After giving vague indications about his position on the minimum wage, President-elect Joe Biden finally confirmed that he will support mears to raise the minimum wage at the federal level to $15 an hour. The announcement could not come at a worse time, as now thousands of small businesses, which are the ones that actually pay the minimum, are either struggling financially or closing down.
Biden’s proposal to increase the minimum wage will not only affect the recovery of jobs in the pandemic, but it is also described as an anti-poverty measure, despite evidence indicating that an increased minimum wage has little impact in getting people out of such a situation.
Currently, no state has an effective minimum wage of $15 an hour, except the capital, Washington D.C. The states of Washington and Massachusetts currently have the highest minimum wages at $13.50 an hour and $12.75 respectively, according to the Department of Labor. Florida approved by referendum an increase in the minimum wage to $15 per hour, but this will be done via a $1 increase per year until 2026.
The Congressional Budget Office found that an increase in the minimum wage in 2024 to $15 an hour, while raising the earnings of 17 million Americans earning a minimum wage, would come at the expense of more than 1.5 million unemployed in industries where work is easily automated or can be replaced with foreign, and often informal, labor.
A study by Purdue University estimates that a significant increase in the minimum wage could shift the costs of this increase to the prices of final products in low-skilled labor-intensive industries, such as fast food.
Considering that the vast majority of people earning a minimum wage in the United States do not work in corporations, but in small and medium enterprises (SMEs), it is likely that a significant increase in the minimum wage would at best deter these businesses from hiring new personnel – or at worse laying off people permanently.
Supporters of the $15 minimum wage often refer to it as an economic stimulus to aggregate demand. This is supposed to stimulate long-term growth from increased consumption. Unfortunately, this is a naive view of how the economy works.
Economic growth is the actual creation of new goods and services for society. This creation of tangible value is what allows real wages to grow, not a magic number decreed by a politician. What the U.S. economy had been experiencing before the pandemic was exactly that: higher growth rates than in previous years, accompanied by increased wages for entry-level positions in business.
There are better measures against poverty than raising the minimum wage
Although the conclusion is clear: raising the minimum wage is a terrible anti-poverty measure, there is little talk of alternatives proven to be more effective, such as tax credits.
For many low-income taxpayers, two key provisions of the tax code – the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC) – prevent them and their families from falling into poverty.
What makes the EITC and the ACTC unique is that they are refundable – that is, after offsetting taxes owed, filers receive the rest of the credit on their tax refunds. As a result, the tax credits effectively increase the take-home pay of low and moderate-income working families.
Twenty-three percent of U.S. households do not pay income taxes, and three-quarters of these do not pay taxes because of provisions that benefit older people and low-income working families with children.
For example, a couple with two children who earn less than $26,400 a year will not pay any federal income tax because their standard deduction is $11,600. And for low income and number of children they would have four exemptions scalable to $3,700 reducing their taxable income to zero.
The basic structure of the income tax simply exempts subsistence levels of income from the tax. The couple could earn an additional $19,375, per year, without paying income tax because their pre-credit tax liability of $2,056 would be eliminated by a $2,000 child tax credit and $57 EITC.
Tax credits for parents recognize the fact that educating the next generation is a costly investment in human capital that will generate dividends for society as a whole. Meanwhile, tax breaks for social security payments can be defended on the grounds that they are unlikely to create significant employment disincentives.
These tax credits-in the essence of what Milton Friedman called “negative tax income”-have proven much more effective in combating poverty than simply increasing the cost of employment. While there is indeed costly, this cost is much less than the cost in jobs lost or lost to be created by any Democrat-led economic reforms.