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How to Raise the Minimum Wage, If You Must

With Democrats pushing for a $15 minimum wage in the forthcoming Covid-19 relief bill, the “Fight for 15” has officially gone national. Budget reconciliation rules allow for a simple majority to pass spending provisions, but forbid regulatory reforms that are extraneous to the budget. The push is happening anyway, Byrd Rule be damned, as indication of how popular a $15 minimum wage is with the general public. It’s a political winner just to fight, even if the fight is ultimately in vain. Yet it may not have to be in vain if the Biden administration is serious about bipartisanship.

In a surprising twist, Republican Senators Tom Cotton and Mitt Romney have announced openness to raising the federal minimum wage to $10 per hour in exchange for greater employer-level immigration enforcement through E-Verify. Immigration policy isn’t my wheelhouse, yet the combination has some internal coherence. Long before a higher federal minimum wage has noticeable dis-employment effects, it would at least give lower skill native workers a competitive edge over their immigrant counterparts. This is why a higher minimum wage has been endorsed by immigration restrictionists like Ron Unz and Ann Coulter.

I am not a big fan of the minimum wage, precisely because it removes the bottom rungs out of the labor force for natives and immigrants alike. The fact that so many lower-skilled immigrants to the United States are self-employed or work as independent contractors is a testament to the barriers to “primary” labor market integration that already exist. The U.S. labor market is nonetheless significantly more flexible than in many European countries, where (not coincidentally) low-skill immigrants often struggle to integrate, face higher rates of unemployment, or become segmented into undesirable occupations. This is not a state of affairs the U.S. should seek emulate. Indeed, low-skill migrants to Southern European countries with rigid labor markets are much more likely to work in the shadow economy or other “secondary” labor markets relative to their counterparts in the UK or Denmark, where labor regulations are comparatively flexible.

A higher federal minimum wage could either ameliorate or worsen the development of a split labor market depending on how its designed and enforced. Recent minimum wage increases in the U.S. have tended to induce in-migration of legal immigrants, for example, while pushing-out undocumented immigrants. City- and state-level minimum wage hikes have thus had less impact on aggregate employment than one might expect, as the lowest skilled workers are induced to either move away or turn to unregulated industries. With a sufficiently high federal minimum wage, there’d be no where for the least skilled workers to move but out of the country, which for some conservatives appears to be the point.

Building a better minimum wage

That being said, there are better and worse ways to increase the minimum wage than simply picking $10 because it’s round or $15 for its alliterative properties. Ideally, the federal minimum wage would be pegged to some percentage of the state median wage, given the potentially perilous impact of a one-size-fits all minimum wage in a country with large regional differences in labor productivity. The enactment of the minimum wage hike in the Fair Labor Standards Act amendment of 1966, for example, had little aggregate impact on employment nationwide, but nonetheless resulted in a 3.4 percent (3 percentage point) drop in Black employment given the lower average wages and levels of labor productivity in the American South. 

Back in 2016, Arin Dube estimated that pegging the minimum wage to 50% of state median wages would result in a higher federal minimum wage in all 50 states, and — taking into account different state-level minimum wages — translate into a 26.2 percent increase in the effective statutory minimum wage overall. That surely has changed given the number of successful state and city ballot initiatives in recent years, but is a useful starting point. 50% of the median wage would be in line with the international norm, however 2019 research by Anna Godoey and Michael Reich of the UC Berkeley found that past increases in state minimums didn’t hurt employment in low-wage counties until the new floor equaled or surpassed 82% of the prevailing median wage. Lawmakers could pick a number between 50-80% of the median and be relatively safe about avoiding measurable dis-employment effects. Nationally, the median hourly wage in 2019 was $15.35. So if one is targeting a statutory minimum in the $10-15 range, setting the peg to 65% of the state median wage would be right on the money.

The BLS produces median wage estimates by state already, so it wouldn’t be too much trouble to have the Department of Labor publish a median hourly wage estimate by state for the purposes of a peg. They already do far more complicated calculations for determining things like the Adverse Effect Wage Rate for H-2A workers. You could get fancy and have the wage be based on the three year moving average to account for volatility from recessions and the like. Using the average wage may be even better than the median, as well, since the average wage captures rising inequality. This may be too clever by half, but that would make minimum wages automatically lean against changes in state-level income inequality.

The nice thing about this approach is that it would automatically index the minimum wage to state level median wage growth. Were it indexed to national wage growth, you could get perverse dynamics where a small number of populous states experience a burst in productivity, pulling up the minimum wages of every state whether or not they’re experiencing the same productivity growth. Poor states like Mississippi are stuck using the U.S. dollar, and so depend on relatively lower labor costs for their competitiveness. Indeed, Mississippi’s median wage is only $15 per hour. If that became their minimum wage as well, there would be short-run dis-employment effects, but also longer-run negative consequences on their regional development. Phasing any wage hike in overtime can help facilitate these adjustments, but only so much. A higher minimum wage may push businesses to adopt labor-saving technology, but you can’t brute-force regional productivity convergence, the rate of which has been declining in the U.S. since 1980.

Indexing minimum wages is good policy. But on the political dimension, it almost never happens because doing so removes future increases to the minimum wage as a perennial issue for politicians to campaign on. So longer-term, indexing is smart politics, too, because it’d create a one-off boost to the wage floor while removing future increases as a political football.

Exempt younger workers, but not small businesses or prisons

Minimum wage laws should also provide some kind of exemption for the under 18 crowd, since they’re just entering the labor market. The easiest way would be to simply set their peg to a lower percentage, say 50% of the state median rather than 65% for everyone else. That 15 percentage point differential would encourage employers to hire younger workers on the margin. The age cut-off could even be set higher, say to age 25, given the growing “failure to launch” problem in this country — what Ben Sasse has called “The Vanishing American Adult.” Other countries often have wage subsidies for youth to get them out of mom’s basement and into the labor force. Weirdly, though, the closest thing the U.S. has to a wage subsidy, the Earned Income Tax Credit (EITC), is only available starting at age 25. A federal minimum wage increase could be paired with reforms to lower the EITC’s eligibility to 18+, in order to ensure we aren’t pulling-up the draw bridge for those not yet in adulthood.

Exemptions for small businesses I’m less enthused about, for the usual Michael Lindian reasons, though I understand the politics here are extremely tricky. This is particular relevant for those motivated by immigration enforcement, since small and independent business are often the worst offenders when it comes fair labor violations (if they’re even applicable) and employing undocumented workers. Estimates suggest fully 10% of employees in the restaurant industry are unauthorized, for example, with that number climbing closer to 40% in big metros like LA and NYC. Exempting those businesses would undermine any role the minimum wage could play in leveling the playing field for native workers, while deepening immigrants’ occupational segregation. Ensuring that the federal minimum wage includes a much higher minimum for tipped workers is similarly important. The statutory minimum for tipped workers is only $2.13 per hour, which helps explain how restaurants have become a huge source of labor arbitrage, in particular.

More provocatively, the Cotton-Romney proposal could consider boosting the minimum wage for prison inmates, as well. Under the FLSA, prisoners are exempt from minimum wages and most other labor protections because they’re not considered employees. As a result, prisoners have become a de facto source of slave labor in many states. It’s truly heinous, but also — from a tight labor markets POV — if an employer paying sub-minimum wages to illegal immigrants harms native workers, why wouldn’t employing tens of thousands of prisoners on farms and factories at wages as low as 33 cents per hour? I haven’t looked deeply at the federalism ramifications of this, however the Cotton-Romney proposal could at the very least apply the new minimum to the more than 17,000 inmates in federal prisons working at government-owned factories, farms, and call centers across the country. State correctional facilities should be forced to pay a fair wage for their inmates, as well, though I can at least appreciate why one wouldn’t wish to spark a weird 13th amendment lawsuit from some angry warden in Alabama.

It’s heartening to see Republican Senators propose a reform that goes against the low-road orthodoxies of the business community. Nonetheless, the minimum wage is a blunt policy instrument that, when pushed too high, can create genuine barriers to lower skill workers just entering the labor market. A better approach would be to peg the federal minimum wage to state average wages, allow a lower minimum wage for workers under 25, and include few if any exemptions based on business size or type. This way a higher minimum wage would serve to level the playing field in a regionally-sensitive way, while, if anything, helping to de-segment the labor market for low skilled natives and immigrants alike.

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Samuel Hammond is the Director of Poverty and Welfare Policy at the Niskanen Center.

@hamandcheese

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