Livable wages and less income disparity are noble objectives that resonate with many people. President Obama has proposed that Congress raise the minimum wage as a way to meet those objectives. But there's a better way to improve wages, assist low-income workers and flatten the income distribution.
The unemployment rate in the U.S. is 6.6%. For the young, the old and many minority groups, it's much higher. With so many unemployed workers, the sensible economic policy would be to subsidize labor rather than raise the minimum wage. That's because raising the minimum wage is the equivalent of taxing employers for the work done by their employees and giving the proceeds to the workers. And that works against employment, not in favor of it.
Common sense supports this. The strongest principle of economics — demand theory — maintains that people buy less when an item is costly and more when it is cheap. That means employers will buy less labor when wages are high and they'll offer more employment when labor is less costly to them. The Congressional Budget Office report released Tuesday supports this view. Its nonpartisan analysts predict that the proposed increase in the minimum wage to $10.10 an hour would cost the economy 500,000 jobs.
It's true that while some studies show the negative effect of raising the minimum wage, others show that has little or no downward impact on employment. Such contradictory results are due to the complexity of factors regarding employment. For example, employers rarely cut jobs immediately after a minimum-wage increase. They often wait for natural attrition to lower their head counts, or they may refrain from replacing employees when they know an increase is coming.
But the absence of definitive evidence does not indicate that demand theory doesn't apply to increasing the minimum wage. It merely indicates that the effect is hard to measure.
Loss of jobs — overall and over time — isn't the only negative effect of mandating an increase in the minimum wage. When employers must pay above-market wages, the ratio of job seekers to available jobs rises, and that allows employers to pick and choose. With more workers to pick from, employers can more easily get away with basing their hiring decisions on race, color, religion, sex, national origin, disabilities or age. They also are more likely to practice legal forms of discrimination: When faced with many job candidates, employers tend to hire the most experienced workers. That means those just starting out remain unemployed. Worse, they lose the opportunity to build the work experience needed to obtain better jobs.
Proponents of mandating higher minimum wages believe that higher wages can help level the lopsided income distribution in America. Obviously, it would raise the incomes of minimum-wage employees. But to some extent this benefit would be offset as other workers lose their jobs or work fewer hours. The increased labor costs that companies would pass on to consumers in the form of high product prices also would offset raised incomes. And some minimum-wage employers, whose customers can't afford to pay higher prices, would fail, again offsetting gains with lost jobs.
What's a better way? Do away with minimum wages altogether and institute wage subsidies. The government should give vouchers to unemployed workers seeking low-income jobs. Those vouchers would provide wage subsidies to employers who hire them. The subsidies would be based on the wages that the employers offer, with the greatest subsidies going to the lowest-wage jobs.
The subsidies would lower labor costs, thereby increasing the number of jobs employers offer to low-income workers. Wages earned overall by the poor would increase, more young people would get jobs and gain valuable work experience, fewer people would be on the streets, fragile businesses could thrive and new companies would start up. More jobs also would reduce welfare grants and increase payroll taxes, which could help fund the subsidies. Everyone would be better off as the subsidies lowered product prices and increased production.
To some extent, the government already has a wage subsidy plan; it's called the earned income tax credit. It lowers the income taxes of low-income workers. For those who make so little that they don't owe income tax, the credit provides income subsidies. An increase in this credit also would flatten the income distribution.
But the earned income tax credit does not help those who are unemployed. Wage vouchers are a better policy than the earned income tax credit because they immediately and obviously lower the cost of employing workers, so the number of jobs increases and the unemployment rate drops.
Legislating an increase in the minimum wage is the quintessential example of an unfunded government mandate. It's identical to a simultaneous tax and income transfer program. It unwisely taxes employers who create jobs, and it unfairly subsidizes only low-income workers who have jobs. Subsidizing wages would be much better for the economy than raising the minimum wage.
Larry Harris holds the Fred V. Keenan Chair in Finance at the USC Marshall School of Business. He was chief economist of the SEC from 2002 to 2004.