What’s Best At Reducing Poverty? An Examination of the Effectiveness of the 2007 Minimum Wage Increase

Content

On July 24th, 2009, the federal minimum was raised to $7.25 an hour. This was the last of three 70-cent increases which began in July 2007, and were mandated by the Fair Minimum Wage Act (FMWA) of 2007. In an op-ed published that same day, Secretary of Labor Hilda Solis praised the increase for helping “put between 3 million and 5 million Americans a step closer to making ends meet every month.”

Proponents of the FMWA argue that an increase in the minimum wage is particularly important during an economic recession. They claim it raises the wages of poor and low-income workers and thus leads to increased consumer spending. Some have made the case that the FMWA does not go far enough; most notably, as a candidate for president in 2008, Barack Obama promised to raise the minimum wage to $9.50 by 2011 as part of his plan to combat poverty.

The confidence behind these claims begs the question: has the FMWA been proven an effective and efficient policy prescription to lift low-income families out of poverty?

In this study, the authors examine this question by focusing on the FMWA side-by-side with other anti-poverty solutions. Using two sets of recent earnings data, Drs. John P. Formby, John A. Bishop, and Hoseong Kim evaluate the poverty-reducing effects of the three 70-cent increases in the minimum wage. They find that these increases are not well-targeted at poor and low-income populations. Further, they determine that two policy alternatives to the FMWA—an expansion of the Earned Income Tax Credit (EITC) and an increased rebate of the Federal Insurance Contributions Act (FICA) tax—would each be a more effective and less costly means to assist needy families.

Advocates of a higher minimum wage frequently portray the policy as a direct benefit to America’s poor and low income families. This study casts doubt on that piece of conventional wisdom, as the authors find that “many low income families do not contain a low-wage worker.” As a result, more than 85 percent of low-income families saw no direct monetary benefit from each of the three 70-cent wage increases.

Better-targeted alternatives to the FMWA include an expansion of the EITC and an increase in the FICA tax rebate. Both of these policies can be directed at specific income brackets; the authors find that—compared to the FMWA—both the EITC and FICA rebate put more dollars in the pockets of those poor families who need it most.

The authors show that 1.95 million people living below 150 percent of the federal poverty level would be lifted out of poverty due to an EITC expansion while 1.65 million people would escape poverty as a result of a FICA rebate. In other words, 2.5 times more Americans would escape poverty with an EITC expansion than with the FMWA.

A minimum wage increase is a costly policy—for both employers and employees. For employers, the wages of entry-level employees of course increase. Those hikes in turn produce “spillover” wage increases for those earning slightly more than the minimum wage. The authors point to indirect “disemployment” costs repeatedly mentioned in the vast body of wage literature, as higher wages make it more difficult for inexperienced earners and young applicants to find employment.

The authors conclude the study by considering President Obama’s 2008 campaign promise to raise the minimum wage to $9.50 by the year 2011. They find this $2.25 increase in the minimum wage to be deficient in the same way as the FMWA; it is not well-targeted to poor and low-income families, and not as cost-effective as policy alternatives like an EITC expansion.

In the public debate on the minimum wage, the burden of proof often rests with those in opposition. After all, speaking out against increases in the wages of American workers is not likely to win a legislator popular support. However, the work of Drs. Formby, Bishop, and Kim suggests that those who advocate for such increases bear a burden of their own—a lack of proof that their favored policy is a well-targeted or cost-effective method to help poor and low-income families. Instead of offering lip service to impoverished constituents, legislators should support those policies which have a proven record of lifting people out of poverty.

—Employment Policies Institute

Download the one-page policy brief in .pdf format