers.

According to this curve, the effective minimum wage is higher in 1996 than at any other point in the past twenty-five years, even before it was increased. It is more than half (52 percent) the average wage rate, slightly exceeding the values in the late 1970s. The EITC was increased several times in the last six years, and the minimum wage was increased in 1990 and 1991. As a result, minimum wage workers who were sole family breadwinners saw their effective wages grow significantly during the 1990s. In the past seven years, indeed, the effective minimum wage increased at an annual rate of 6.4 percent--nearly two and a half times as fast as the average wage paid to all workers.

Several other governmental programs offer further income support for poor families, further raising the average hourly earnings of their minimum wage breadwinners. Such programs include food stamps, Aid to Families with Dependent Children (AFDC), Social Security Insurance (SSI), Medicaid, and housing assistance. To illustrate the implications of these programs, consider the supplemental income paid by food stamps alone. The top curve in our chart calculates the implicit hourly earnings received by these breadwinners. Adding food stamps and the EITC to the earnings of the head of a household raises the implicit hourly wage to $7.88 in 1996, reaching 67 percent of the average wage rate. Once again, this is the highest percentage in twenty-five years.

How much further will these minimum wage breadwinners benefit from the increase in the minimum wage, assuming they remain employed? The $0.90 wage increase from $4.25 to $5.15 raises the effective average hourly earnings of a family head receiving EITC by the full $0.90 (from $5.95 to $6.85), attaining a level nearly 60 percent of the average wage. Families who also collect food stamps lose some benefits as a result of the higher earnings induced by the minimum wage hike, so the heads of these households will see an increase of only $0.69 per hour (from $7.88 to $8.57), reaching a wage level almost 75 percent of the average wage. Of course, both families would have to pay part of their higher earnings as payroll taxes, meaning that none would receive the full amount mandated by the minimum wage increase.

Although the caricature of the minimum wage worker as a family's sole breadwinner serves as a convenient device for those favoring a raise in the minimum wage, this representation is the exception rather than the rule. In 1993 only 7 percent of workers earning below $5.00 an hour were the sole breadwinners in families with children, based on our calculations. What kinds of families do the other 93 percent of minimum wage workers come from?

Almost 15 percent of families in the United States had a member earning below $5.00 per hour in 1993. Slightly more than 40 percent of these minimum wage families had incomes above the U.S. median, supporting the contention that many minimum wage workers come from upper-income families. Just over 50 percent of minimum wage families consisted of married couples with children, but in these families earnings from all low-wage jobs on average accounted for only about 23 percent of total family income. Another 16 percent of minimum wage families consisted of nonmarried adults with children, but even here earnings from low-wage jobs on average contributed only about half these families' total income. Considering all minimum wage families with children, half the low-wage workers in these families were teenagers. These facts lead to the unavoidable conclusion that raising the minimum wage has primarily benefited nonpoor families who have secondary low-wage workers.

Who pays for a higher minimum wage? A legislated minimum wage hike is no different from a hike in the payroll tax on low-wage workers, with the proceeds contributed to these workers as taxable income. Three groups pay for this tax: owners of the businesses who employ these workers; the customers who purchase products from these businesses; and some low-wage workers themselves who lose their jobs because of the higher minimum wage. What are the relative incomes of these groups? The vast majority of low-wage workers are hired by small businesses in service industries. Small businesses, which hire the majority of low-wage workers, are not typically owned by Americans who come from the upper strata of the income distribution. Picture for example, restaurants and gardening services. Nor are the consumers who patronize such businesses--and to whom some of the cost of the higher minimum wage will be passed on in the form of higher prices--necessarily wealthy. Picture the customers of fast-food restaurants. And because the higher minimum wage raises the cost of labor, the inescapable economic fact of life is that fewer workers will be hired, with the most disadvantaged individuals unable to find employment. No matter which of these taxpayer groups one considers--small businesses, consumers, or disadvantaged workers--the people who are paying for the higher minimum wage tax are primarily middle- and low-income families.

Hiking the minimum wage was a bad way to help low-wage workers--first, because so much of its benefits go to families with relatively high incomes and, second, because lower-income families are much more likely to bear the burden of the implicit tax imposed by the wage hike than they would any other form of tax the federal government would be likely to impose to fund low-income benefits. The EITC, by contrast, was designed to make transfers to the working poor efficient (higher-income families do not receive the benefits), with the tax burden dictated by what Congress and the administration view as an equitable distribution. Help for low-wage workers wasn't needed in the first place--as we've said, the effective minimum wage rate was already at its highest level in two decades. But if Congress and the president wanted to take action all the same, they should have expanded the EITC and left the minimum wage alone.

Thomas MaCurdy holds a joint appointment as a senior fellow at the Hoover Institution and a professor of economics at Stanford University, where he has taught since 1978. He is also a senior fellow at the Stanford Institute of Economic Policy Research, an adjunct fellow at the Public Policy Institute of California, and a research associate of the National Bureau of Economic Research.

John F. Cogan is the Leonard and Shirley Ely Senior Fellow at the Hoover Institution and a professor in the Public Policy Program at Stanford University. His current research is focused on U.S. budget and fiscal policy, social security, and health care. He has devoted a considerable part of his career to public service. He is a member of Governor Arnold Schwarzenegger's Council of Economic Advisers and serves on the governor's Public Employee Post-Employment Benefits Commission. He has also served on numerous congressional and presidential advisory commissions. He served deputy director of the U.S. Office of Management and Budget (OMB) from 1988 to 1989, associate director for economics and government and subsequently as associate director for human resources between 1983 and 1986, and as assistant secretary for policy in the U.S. Department of Labor from 1981 to 1983.