Tuesday, August 20, 2013

Minimum Wage: Part 2

Suppose a worker earns the federal minimum wage of $7.25/hr. Moreover, suppose the worker supplies their labor 40 hours each week for 50 weeks. A simple calculation means that worker will earn $14,420 each year. However, some of those earnings are taken through FICA (7.65 percent between Social Security and Medicare). That means that the actual annual take-home earnings are $13,320. Then, additional funds will be subtracted if there is a state income tax. For the sake of the examples presented we will consider that people reside in Florida (there is no state income tax).

Of course this might not be a good assumption for more than one reason. In Tallahassee a dollar stretches like salt water taffy compared to  San Francisco. However, some cities and states with high cost of living have attempted to offset this problem through local wage policies that exceed the federal standards.* Another interesting and related point, the poverty thresholds we will be talking about are not Cost of Living adjusted. Put another way, the thresholds do not account for the fact that a dollar amount means something different in Tallahassee than San Francisco.

Consider four situations. In situation #1 the worker has zero "dependents". In situation #2 the worker is married to another person working for minimum wage and the people do not have children. In situation #3 the same couple is married has two children. In situation #4 the worker is unmarried and has two children.

A quick note about the poverty threshold, you will see that going from zero to two children increases the poverty threshold. That is because the poverty threshold represents the maximum amount a person can earn and still be considered "in poverty". Moreover, I will be using the expenses (not the income(s)) from the recent McDonalds employee budget that has caused quite a stir. In total, the expenses are $1,310/month. I think that these expenditures could be lower on some dimensions like auto payment/insurance/gas compared to public transportation. And, it is possible to live at a location that is less expensive (I've done it). But, it is also the case that the McDonalds budget does not specify a monthly grocery bill which I will do in each situation.

Situation #1: Unmarried with No Children
Take-home earnings are $13,320. The person earns an income that exceeds the poverty threshold of $11,945. For a single individual let's assume that grocery expenditures are $200/month. That is a pretty comfortable amount to spend for a single individual. Given the McDonalds monthly budget that means that expenses are $1,510/month, or, $18,120/year. There is a deficit here.

But, while this person does not earn an income below the poverty threshold this person does meet requirements for programs such as food stamps and Section 8 housing (in Tallahassee the person earns less than 50% of the median and therefore qualifies) Depending on their magnitude these subsidies would serve to erase the deficit.  Which brings up questions about what determines the magnitude of these benefits. To be honest, I do not know all the factors.

Without these programs the person would need an approx. wage of $10/hr to earn the money needed to cover the aforementioned costs.

Situation #2: Married with No Children
Combined annual earnings are $26,640. The combined income exceeds the $15,374 poverty threshold. If we increase the housing expense to $750/month to accommodate more space for two people and increase the groceries to $300/month that means that expenditures are $1,760/month or $21,120. You can see that there is no deficit between earnings and expenditures.

Situation #3: Married with two Children
The combined income is still $26,640 but with two children the poverty threshold is $23,283. Your housing expenditures will be higher to accommodate the children and there are increased expenditures on groceries. Also, there will be additional health expenses. Let us suppose all of those increases lead us into $2,000/month territory. But, the biggest expense when it comes to having children (correct me if I am wrong) is childcare.

In the past I've had classes where I asked students to attempt to figure out what their budgets would be when single compared to when they have children. One of the biggest expenditures reported is childcare that can easily cost $400/month between two children. But childcare is also interested because costs can be defrayed by one parent working part time while the other works full time. Also, if you have a nearby family member that has days off from work and is willing to work that is an enormous benefit.

This family would qualify under the Earned Income Tax Credit for approximately $4,000 which would mean that this additional cost of childcare would be mostly defrayed; however, it would be a significant benefit to have a family member near since it would free resources to help on other margins of life.

Situation #4: Unmarried with two Children
The annual take-home earnings are $13,320 however the poverty threshold is $18,498. Being below the poverty threshold means that this person would qualify for a number of programs: Temporary Aid to Needy Families, Food Stamps, Section 8 housing, WIC, and more. In addition, this person would qualify for the Earned Income Tax Credit.

These situations attempt to outline a couple items.

First, life earning the minimum wage is difficult. People earning minimum wage do not have many of the comforts that most of us reading this blog post have. Also, there are slender differences between income and expenses even when welfare expenses kick-in. That means minimum wage earners are vulnerable to shocking events in life like breakdowns of automobiles, severe illness or injury, or theft.

Second, earning minimum wage without a spouse or with children is more difficult. When a couple is married costs can be shared and financial health is easier. While I think children are a blessing from God there can be little doubt that children increase expenses and make margins thinner.

Some closing thoughts.

It should be noted that, as discussed in this Forbes article 24% of minimum wage workers are teens, an additional 26% are non-teens under 25 and non-trivial number of minimum wage workers are working for minimum wage on their second job. I bring this up because not all beneficiaries of the minimum wage are the "poor" most people are attempting to help. Instead, a large portion of people earning the minimum wage are earning it in a "snapshot" but will later be working for higher wages. This is true even of low skilled individuals.
That does not even account for the possible unemployment effects discussed in the earlier article. One recent example of minimum wage harming the poor is the attempt for Washington DC to impose minimum wages on big box stores like WalMart. New jobs were not created, and, the poor are still purchasing goods from WalMart but now must continue to pay high transportation costs to venture out to locales where WalMart exists.   

Therefore, the minimum wage can be thought of as a blunt policy instrument. 

What would be better? We could increase the size of the social safety net; but, we do not want the net to become a hammock. That is, we do not want for greater welfare expenditures to present people with a perverse incentive to not work for fear that benefits will be lost. This idea called the "backward hustle" was presented here in a previous post. Or, would it be better instead to preserve the incentive to work and gain skills?

The earned income tax credit is a less blunt policy instrument that applies to people of a particular income range that are labeled independent (not dependent like your kids). The earned income tax credit also provides an incentive to gain skills and earn higher wages since there are not knife edge losses. These knife edge losses come from the fact that as a person earns more money they no longer qualify for food stamps, section 8 housing, etc.  

Obviously an expansion of the earned income tax credit would require the federal government to collect revenues to finance it. These taxes would cause their own distortions; however, I think if given the choice between an increase in the minimum wage, increases in the social safety net, and other policy initiatives I would be more in favor of a well placed tax to finance an expansion of the earned income tax credit.


*For example, San Francisco has a wage ordinance of $10.55/hr. That means that the annual income of a minimum wage worker (after FICA) is $19,485 and a small additional amount would be subtracted for California State tax, around 1%. Let's just say the annual income is $19,300. If I move from Tallahassee to San Francisco, even with the higher minimum wage, my purchasing power is still lower.  What is the lesson here? As a tangent, I find it quite interesting that smart people can observe the *same facts* and still come to quite different conclusions. I'm sure some people would say San Francisco needs a higher minimum wage. Another thought might be, people in these positions should gain skills that employers find valuable enough to compensate at a higher wage.

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