Is raising the minimum wage the only option?

By John W. Diamond, Ph.D.
Director, Center for Public Finance
Edward A. and Hermena Hancock Kelly Fellow in Public Finance


The debate over raising the minimum wage is ongoing and will continue to be a central topic  throughout the 2020 election cycle. For example, the U.S. House of Representatives recently passed the Raise the Wage Act of 2019, which would gradually raise the minimum wage to $15, but it has little chance of passing the Senate.

In July 2019, the Congressional Budget Office (CBO) published a report examining the effects of increasing the federal minimum wage from $7.25 to $10, $12 or $15 per hour by 2025. CBO’s median estimates show that the $15 option would likely increase the wages of 27 million U.S. workers by year 2025 (the year the wage increase is fully in effect). Of this group are 17 million workers who currently earn less than $15 per hour; the increase in the minimum wage would directly impact their hourly wage. The remainder of this group — or 10 million workers — currently make slightly more than $15, but CBO projects that their wages may increase as firms adjust the wages of managers and workers with more seniority.

CBO’s median estimates show that the number of workers below the poverty threshold in 2025 would only fall by 1.3 million with a higher minimum wage. This indicates that the policy does not appear to be well targeted in terms of reducing poverty partly because, as CBO reports, 42% of low-wage workers are in families with incomes of more than three times the poverty level. In addition, the CBO projects that 1.3 million workers would lose their jobs under the median estimates, with job losses ranging from about zero to 3.7 million under CBO’s low and high estimates.

According to the CBO, this policy is projected to decrease total family income by $8.7 billion. This total loss can be broken down to show the winners and losers. In particular, CBO projects (under the median estimates) that the real earnings of workers who remain employed would increase by $64 billion and the real earnings of the total number of workers who lose their jobs would decrease by $20 billion. Real income for business owners would decrease by $14 billion and the real income for consumers would decrease by $39 billion (as a result of the increase in prices for goods produced by low-wage workers). The distribution of the $39 billion decrease in real income would depend on household consumption shares of goods and services produced by low-wage workers.

The $8.7 billion decrease in total family income also can be broken down across various income groups. CBO projects that family income would increase by $7.7 billion for families with incomes below the poverty level ($20,480 for a family of three and $26,330 for a family of four in 2018 dollars); family income would increase by $14.2 billion for families with incomes one to three times the poverty level; family income would decrease by $2.1 billion for families with incomes three to six times the poverty level; and family income would decrease by $28.4 billion for families with incomes more than six times the poverty level.

There is a considerable amount of uncertainty surrounding how a higher minimum wage would affect low-wage workers. In producing their estimates, CBO relies on a number of studies, which are cited in the report. The studies report conflicting evidence on the impact of the minimum wage on wage gains and employment in the near- and long-term. Standard economic theory obtains that an effective wage floor raises wages and reduces the demand for minimum wage workers, thus increasing unemployment. However, other theories such as monopsony (a market with a single buyer with market power) and equilibrium search models imply that minimum wages can increase employment. While empirical evidence is not always consistent with the standard model, there is even less evidence of widespread and significant market power for employers in low-wage labor markets, especially in urban cities. Moreover, much of the evidence either focuses on specific groups or rather short time frames that make it difficult to apply the findings broadly to current economic trends. In addition, determining how technological change and increased automation will impact low-wage workers and change the economic effects of a minimum wage is highly uncertain.

However, there is viable alternative to increasing the minimum wage: increasing the earned income tax credit (EITC), which has several advantages over the minimum wage. Most importantly, the EITC is funded from general funds, so a single group is not unfairly burdened with the cost of implementing the policy. This is not true for the minimum wage. In the case of the minimum wage, the employers of low-wage workers are responsible for the mandated wage payments. Employers can raise prices to shift part of the burden to consumers, reduce the number of workers they hire, or reduce other non-wage benefits to try to avoid this burden. But the fundamental question is why should the employers of low-wage workers be solely responsible for this burden, at least from a legal perspective (i.e., we know that the economic incidence of the burden will be spread across a wider range of economic agents)  —  especially given that small businesses often claim to be unable to withstand such burdens. For example, after Democrats proposed the Raise the Wage Act of 2019, Rep. Terri Sewell, D-Ala., put forth a proposal that would introduce a tax credit for small businesses to help offset the burden caused by the increase in the minimum wage. Legislation aimed at undoing the uneven impact of the minimum wage shows how undesirable its effects are. The EITC would avoid this problem. In addition, since it is household based, the EITC would be better targeted than the minimum wage in helping only low-wage workers.

The uncertainty surrounding the economic effects of a higher minimum wage, including current economic trends in which the benefits of investing in automation to reduce costs are increasing even without an increase in the minimum wage, raise concerns about implementing such a policy. The EITC would avoid this uncertainty. Given the uncertainty surrounding the economic effects and the poorly targeted benefits and burdens of a minimum wage, it is unlikely to be the best policy to increase the wages of low-wage workers. Instead, increasing and expanding the EITC to increase the earnings of low-wage workers is likely a better policy option, even after modifications to the EITC to deal with its treatment of households that vary by size and makeup.