Labor Management

The True Cost of a ‘Living Wage’

Whether a minimum wage hike will destroy jobs as opponents claim, or help to combat poverty as supporters argue, is a question of perspective.
Joel NaroffFebruary 16, 2017
The True Cost of a ‘Living Wage’

With the election of Donald Trump, the chances that the federal minimum wage will be raised are now slim to none. But the drive for a hike in the wage floor, especially after recent increases have come at the state, city and company level, will likely not end anytime soon.

Joel Naroff

Joel Naroff Living wage

So, would a minimum wage hike destroy jobs, as its opponents claim, or would it combat poverty, as supporters argue?

The answer is, of course, yes.

Let’s start with the reasoning behind raising the minimum wage — namely, that it’s only fair that a minimum wage be a “living wage.” A person working full time at $7.25 per hour earns $15,080 annually before taxes. After paying federal income and payroll taxes, state income taxes, sales and excise taxes, real estate taxes (directly or through rent) and other taxes and fees, spendable income falls to about $12,000.

In 2015, the poverty level for an individual was $11,770 annually and $24,250 for a family of four. In other words, the minimum wage is the minimum needed for one person, living in an average cost region, to slip out of poverty. For families or those residing in higher-cost areas, it is a poverty wage.

Should the minimum wage be a “living wage” rather than a poverty wage? That is a political question, not an economic one. The worth to society of having a living wage is a value judgment that gets determined at the ballot box, not by the marketplace.

As for the economics, when you raise costs you lower demand, and so an increase in wages would likely cost jobs. Companies hire workers to make a profit. If hiring more of them will make more money for the business, then more will be hired. When workers cost more than they are worth, they are fired.

Raising the minimum wage, though, doesn’t automatically mean workers become unprofitable. All regulations, whether they were implemented to protect health, increase safety, or minimize economic risk, increase operating expenses. The minimum wage is no exception.

But regulations have benefits as well. Consider productivity. There is a relationship between pay, and in particular changes in pay, and work effort.  It is an argument that many are embracing now that workers’ incomes have been flat and they have learned that working harder doesn’t provide them with much, if any, financial return. And if a higher wage encourages people to work harder (the carrot rather than the stick), unit costs are reduced.

Higher wages can also help retain workers, reducing turnover expenses. For example, at $7.25 an hour, some workers may be more than willing to go somewhere else for the same pay, because their mindset is that they cannot stand their current job. But at $15 an hour, they may find the work less odious. A study by the restaurant industry research firm TDn2k estimated that turnover costs for an hourly restaurant worker run about $2,000, not including productivity losses. That is the equivalent of a $1.00 per hour wage hike for a full-time worker over a year’s time. [Editor’s note: the TDn2k study is not available online. Contact the firm for additional data.]

Further, rising incomes can increase demand. When low-income workers get raises, they spend that income.

However, companies that benefit from the additional spending may not be the same ones that pay the higher labor costs. To the extent that occurs, the minimum-wage-paying firm’s profitability declines, even as other companies experience rising revenues.

Further, businesses cannot simply reduce staff without risking the loss of output and/or service-quality declines that could alienate customers and depress earnings.

Simply put, when wages rise, payrolls don’t have to fall. Indeed, the wage increases currently being driven by tight labor markets co-exist with expanding employment. However, when the hiring needs subside, the higher wages could lead to accelerated layoffs.

If the minimum wage is increased, some workers will lose their jobs while others earn more. Some businesses will see profitability decline, while others will make more money.

Whether the government should raise the minimum wage comes down to weighing the economic and business costs against the benefits, which include the worth of having a “living wage.” Since value judgments are part of that calculation, the answer is not nearly as clear as either side claims.

Joel L. Naroff is president and chief economist at Naroff Economic Advisors and a former chief economist for TD Bank.