A “Grand Bargain” on the Minimum Wage?
Whoever said good policy makes for good politics obviously never heard of the federal minimum wage. The minimum wage is anything but the fairest and most efficient way imaginable to achieve its ostensible goals: reducing income inequality and rewarding the productive effort of low-skilled, entry-level workers. Decreed by Congress based on the loosest of economic analysis and applied to businesses large and small without regard for local market conditions, the minimum wage functions as a non-transparent tax whose ultimate costs — fewer jobs and higher prices — are often borne by the very people it is supposed to help.
The Congressional Budget Office's analysis of President Obama's much-discussed proposal to raise the federal minimum wage from $7.25 per hour to $10.10 (over three years) found that it would lift some 900,000 working people out of poverty — but would likely kill 500,000 jobs. In other words, it would confer a significant benefit on just under a million needy people, at the expense of denying half a million others any opportunity at all to better their lots through work. For reference, there were 46.5 million people in the United States living in poverty in 2012, according to the Census Bureau. And 9.8 million unemployed workers were looking for a job as of May 2014, according to the Bureau of Labor Statistics.
Flawed as it is, though, the minimum wage is here to stay. It is deeply rooted in public opinion — probably the most popular of all New Deal-era policies still on the books, with the exception of Social Security. Economists can demonstrate its perverse unintended consequences all they want, but Americans respond to the intuitive appeal of a federally guaranteed floor below which competition cannot drive wages, especially when the issue is framed in terms of families and fairness.
Voters relish the chance to grant their fellow citizens a raise. Gallup polls going back to the mid-1980s show public support for raising the minimum wage has generally exceeded 70%; a November 2013 Gallup poll found that 76% supported an increase to $9.00 an hour. In March 2014, the Bloomberg National Poll recorded 69% support for Obama's $10.10 proposal. A 2014 ABC News/Washington Poll found that 50% of voters were more likely to support a candidate for Congress who favored a higher minimum wage.
Small wonder, then, that, with control of the Senate at stake, the Democratic Party is making Obama's call for a $10.10 minimum wage a centerpiece of its 2014 campaign at both the state and national levels. For Democrats, the minimum wage is that rare policy issue that's all political upside: The public likes it; the party's ideology favors it; and one of the party's chief interest groups, organized labor, benefits from it, in part because many union contracts link pay to state or national minimum-wage changes.
For a pro-market, pro-business conservative party like the Republicans, on the other hand, the minimum wage is all tradeoffs and dilemmas. The issue forces Republicans to stand for principle, and for the interests of their business supporters, when both run contrary to public sentiment, including the feelings of many rank-and-file Republicans. The Bloomberg National Poll found that 45% of GOP voters favor Obama's proposed minimum-wage hike.
As the political costs to the GOP have mounted and the November 2014 election draws nearer, fissures have appeared in the Republican wall of opposition. In late April and early May, three GOP figures — 2012 presidential nominee Mitt Romney, former Minnesota governor Tim Pawlenty, and probable 2016 candidate Rick Santorum — all backed an unspecified hike in the minimum wage. Yet Republicans in Congress stuck to their guns, with the Senate GOP using the filibuster to block a vote on Obama's $10.10 plan and the Republican-controlled House refusing even to consider it.
The GOP's predicament, of course, is secondary to that of the country, which pays the price for minimum-wage warfare in terms of both political conflict and greater uncertainty for employers and workers. The longer Congress stays deadlocked, the more the struggle gets displaced to states and cities, some of which have enacted their own minimum-wage increases in the absence of a federal one, creating a patchwork of rules from state to state and, occasionally, within individual states.
As of January 2014, 21 states and the District of Columbia had enacted minimums higher than the federal rate, such that 53% of all U.S. workers now live in jurisdictions where the minimum wage exceeds $7.25 per hour. In 11 states, the minimum is adjusted each year for inflation, unlike the federal rate. Washington state currently has the highest state minimum wage at $9.32 per hour, though, under current law, California will surpass this in 2016 when its minimum wage will increase to $10 per hour. Several states have acted to raise their minimum wages gradually to $10.10, President Obama's goal. San Francisco's is already $10.74.
The country badly needs to end this political trench warfare, yet it's certainly not going to conclude with a clear victory for either side, since the Republicans are likely to remain in control of the House well past the 2014 election, a Democrat will be in the White House at least until January 2017, and neither party seems destined to achieve a durable 60-vote majority in the Senate anytime soon.
It may be time, therefore, for a "grand bargain" on the minimum wage, one that would spare the economy from future wrangling over a policy that is, at most, a second-best solution to the problems of low-wage workers. Such a compromise would enable Congress to focus its time, and the public's resources, on policies that deliver support to striving families more efficiently.
The key to the grand bargain would be a tradeoff by each side between policy principle and political advantage. For their part, Republicans would concede to the Democrats that the minimum wage will go up, not only now, but in the future. In return, the Democrats would accept that those increases must be limited, predictable, and — crucially — determined through non-political means. Once that deal is done, both parties could turn to the task of augmenting and reforming a program that both parties have backed in the past, and that offers a more efficient, better-targeted support program for the working poor: the Earned Income Tax Credit.
Whether having a minimum wage is a good idea or not, it is definitely a bad idea to let politicians set it through occasional knock-down, drag-out fights in Congress, based on little more than their own seat-of-the-pants notions of fairness and political self-interest. Therefore, the first element of the grand bargain would be the modernization of the minimum-wage adjustment process — the purpose of which would be to take that process out of the political arena once and for all.
This first step would require Democrats to surrender a weapon they have perennially wielded against the GOP, but they need to be reminded that it's a weapon the author of the minimum-wage law — Franklin Roosevelt — never intended them to have. F.D.R.'s original plan, articulated in a May 24, 1937, speech, called for a national minimum wage as part of a large slate of regulations setting "labor standards which will permit the maximum but prudent employment of our human resources to bring within the reach of the average man and woman a maximum of goods and of services conducive to the fulfillment of the promise of American life." As F.D.R. conceived of them, these standards would not be set by elected lawmakers but by unelected experts, working within the Department of Labor. These disinterested technocrats would continuously fine-tune each business sector's minimum wage based on cost-of-living data and an industry-by-industry assessment of whether wages were below subsistence levels.
It was a classic expression of F.D.R.'s progressive faith in economic management by experts. As such, it was fatally flawed. Not just Republicans and businessmen but labor unions and congressional Democrats balked at the bureaucratic nightmare the president had proposed. After a year-long battle, a simpler plan emerged, setting a 44-hour work week, establishing child-labor laws, and establishing a minimum wage of 25 cents per hour. The minimum would rise to 30 cents in 1939 and to 40 cents in 1945; thereafter, Congress could adjust it by statute. And, indeed, since 1945 Congress has passed 26 increases in the minimum wage, nearly always accompanied by political drama.
Yet Roosevelt's goal — an apolitical wage-setting process — was a good one, and could be achieved today through far less bureaucratic means. Congress could empower the Labor Department to set a benchmark minimum wage based on historical data, and then link this rate to an independent adjustment factor so that it rises consistently, gradually, and automatically in response to evolving economic circumstances, rather than political ones.
The most controversial step would likely be the first one: choosing the benchmark. One option would be to set the minimum wage based on its historical relationship to the poverty level. Since the federal government first established a definition of poverty in 1959, the average income for a full-time worker earning the minimum wage has averaged two-thirds of the poverty line for a family of four. The current poverty line for such a family is $23,850. For an employee working 40 hours per week, 50 weeks per year, to make about two-thirds of that amount, the minimum wage would need to be $8.00 per hour — a 75-cent increase over the current rate. As the CBO study implies, such a raise would do far less significant damage to employment than the increase to $10.10 that the president and his party are seeking.
A second option would set the minimum wage based on its historic relationship to private-sector wages. Since it was first implemented in 1938, the minimum's highest real value has been 54% of the average private-sector hourly wage, a level achieved in 1968. Its lowest real value has been 36%, which is where it stands today. The midpoint between those two extremes is 45%. Today's average private-sector hourly wage is about $20; multiplying that figure by 45% yields a minimum wage of about $9.00 per hour. That happens to be what President Obama suggested in his 2013 State of the Union address, before jacking it up to $10.10 later on.
An increase to $8.00 or $9.00 per hour, or somewhere in between, would be significant — up to 25% more than the current minimum wage — but well within the range of the increments undertaken in past minimum-wage legislation. There would be far less risk of a "shock" to the labor market than with President Obama's proposed $10.10 wage, which represents an unprecedented 39% hike (though the proposal would phase in the increase over three years). The CBO analysis found that increasing the minimum wage to $9.00 would endanger 100,000 jobs, 80% fewer than the $10.10 proposal.
Once a new minimum has been agreed upon, the next step would be to ensure that the rate retains its real value so that Congress would not have to revisit the matter. This could be accomplished by indexing the minimum wage to an appropriate inflation factor, making future raises annual, incremental, and foreseeable, with no need for repeated legislation — and repeated legislative battles.
Social Security provides a useful analogy here. For the first ten years of that program, a beneficiary received the same payment every month. Benefits were not recomputed until the 1950s, when Congress acted to dramatically raise payments twice, in 1950 and again in 1952. Subsequent increases had to be made through separate legislation until 1972, when the law was changed to provide automatic, annual cost-of-living allowances based on increases in the Consumer Price Index. Those annual adjustments began in 1975 and ensure that the purchasing power of Social Security benefit payments stays constant as the cost of living rises.
Regular increases in the minimum wage could work in a similar way — albeit on a much smaller, more manageable scale — using the CPI to maintain purchasing power. To be sure, using inflation as the only index presents the risk that the minimum wage could lag behind overall wage growth in years when it outstrips CPI growth. This might well be appropriate, since the purpose of the minimum wage is to provide workers with a basic level of purchasing power below which they cannot fall. But if legislators wanted to retain a link to wages as well as inflation, they could index the minimum wage to inflation or to growth in the average private-sector hourly wage, whichever is greater in a given year. The determination of the coming year's increase would be made and announced several months in advance, to give employers time to adjust as necessary.
This approach would reduce uncertainty for employers, avert economic shocks that destroy jobs, and eliminate one source of near-constant debate in gridlocked Washington. Instead of periodic multi-year political donnybrooks, each minimum-wage increase would be a modest annual blip, a political non-event. Call it the "fix it and forget it" approach.
To be sure, this would require Republicans to give up on abolishing the minimum wage, cutting it back, or allowing inflation to erode its value over time — goals still cherished, more or less publicly, by party activists, free-market think tanks, and some business lobbies. But basic political realism says this is futile. There is nothing to be gained by pretending otherwise and much to be gained, both politically and substantively, by accepting a reasonable second-best solution.
A more nuanced objection from the right would be that it's a mistake to entrench the federal minimum wage because it fails to account for local labor-market conditions. As Andrew Biggs and Mark Perry argue in a recent American Enterprise Institute paper, a higher minimum wage would be of little benefit to entry-level workers in a high-cost-of-living area like New York City, while it would price them out of the job market in a low-cost locale like Birmingham, Alabama. And indexing it to inflation would merely perpetuate these imbalances permanently.
As a matter of economics, Biggs and Perry are surely correct: Pegging the minimum wage to the poverty rate or average national wages would not do away with the kind of distortions they describe. Nor, however, would it create or necessarily worsen those distortions; a minimum wage already exists and probably always will. The point here is to contain the damage it does and minimize its use as a political weapon.
States and localities would retain the option of raising their minimum wages to account for higher local living costs. Importantly, though, the establishment of a more rationally derived national minimum would reduce their incentive, both economic and political, to do so. Those who successfully advocated recent raises in states like California might have had a harder time if an objectively pegged, inflation-indexed federal minimum wage had been in place.
As for the Democrats, a plan to raise the minimum wage by statute — but only one last time — and then raise it a little bit every year thereafter would be hard to swallow politically, since they benefit from repeated showdowns. But, as advocates of a robust minimum wage, it's hard to see how they could raise any principled objection to it — unless they insist on nothing less than President Obama's $10.10. Notably, that number was itself the product of a purely political debate within the White House, not a technical economic discussion. As Zachary Goldfarb reported in a March 6, 2014, Washington Post story, President Obama supported a $9.50 minimum in his 2008 campaign, opted for $9.00 in 2013 because he thought it would be more acceptable to business, and then finally embraced $10.10 at the behest of liberal activist groups.
Some of those groups consider the president's latest suggestion woefully inadequate, since they believe that a higher minimum is vital to reversing the last few decades' worth of wage stagnation and income inequality. The left-leaning Center for Economic and Policy Research produced a study in 2012 showing that the minimum wage would have grown to nearly $22.00 per hour if it had kept up with worker-productivity growth since 1968. But there are both theoretical and practical problems with that argument. The fairness of rewarding today's workers for past productivity increases is unclear, especially since some of the productivity growth was a result of technological innovation. And, of course, the more the minimum wage increases, the greater the risk that lower-skill workers will not be able to find jobs at all. Even liberal economist Paul Krugman has conceded that a $20-per-hour minimum wage "would create a lot of problems."
To be sure, liberals often cite recent economic studies, known collectively as "the new minimum-wage research," to downplay the job-destroying impact of higher minimum wages. An early and influential paper by David Card and Alan Krueger in 1994 compared data from fast-food restaurants in New Jersey, which had raised its state minimum wage 19%, and similar restaurants in neighboring Pennsylvania, which had not raised its minimum wage. They found "no evidence" that the increase in wages reduced employment but that it paradoxically increased employment. The Card-Krueger paper and similar studies done since have been cited as proof that minimum-wage increases typical of recent American history have no negative impact on employment.
If this research is correct, employers must be finding ways to offset the higher minimum wage without reducing employment: They may raise prices, cut profits, or organize their businesses more efficiently, while reaping the productivity benefits of a happier, more stable workforce. Hard data are scarce, but some argue employers make several small adjustments that allow them to keep their employees. John Schmitt of the Center for Economic and Policy Research has identified four such adjustments that are the most important for businesses trying to offset a rise in the minimum wage: lower labor turnover, greater organizational efficiency, "wage compression" (lower wages higher up the pay scale), and small price increases.
It is important to note, however, that two of those offsets — wage compression and higher prices — will disproportionately harm low-income workers, since they are consumers as well as workers looking to advance in their careers. And no studies have yet tested the impact of an increase as large as the one Obama is proposing, much less a raise to $22.
Once the minimum wage has been permanently benchmarked, adjusted, and consequently depoliticized, Congress will be freer to tackle the real issue at hand, which is raising the prospects of low-income workers. This would be amply justified, since the minimum wage does less to advance this cause than its most ardent proponents imply.
In his 2014 State of the Union address, President Obama justified his call for a $10.10 minimum by declaring that "no one who works full time should ever have to raise a family in poverty." It's a fine sentiment, but the fact is just 4% of minimum-wage workers are single parents working full time to provide for children, according to Bureau of Labor Statistics data. The majority of minimum-wage workers do not live in poverty. Very few minimum-wage workers are their households' sole breadwinners. And much of the economic benefit from Obama's proposal — one-third of it, according to CBO — would accrue to workers, such as middle-class teenagers in summer jobs, who aren't poor at all. Many employers offer minimum-wage jobs as opportunities to train workers who are not yet productive enough for higher-paying work. And workers often see minimum-wage jobs as entry points into the work force or opportunities to learn a new trade; indeed, two-thirds of minimum-wage workers will earn raises within a year of starting their jobs.
A 2010 study by Joseph Sabia and Richard Burkhauser found that only 11.3% of the workers who would benefit from an increase in the minimum wage from $7.25 to $9.50 would come from poor households, even assuming that no jobs were lost. When the researchers allowed for negative job effects, the working poor lost a disproportionate share of the jobs. Another study by Sabia from 2007 revealed that single mothers' employment dropped by 6% for every 10% increase in the minimum wage.
By contrast, the federal Earned Income Tax Credit targets benefits to the working poor. Originally enacted during the Ford administration as part of the Tax Reduction Act of 1975, the EITC effectively functions as a negative income tax that supplements the incomes of people who work long hours for low wages — and only people who work long hours for low wages. Today, it is the largest federal cash-transfer program for the poor, distributing $63 billion worth of tax refunds to 27 million workers in 2012. Along with the welfare reform of 1996, the EITC has helped encourage single parents, and especially single mothers, to enter the work force. A single working mother of two making less than $43,756 per year can expect to receive up to $5,460 in 2014 through the EITC. The program lifted 6.5 million people, including 3.3 million children, out of poverty last year.
Much of the EITC's early expansion took place under President Ronald Reagan, who called it "the best anti-poverty, the best pro-family, the best job creation measure to come out of Congress." Though liberals often lament the fact that the minimum wage did not go up during the eight years of Reagan's presidency and never fully recovered the value it lost to inflation during that time, the EITC's growth offset much of the minimum wage's fall in real terms — both during Reagan's presidency and thereafter. Indeed, though many bemoan the decline in the real value of the minimum wage since Reagan, a better description of the trend over the past several decades is that federal support for the working poor has gradually shifted, in real terms, from reliance on the minimum wage to reliance on the EITC.
The EITC's focus on working families with children, however, has inevitably left out single adult workers without children. Under current rules, the most such individuals can receive is $496 per year. This is a major gap in the program, and filling it would form the next element of a grand bargain. Indeed, there is already bipartisan support for the idea, which has been backed by both President Obama and, in a somewhat modified form, Republican senator Marco Rubio of Florida.
Still, an expansion of the EITC would likely come under attack from both the left and the right. Many liberals regard the EITC as necessary but not sufficient to substitute for a much higher minimum wage. They also see it as a form of corporate welfare, since it enables firms to pay workers lower hourly wages — rewarding "corporate irresponsibility."
The EITC does indeed implicitly subsidize hiring low-wage workers — but this is a feature, not a bug. In a sense, a robust work ethic, poverty reduction, and greater income equality are the "positive externalities" society enjoys when appropriate, decently paid employment is readily available to people at all skill levels. It makes little sense to assign profit-making corporations "responsibility" for maximizing these externalities since, by definition, they do not redound directly to shareholders' benefit.
Government is in a better position to incentivize work effort, thereby lowering poverty and increasing equality. And a tax-code subsidy that reflects the general public's interest in promoting these goals is an appropriate method for doing so. Furthermore, it is arguably a more transparent way of helping low-income workers than the minimum wage is, since the minimum wage works like an invisible tax that businesses pass along to workers and consumers, and its benefits accrue to many people who aren't actually poor.
On the right, the usual objection to the EITC is that its undeniable benefits to the working poor come at the price of a high rate of waste and abuse. Alas, there is more than a little truth to this. The EITC's improper-payments rate regularly exceeds 20% per year. Such errors cost the program between $13.3 billion and $15.6 billion in fiscal year 2013, according to the Treasury Department's inspector general. Much of this likely consisted of fraud, often perpetrated by tax preparers who deliberately inflate a customer's credit in return for a share of the money.
Democrats have had a tendency to deny this embarrassing aspect of the EITC, for fear of endangering the program as a whole. Republicans could and should make a serious effort to correct this chronic problem a condition of expanding the EITC. Indeed, they should insist that savings from those reforms be dedicated to paying for the expansion of the program for single, childless workers. An innovative feature of Congressman David Camp's 2014 tax-reform plan was a proposal to reconceive EITC payments as a payroll-tax rebate rather than an income-tax credit, thus making it far easier to calculate and less vulnerable to fraud.
Still, serious as they are, the EITC's problems should not be exaggerated. Many overpayments are traceable not to fraud but to workers' genuine difficulties navigating the EITC's complex eligibility criteria, which are especially incomprehensible for divorced or separated parents who share custody over minor children. And offsetting the cost of excess EITC payments is the fact that about 22% of potentially eligible workers never file for the EITC because of the program's daunting rules and regulations, Treasury's inspector general has found.
In short, the EITC's shortcomings can and should be addressed — though it will require Democrats to admit that not every dollar of EITC money goes to a deserving recipient, and it will require Republicans to engage with, and reform, the IRS, an agency they are usually content to condemn.
A GRAND BARGAIN?
Taken together, these measures could permanently end the inconsistency and uncertainty that have plagued the debate about the minimum wage and the federal government's support for low-income workers more generally. A moderate increase in the minimum wage, pegged to an objective, historically based benchmark, and followed by automatic cost-of-living adjustments, represents an obvious middle ground between today's Republican and Democratic positions — and, most importantly, promises to preempt such demands from polarizing our politics in the future. An expanded and reformed EITC, meanwhile, would further shift the burden of federal support for low-income workers from the minimum wage to a more precisely targeted tax credit to help workers who are truly struggling.
Such a bargain could be a boon to the country — and would also be especially helpful to the Republican Party, which is at an inherent disadvantage in the minimum-wage debate, given the public's sympathy for this particular legacy of the New Deal. There will nevertheless be a strong temptation for the GOP to think small, as Republicans did the last two times they consented to minimum-wage increases. In 1996, President Bill Clinton bought the Republican-controlled Congress's support by agreeing to a package of small-business tax cuts, which were advertised as offsetting the cost to employers of the higher minimum. In 2007, President George W. Bush cut essentially the same deal with a Democratic Congress. In recent months, some Senate Republicans have reportedly pursued a similar pact, though the Senate Democratic leadership, content to exploit its advantage on the issue, showed little interest.
Republicans would be better off going for the grand bargain — as some in the GOP have figured out at the state level. In May 2014, the Republican-majority Michigan state legislature, facing a union-backed drive for a referendum to raise the state minimum wage to $10.10, voted to hike the state's $7.40 hourly minimum wage to $9.25 by 2018 and index it to inflation thereafter. Republican governor Rick Snyder signed the bill. Democrats had little choice but to support it, and they did — even though the legislation will likely scuttle the $10.10 referendum and obviate future minimum-wage battles that would probably have favored Democrats politically.
At the national level, too, it's up to Republicans to make the first move. Instead of clinging to an economically justifiable but politically unrealistic party line that gives them nothing to say but "no" in response to Democratic demands for minimum-wage increases, the GOP should dare to outline an approach that defuses minimum-wage politics for good and — more importantly — benefits the country by emphasizing programs that help the working poor more than the minimum wage does and with fewer negative economic side effects. Republicans should dare Democrats to say "no" to that.