This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

This article is from the July/August 2012 issue of Dollars & Sense magazine.

How High Could The Minimum Wage Go?

A 70% boost—to $12.30/hour—would help millions of workers, without killing jobs.

BY JEANNETTE WICKS-LIM | July/August 2012

The minimum wage needs a jolt—not just the usual fine-tuning—if it’s ever going to serve as a living wage. Annual full-time earnings at today’s $7.25 federal minimum wage are about $15,000 per year. This doesn’t come anywhere near providing a decent living standard by any reasonable definition, for any household, least of all households with children. But among the seventeen states that either have active campaigns to raise their minimum wage or have raised them already this year, none have suggested raising the wage floor by more than 20%.

How high can the minimum wage go? As it turns out, a lot higher. Economists typically examine whether current minimum-wage laws hike pay rates up too high and cause employers to shed workers from their payrolls in response. But the current stockpile of economic research on minimum wages suggests that past increases have not caused any notable job losses. In other words, minimum wages in the United States have yet to be set too high. In fact, if we use past experience as a guide, businesses should be able to adjust to a jump in the minimum wage as great as 70%. That would push the federal minimum wage up to $12.30. In states with average living costs, full-time earnings at $12.30 per hour can cover the basic needs of the typical low-income working household (assuming both adults in two-adult households are employed).

Why is such a large increase possible? It’s because minimum-wage hikes—particularly those in the 20-to-30% range adopted in the United States—impose very modest cost increases on businesses. This is true even for the low-wage, labor-intensive restaurant industry. And because these cost increases are so modest, affected businesses have a variety of options for adjusting to their higher labor costs that are less drastic than laying off workers.

Take, for example, the 31% rise in Arizona’s state minimum wage in 2006, from $5.15 to $6.75. My colleague Robert Pollin and I have estimated that the average restaurant in Arizona could expect to see its costs rise between 1% and 2% of their sales revenue. What kind of adjustment would this restaurant need to make? A price hike of 1% or 2% would completely cover this cost increase. This would amount to raising the price of a $10.00 meal to $10.20.

To figure out what is the largest increase businesses can adjust to without laying off workers, we can take stock of what we know about how businesses have adjusted in the past and then figure out how much businesses can adjust along those lines.

Let’s stick with the example of restaurants, since these businesses tend to experience the largest rise in costs. And let’s start with a big increase in the minimum wage: 50%. If we add together all the raises mandated by such an increase in the minimum wage (assuming the same number of workers and hours worked), the raises employers would need to give workers earning wages above the minimum wage to maintain a stable wage hierarchy, and their higher payroll taxes, the total cost increase of a 50% minimum-wage hike would be 3.2% of restaurant sales.

The cost increase that these restaurants need to absorb, however,will actually be even smaller than 3.2% of their sales revenue.That’s because when workers’ wages rise, workers stay at their jobs for longer periods of time, saving businesses the money they would otherwise have spent on recruiting and training new workers. These savings range between 10% and 25% of the costs from raising the minimum wage. If the higher wage motivates workers to work harder, businesses would experience even more cost savings.

So what would happen if restaurants raised their prices to cover their minimum wage cost increases? One answer is that people may react to the higher prices by eating out less often and restaurant owners would lose business. With a large enough falloff in business, restaurants would have to cut back on their workforce. But it’s unlikely that a price increase as small as 3% would stop people from eating out. Think about it: if a family is already willing to pay $40.00 to eat dinner out, it hardly seems likely that a price increase as small as $1.20 would to cause them to forgo all the benefits of eating out like getting together with family or friends and saving time in meal preparation, clean up, and grocery shopping.

Still, let’s assume that a 3% price hike actually does influence people to eat out less. The key questions now are how much less and can restaurant owners make up their lost business activity? Economists have found that restaurant patrons do not react strongly to changes in menu prices (economists call this an “inelastic” demand). Estimates from industry research suggest that a price increase of 3% may reduce consumer demand by about 2%.

However, if these small price increases take place within a growing economy—even a slow-growing economy—restaurant owners will probably see basically no change in their sales. This is because as the economy expands and peoples’ incomes rise, people eat out more. In an economy growing at a rate of 3% annually, which is slower than average for the U.S. economy, consumer demand for restaurant meals will typically rise by about 2.4%. This would boost sales more than enough to make up for any loss that restaurants may experience from a 3% price increase. In other words, consumers would still eat out more often even after a 50% minimum-wage hike.

After taking account of the ways that restaurants can adjust to the higher labor costs from a minimum wage hike, it turns out that the biggest minimum wage increase that restaurants can absorb while maintaining at least the same level of business activity is 70%. In 2004, Santa Fe, New Mexico, came close to this. Its citywide living-wage ordinance raised the wage floor by 65%—from $5.15 to $8.50. A city-commissioned report after it was put into effect found that “overall employment levels have been unaffected by the living wage ordinance.”

However, even if the federal minimum rate were 70% higher, or $12.30, it would still fall short for two major groups of workers. First, one-worker families raising young children need generous income supports in addition to minimum wage earnings to help cover the high cost of raising children. Second, minimum-wage workers who live in expensive areas, such as New York City and Washington, D.C., require affordable housing programs.

A 70% minimum-wage hike is the biggest one-time increase that U.S. businesses can absorb without cutting jobs, but it’s not the end of the story. In the future, the minimum wage can inch further upward. For example, it could rise in step with the expanding productive capacity of the U.S. economy, as it did in the 1950s and 1960s. A $12.30 minimum wage today rising each year with worker productivity would reach $17.00 in just over ten years (in 2011 dollars). This wage would be high enough so that a single parent with one child could support a minimally decent living standard. We would finally begin transforming the minimum wage into a living wage for all workers.

Policy discussions around the minimum wage need to move past the debate of whether or not it causes job loss. The evidence is clear: minimum wages, in the range of what’s been adopted in the past, do not produce any significant job losses. Now it is time to focus on how we can use minimum wages to maximally support low-wage workers. Can we raise the minimum wage rate to a level we can call a living wage? By my reckoning, we can.

is an assistant research professor at the Political Economy Research Institute ,at UMass-Amherst.

: Jeannette Wicks-Lim and Jeffrey Thompson, “Combining the Minimum Wage and Earned Income Tax Credit Policies to Guarantee a Decent Living Standard to All U.S. Workers”(Political Economy Research Institute, October 2010).