The Free Market
Minimum Wage, Minimum Tax
The Free Market 14, no. 11 (November 1996)
Republicans seemed sincere when they argued against a minimum-wage increase. In their rhetoric they were right: it increases unemployment, especially among the poor, by making work illegal. Even the head of Clinton's Council of Economic Advisers denounced the minimum wage—when he was a private economist.
But when it came down to the wire, both parties backed the increase. The labor unions and the partisans of the controlled economy won a huge one. Austrian economists could only marvel at the triumph of politics over reason.
Why did this happen? It wasn't intellectual confusion. No government intervention has been so widely debunked as the minimum wage. It wasn't public pressure; opinion polls showed support for the increase, but it was far from intense. While the political contributions of labor unions help explain the Democrats behavior, it doesn't explain why the Republicans went along.
The real reason has to do with the least-discussed effect—call it the dirty secret—of the minimum wage. To be sure, raising it hurts many workers, who are thereby priced out of the market. But among those who keep their jobs, their wages increase and they pay more in taxes to government at all levels.
Like inflation, an increase in the minimum wage is a stealthy tax increase as well. It provides in billions in new revenue for the president and Congress to play with, while allowing them to forecast smaller deficits.
Let's see how this works. Congress increased the minimum wage from $4.25 to $4.75 and then to $5.15. If workers keep their jobs, and most will, millions of people get a pay raise. It amounts to an additional $20 per week before taxes. But they also pay more in taxes of all kinds. Government at all levels takes between 25% to 35% of this wage increase in taxes. The Feds devour more than 80% of that.
In the end, workers who have had their wages increased by law may take home as little as $2 more per day after taxes. But that's just the first round. If workers spend the money, they pay sales and excise taxes. If they save and earn interest, they pay more income taxes. If they pay property and capital gains tax, they pay even more taxes.
Considering just these effects, an increase in the minimum wage allows the federal government to rake in as much as $6 billion dollars more per year from workers who keep their jobs. In addition, these workers have to pay Social Security and Medicare taxes.
Employers have to match that amount so that federal taxes take the equivalent of 30% of the increase. Much of this money is spent on programs like Social Security, which won't even be around for most minimum-wage workers to benefit from.
Higher wages also mean that workers will be required to be more productive, further increasing revenue. Employers make tradeoffs to accommodate the change. They reduce the quality of working conditions. They permit fewer breaks. They eliminate amenities like free coffee. Most workers see untaxed benefits reduced or cut altogether.
But the benefits to Uncle Sam don't stop there. The minimum wage increase impacts all wage rates in the economy with a "snowballing effect." Workers earning $5/hour demand raises and so will employees making $6/hour. Fat-cat union workers earning $15-$35/hour are the big winners from the increase. Their contracts are indexed to the minimum-wage rate, and they never lose their jobs as a result of an increase.
With a labor force far exceeding one hundred million, if only half get a $.90 increase, the feds could be rolling in as much as $30 billion more per year. It's no coincidence, then, that the first round of increases went into effect on October 1, 1996, the beginning of the new fiscal year in 1996. New revenue for the new fiscal year is Congress's Auld Lang Syne.
Elites in both parties love new government revenue, but they prefer to get it inconspicuously. If a tax increase can be passed off as a wage increase—and create the impression that government has done workers a favor—it's a winner all around.
Call it a revenue raiser. Call it a sop to unions. Call it an election-year tactic to get votes. But don't call it a help to the poor who are fired or never hired, or whose higher earnings are taxed away, never to be seen again.
Mark Thornton is O.P. Alford III Resident Scholar at the Mises Institute and a contributing editor to The Free Market.
Cite This Article
Thornton, Mark. "Minimum Wage, Minimum Tax." The Free Market 14, no. 11 (November 1996).