Fred Thompson: The CBO Report and the Minimum Wage II

Fred Thompson checks in again with the second of a two-part post on the minimum wage. Part I was posted yesterday.

THE CBO REPORT AND THE MINIMUM WAGE II

One big difference between the CBO report and how the CEA spins it is that CBO emphasizes that a minimum-wage hike has costs. To put it another way, the minimum wage is like a tax on low-wage work; as is generally the case, when you tax something you get less of it, but as with any other tax, some folks are also left with less money in their pockets. Figure 2 (in my previous post) shows that the costs to those who purchase low-wage work, either directly as employers (through reduced profits) or indirectly as consumers (by paying higher prices for the stuff made using low-wage labor), is A+B or .5*(16.5 million +17 million)*(2000*$2.50) or $83.75 billion. The net loss is therefore B+D. In other words, the losers lose more than the winners gain, $8.75 billion more, which, as the CBO emphasizes, is in this context a fairly small number (about what it would cost to buy 40 F-35s).

Besides, it is in the nature of transfer programs, no matter how they are financed to take in more than they hand out. Economists call this difference ‘the leaky-bucket ratio.” According to the CBO, the minimum wage’s leaky-bucket ratio is nearly as good as the Earned Income Tax Credit’s – it’s associated with greater allocative inefficiency, but is also relatively less costly to administer. It only costs the losers about $1.10-$1.15 to transfer a dollar to a low-wage worker via the minimum wage.

Nevertheless, the CBO also reminds us that less than 20 percent of low-wage workers are from poor (below the federal poverty line) households, which means that if what we are concerned about is how much it costs us to transfer a dollar to a poor family (rather than to a low-wage worker) via the minimum wage, the leaky-bucket ratio is not nine percent but more like 80 or 90 percent, which is distinctly inferior to the EITC.

The CBO also emphasizes that who bears the burden of the minimum wage matters in two distinctly different ways: its effect on the demand for low-wage workers (negative) and its effect on aggregate demand (positive). In both instances, how much depends on whether its burden is shifted back to the owners of the enterprises that hire minimum wage workers (lower profits) or forward to consumers (higher product prices). This is important to an assessment of the employment effect of a minimum-wage hike, because if most of the tax is shifted forward to consumers, the effect will be small; at the same time, consumption taxes tend to be pretty regressive, if minimum wage hikes are entirely shifted forward to consumers in higher prices, the pockets of the families from whom the cash is taken won’t on average be very much deeper than those to whom it is given.

In contrast, business owners tend to have much deeper pockets than the families of minimum-wage workers. If minimum wage hikes come out of profits, they would have the net effect of transferring cash to folks with a much higher propensity to spend it, thus significantly increasing aggregate demand. Unfortunately, they would also result in a lot of low-wage job losses.

The CBO’s analysis finds that about ¾ of the cost of a minimum wage hike will be shifted forward to consumers in the form of higher prices and about ¼ back to profits, which is how they come to the conclusion that the low-wage job losses from a big jump in the minimum wage will be relatively small. At the same time, this finding is also consistent with the conclusion the distributional burden of a minimum-wage hike will be approximately proportional to income, which is significantly but not hugely different from the distribution of households supplying low-wage workers (see the CEA’s point 2 above, for the magnitudes at issue). Hence, the CBO concludes that boosting the minimum wage tends to increase aggregate demand, but only slightly.

The one kicker goes to the minimum wage’s effect on labor supply and how subsequent minimum wage jobs will be rationed. This could actually go either way: higher wages lead to lower turnover, reducing the amount employers must spend recruiting and training new employees. Paying workers more can also improve motivation, morale, focus, and health, all of which can make workers more productive. In addition, business owners can adjust in ways other than reducing low employment – for example, the CEA mentions accepting lower profits, although replacing low-wage workers with capital or higher skilled workers seems more likely, and would be easy to do if a higher minimum wage induced more higher-skilled workers to seek minimum wage jobs.

Finally, the CBO report looks at the effects of a higher minimum wage on the wages of folks who are already earning more than the proposed minimum wage. Many of those folks can expect to see their wages bumped up. The question is, how much? The study referenced by the CEA simply assumed that the gain to above-the-proposed-minimum-wage workers would be equal to the gain accruing to those below the proposed minimum wage. In contrast, the CBO used the variation in state minimum wages – half of America’s workers live in states where the minimum wage is equal to the federal minimum, $7.25; a fourth live in states where it’s $8.01 or higher; and a fourth live in states where it’s somewhere in the middle – to suss out the size of the effect on those above the proposed federal $10.10 level. It concluded that the effect would be about half of the difference between the proposed level and the state’s current minimum, or about $30 billion altogether.

The CBO report is a great illustration of how state policies serve as laboratories of public policy. Nearly every finding in the report is based upon quantitative comparative analysis of how effects vary as a consequence of different minimums across states and over time. As an economist, with an intellectual interest in this issue, I cannot help but wish that Washington State would soon adopt a $15 per hour minimum wage. I’d really like to see what would happen. As a citizen of Oregon, I’d prefer to learn from someone else’s experience.