Minimum Wage, Maximum Damage

Minimum Wage, Maximum Damage

Here is the simple truth, that is in the richest country in the world we can no longer tolerate millions of our workers being unable to feed their families because they are working for starvation wages.

Senator Bernie Sanders

Senator Sanders asserts that this “simple truth” justifies the “fight for $15”, but if the fight for $15 is successful, it will impose far more costs than benefits.

Before thinking through the impacts, it is worth clarifying who earns the current minimum wage. Currently, approximately 1.2 percent of workers earn the minimum wage or less according to the Bureau of Labor Statistics (BLS). Further, minimum wage workers tend to be young. Although workers under age 25 represented only about one-fifth of hourly paid workers, they made up just under half of those paid the federal minimum wage or less. Among employed teenagers (ages 16 to 19) paid by the hour, about 8 percent earned the minimum wage or less, compared with about 1 percent of workers age 25 and older.

Not only are minimum wage proponents distorting the population impacted, but they also fail to understand the economic trade-offs required. To understand the trade-offs, it is helpful to review the financials of a typical retail business, which is the sector where the vast majority of minimum wage workers are employed. Based on the average annual revenue of a small retailer ($262,092), and the average cost structure, a pro-forma financial statement of a small retailer looks something like Table 1. Table 1 illustrates that based on the current costs of running a retail store, the average small retailer earns about $43,000 in profits annually.

Table 1
Pro-forma Financials for an Average Small Retailer

Gross Revenues $268,092
Inventory Cost $80,428
Store Payroll $48,257
Distribution $8,043
Rent $40,214
Other Retail Costs $21,447
Marketing $26,809
Profit $42,895

If the $15 minimum wage was implemented, without any compensating behavior, then the store’s payroll costs will increase. Based on the average wage of retail salespeople according to the BLS, along with the distribution of the average wage, a $15 minimum wage will increase payroll costs for a small retailer by 18.6 percent, or an $8,960 increase in the store’s payroll costs. Without decreasing hours or increasing prices, such a cost increase would decrease the profits for a small business owner by 20.9 percent.

One way to pay for the minimum wage increase is if the small business owner allows their profits to go down in order to fund the higher wages. A nearly $9,000 drop in revenues is unsustainable for many small businesses. Consequently, without making some type of change, the minimum wage increase could drive many small businesses into bankruptcy. Rising bankruptcies and declining profitability worsens the incentives for entrepreneurship, a major driver of the economy and productivity.

Another potential response to the minimum wage increase is for businesses, particularly small businesses, to reduce the number of people on their payroll. The Congressional Budget Office (CBO), in fact, believes that many businesses would need to lay off workers (about 1.4 million total) if the current minimum wage increase proposal were implemented.

Of course, not all workers will lose their jobs. Many others will remain employed and, if their hours are not reduced, they will earn more money. But, even these workers will not benefit by the full value of the minimum wage increase. As the financials of the average small retailer detailed above demonstrate, if workers are earning more money, then this additional money will significantly harm profitability unless the retailer increases prices.

Rising prices of goods and services to offset the higher labor costs is likely, which is exactly what the CBO is also expecting. Consistent with their prediction, past increases in the minimum wage at the state and local level have led to commensurate price increases. For instance, a study of how McDonalds restaurants responded to 300 minimum-wage increases that took place across the U.S. between 2016 and 2020 “found that the higher cost of labor that results from increasing minimum wages gets passed on to consumers in the form of more expensive Big Macs.”

These rising prices will offset the wage gains for those workers who are lucky enough to keep their jobs and earn a higher salary. For those who lost their job, the rising price environment will make them even worse off.

This analysis demonstrates that, as Milton Friedman famously noted, there is no such thing as a free lunch. The simple truth is that a minimum wage increase harms many low-wage workers, increases prices for everyone, and makes it more difficult for small business owners to thrive.

Dr. Wayne Winegarden is senior fellow in business and economics at the Pacific Research Institute and director of PRI’s Center for Medical Economics and Innovation.

Other posts you might like

Subscribe to our newsletter:

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.