Research

Minimum Wage Effects in the Post-welfare Reform Era

David Neumark • Published on

Overview

Minimum wage laws remain a subject of considerable debate at all levels of government despite years of research on their costs and benefits. At the national level, there have been frequent proposals in recent years to increase the federal minimum wage. Many states have followed suit, attempting (and sometimes succeeding) to raise their minimum wages above the federal level. At the present time, 21 states and the District of Columbia have minimum wages that exceed the federal wage floor, while 6 others recently passed ballot initiatives to raise theirs as well. Additionally, city-wide minimum wages have been enacted in a handful of cities, and living wages which typically set a higher minimum wage for a subset of workers in an area have spread to scores of other cities.

A major drawback of much of the existing minimum wage research is that it was performed using data that extends through the mid-1990s at the latest. Since then, the low-wage labor market has undergone substantial changes. Welfare reform, expansions of the federal Earned Income Tax Credit (EITC), and the growth of state EITCs have changed work incentives faced by the poor and thus the types of individuals competing for entry-level jobs. These reforms may have altered the effects of minimum wages as well. Therefore, evidence from earlier research is likely less applicable to the evaluation of recent or future increases in state and federal minimum wages. In this study, Dr. David Neumark of the University of California at Irvine focuses on the effects of state-level minimum wages in the post-welfare reform era. Specifically, he estimates the effect of the minimum wage on employment levels, wages, and earnings of teenagers and young adults (aged 16-24) for a wide variety of demographic and skill groups over the 1997-2005 period. Additionally, he estimates the effects of other policy changes and investigates potential interaction effects. The author finds, consistent with earlier research, that the most negative minimum wage employment effects are felt by at-risk groups, such as the less-skilled and young minority males. He also finds that there may be positive minimum wage effects on the employment of young minority women aged 20-24 when combined with EITC policies. However, this benefit comes at a substantial cost to other groups. Among those who pay the highest costs are minority males and female high school dropouts. Minority males and high school dropouts often serve as “poster children” for increases in the minimum wage, yet experience the strongest disemployment effects as well as decreased earnings which are magnified by higher state EITC levels.

Welfare Reform and the EITC

In his analysis of the post-welfare reform era, the author considers EITC expansions and the 1996 Personal Responsibility and Work Opportunity Reconciliation Act (PROWRA) legislation that replaced the Aid to Families with Dependent Children (AFDC) program with Temporary Assistance to Needy Families (TANF). TANF made welfare funds available to states under the condition that they introduce policies designed to move recipients off welfare by encouraging self-sufficiency. Such policies have included specific legislation requiring welfare recipients to work, as well as limits on the number of months that families can receive welfare payments. Although the author specifically included these time limits and work requirements, he was unable to find any interaction between them and the minimum wage regarding their effect on employment.

Therefore, the analysis focuses primarily on the EITC. At the federal level, the EITC increased sharply during the 1990s, rising to a 40 percent earned income tax credit (with two children) in 1996, where it has remained since. Additionally, a number of states introduced their own EITC programs, which typically specify a percentage supplement to the federal EITC. Currently, 20 states plus the District of Columbia have their own EITC programs. In most cases, state-level EITCs are refundable, generally fully so, but since the results did not differ based on refundability, this distinction is ignored.

Employment

Minimum wages have strongly negative effects on the employment of teenagers and minorities (African American, Hispanic, or both). The author finds that a 10% increase in the minimum wage will decrease minority employment by 3.9%, with the majority of the burden falling on minority teenagers (6.6%). Although the size of the disemployment effects for African Americans is quite large -2.8% (and even larger for African American teenagers, -8.4%), it is the statistically significant effect for Hispanics (-4.9%) that is driving these results. This supports earlier research which found that minimum wages have the largest negative effects on low-skilled employees, such as teens and minority teens.

Most of these negative results appear to be due to the impact that minimum wages have had on male employment in the post-welfare era. The author finds uniformly negative effects on males, particularly minorities. For every 10% increase in the minimum wage, African American or Hispanic males aged 16-24 and 20-24 experienced decreased employment of 6.3% and 5.5% respectively during this period. While minimum wages appear to have had less of a negative impact on women’s employment, there is still very strong evidence of disemployment effects among the least-skilled (i.e., high school dropouts). For these vulnerable individuals, a 10% increase in the minimum wage led to an 8% decrease in employment. Moreover, the relatively favorable results for females are tempered by evidence that for some women a high minimum wage coupled with an EITC reduces their employment prospects.

Wages and Earnings

For the most part, the author finds positive effects on wages from minimum wage hikes. This includes the wages of the least skilled, both male and female. The minimum wage has a particularly positive impact on the earnings of 20-24 year-old African American or Hispanic women, increasing their earnings by 8% for each 10% increase in the minimum wage. This is not surprising, since the wage effect for this group was one of the highest and the employment effect was small but positive. However, at the same time, the EITC reduces wages for 16-24 and 20-24 year-old minority men and women.

The evidence reveals policy effects on earnings that differ substantially across different groups. The EITC boosts minority women’s earnings, and coupling the EITC with a higher minimum wage appears to enhance this positive effect. In contrast, higher minimum wages reduce the earnings of minority men, particularly when the EITC is high (for those aged 16-24, a 10% increase in the minimum wage coupled with a 25% state EITC supplement is associated with a 19.8% decrease in earnings). This policy combination also hurts female teenagers and 20-24 year-old high school dropouts.

Conclusion

In considering the post-welfare reform era, the author finds that the disemployment effects of minimum wages are concentrated on young minority men; for young white men, the estimated effects are negative but smaller and not statistically significant. For young women, in contrast, there is little evidence of minimum wage effects on employment, with the exception of high school dropouts.

The effect of mixing minimum wage policies with EITCs varies quite sharply between men and women. Higher minimum wages reduce the earnings of minority men, more so when the EITC is high. In contrast, the EITC boosts minority women’s employment and earnings. With the negative effects of coupling minimum wage hikes with EITC policies concentrated on already vulnerable groups (particularly young minority men and the least-skilled), governments should exhibit extreme caution in trying to enhance the EITC with higher minimum wages, which have been shown to affect many individuals who are not in low-income families.