Effective Tax Rates and the Living Wage

Content

Executive Summary

Over the past decade, more than 110 ordinances
have been passed mandating “living
wages” for employees in businesses contracting
with a locality and/or receiving financial
assistance through tax breaks or economic
development grants. The wage rates set by
these ordinances often exceed the federal minimum
wage by 150–200 percent. These original
laws—which applied to very few businesses—
had a limited effect on the overall economy of
a city. Over the past year, however, these initial
ordinances have been used as the basis for
expanded citywide living wage ordinances.

The first of these expanded city wide living
wage ordinances to pass was in Santa Fe, New
Mexico, where an $8.50 minimum wage went
into effect (after a court challenge) in June
2004. This initial level will increase to $10.50
an hour by 2008 and will thereafter be indexed
to inflation. In November 2003, voters in San
Francisco passed an $8.50 minimum wage for
city businesses, and the Madison, Wisconsin,
city council passed a $7.75 minimum wage in
that city soon after. While the “success” of living
wage ordinances is often cited in support of
citywide wage floors, there have been few
rigorous studies analyzing the effect of these
living wages on either the total income or living
standards of low-income families.

In this study, Dr. Aaron Yelowitz of the
University of Kentucky and Dr. Richard Toikka
of the Lewin Group utilized Survey of Income
and Program Participation (SIPP) data to analyze
the effect of living wage ordinances on
earnings, income, and government assistance.
In order to more fully analyze changes in the
standard of living for low-income families, this
study examines total income and not simply
earnings. If living wage ordinances were to
increase earnings but do so only at the expense
of other forms of income, the policy would
only change the composition of income and not
increase the quality of life for low-income families—
the stated purpose of these ordinances.
Quantifying the ordinances’ benefits is critical
because increasing the wage floor leads to disemployment as businesses either decrease their
labor force, shift to more efficient employees,
or leave the jurisdiction entirely. It would take
a significant benefit to justify this cost.

Previous work on this topic (Toikka,
Yelowitz, and Neveu, 2003) found that
low-income families face exceptionally high
marginal tax rates and—as a result—living
wage ordinances appeared to be badly targeted
and ineffective at raising comprehensive disposable
income. This study extends that earlier
work by estimating the actual responses of
households to living wage mandates by utilizing
the 1996 SIPP data set.1

As mentioned above, previous work analyzing
the effectiveness of living wage ordinances
examined only cash income. For example,
Neumark and Adams (2002) found a modest
decrease in poverty rates utilizing data from the
Current Population Survey Annual Demographic
Files measure of cash income, which excludes
in-kind benefits such as food stamps and subsidies
such as Earned Income Tax Credit (EITC)
payments. Failing to account for these income
sources can dramatically distort the effect of a
policy on the actual standard of living for a
family. For example, a family with two children
can qualify for more than $4,000 in tax-free
cash assistance as a result of the EITC (and
earn even more in states with supplemental
state-run EITC programs). A benefit of this size
would clearly affect the quality of life of lowincome
families.

As earnings increase, recipients can see the
benefits from these programs decrease dramatically. For example, the marginal tax rate in the
“phase-out range” for the EITC can reach as
high as 21.06 percent and the tax rates for food
stamps are generally 30 percent. Failing to
include the loss of these benefits when evaluating
the benefit of living wage ordinances can
dramatically inflate the perceived effectiveness.

Examining the effect of living wage ordinances,
the authors found that the ordinances
decreased cash transfer assistance. Specifically,
the authors found that the enactment of a living
wage ordinance decreased assistance by $34 per
month. In addition, the authors found that the
increase in earnings resulting from the ordinance
was only $16 per month. This means that for
every dollar in increased earnings from a living
wage ordinance, families can expect to lose up to
$2.12 in cash assistance—greatly limiting the
ability of the policy to help low-income families.
Controlling for factors such as the business
cycle, state minimum wage levels, and welfare
reform, the authors found that the enactment of
a living wage increased total family income by
only $55 per month. Due to lost benefits, 38 percent
of this increase in income is crowded out.
If the effect of important programs like food
stamps is factored in, this tax rate would likely
be higher.

Overall, the authors have found that living
wage ordinances do little to actually increase the
standard of living for low-income families. The
$55-a-month increase in total family earnings
represents a less than 2 percent increase for the
average family. In terms of an increase in earnings,
the $16-per-month increase represents an
increase of approximately one-half of one percent.
The authors state, “a reasonable reading of
our results is that the living wage has a limited
capability in improving the economic status of
the poor.” This limited capability is important
because decades of studies clearly show that
mandated wage floors create disemployment
effects—particularly for the low-skilled employees
these laws are intended to help. Pushing the
intended beneficiaries out of a job while providing
minimal benefits to remaining employees
makes living wage ordinances an ineffective
anti-poverty policy.