Minimum Wage Increases: The Unintended Consequences

Partisan mudslinging aside, how should elected officials tackle the ongoing minimum wage debate? On one hand, an increase in the minimum wage may lift some families out of poverty. On the other hand, higher unemployment and increased dis-employment incentives for firms may plunge some families into poverty. On the whole, is a higher minimum wage a tool in the arsenal to fight poverty, or will it hamper economic growth—potentially hurting those who are most vulnerable?

In their seminal paper on the subject, “Do Minimum Wages Fight Poverty?,” David Neumark and William Wascher explore the costs and benefits of minimum wage increases along with the short-term and long-term aggregate effects. They find that jurisdictions that increased minimum wages also saw a 2.2 percent increase in the likelihood that poverty-stricken residents remained poor.

The authors use Current Population Survey data from 1986 to 1995. They extract information on the labor market status of each family member age 16 and older and classify each family as being above or below the poverty line. Because changes in earnings can fluctuate for many reasons, the authors control for business cycle conditions and local level shocks and construct weighted distributions at the 25^th and 50^th percentiles.

Neumark and Wascher’s results are compelling. For example, 64.7 percent of families in poverty at the time of a minimum wage increase remained so one year later. Interestingly, in states where there was no minimum wage increase, only 63.6 percent of families remained in poverty, suggesting that minimum wage increases may actually hamper some families from leaving poverty. Given that employment effects may take one year to adjust to higher wages, the authors estimate that lagged minimum wage increases raise the likelihood that poor families will remain poor by 2.2 percent. Even worse, the potential that non-poor families will fall into poverty increases by 0.4 percent.

Unfortunately, increases in poverty are not countered by beneficial changes in income distribution for families just above the poverty line. For instance, families with a near-poverty income-to-needs ratio see their likelihood of moving to a more comfortable ratio reduced by nearly six percent in the year after a minimum wage increase.

Nevertheless, families that remain below the poverty line both initially and one year later see a 7.2 percent increased likelihood for higher earnings, thus pointing to a potential benefit for some.

On balance, increases in minimum wages appear to help some poor families escape poverty while having the perverse effect of dragging other families below the poverty line. The authors conclude that increases in minimum wages do not fight poverty mainly because the income redistribution effects remain within the cluster of lower-income families.

When it comes to fighting poverty, Neumark and Wascher conclude that a sudden increase in minimum wages will probably not have any real positive aggregate effect. If anything, it is important to remember that the minimum wage was established as a law to protect workers and not as a program to combat poverty. Data-driven and dispassionate research, such as this piece, ought to inform what is otherwise a very heated debate.

Article Source: David Neumark and William Wascher, “Do Minimum Wages Fight Poverty?,” NBER Working Paper 6127 (August 1997).

Feature Photo: cc/(Henrik Berger Jørgensen)