Rethinking the U. S. Minimum Wage

The U.S. minimum wage laws were first enacted in the 1938 Fair Labor Standards Act. This act set a few things down for wages and labor, the most important ones being that regular pay time was limited to 40 hours—anything over that being overtime pay (which would be paid at 1.5 times the regular rate), and that the minimum wage at the time was set to 40 cents (about $7.6 in 2021 dollars). After further amendments, the last time the minimum wage was set was in 2009 at $7.25 [2]. Overall, it looks like the minimum wage has never really gone up when adjusted for inflation (it actually has gone down since 1968), and these days America is contemplating raising the minimum wage up to $15.

Any sensible person who looks into the topic of whether raising it is a good or bad thing, who looks into arguments made on both sides will see that there are good points on both sides. What I want to discuss, on the other hand, is how minimum wage is set up and why we ought to rethink it. I believe the way minimum wage is set up is deeply flawed and unfair—that is, I believe there are ways to still have a minimum wage (whatever that wage is, be it $7.25, $7.6, or $15) but make it more fair, and in this article I will be talking exactly about that.

Photo by Alexander Schimmeck on Unsplash

Price, Cost, and the Cost of Minimum Wage

First, I want us to think about two concepts that people often mix up: price and cost. Between the two, price is the easier one to understand so let’s start with it.

Price and Cost

I’ve actually written about this concept in the past in Before You Blame Capitalism, but I want to reiterate the concepts further.

Price is simply how much money you have to pay for something, or more generally how much currency you have to give in order to get some specific thing in return. A few examples:

  • If you go on Amazon and check out the book Basic Economics, you’ll see it listed for $25.49 (at least it on May 11, 2021 for me). $25.49 is the price of that book.
  • Many video games often have internal “coins” that you can use to buy packs. The number of coins you need to exchange for those packs is the price of the packs.

Price is often readily available and easy to grasp because it’s something you have to give in exchange for something else. Cost, on the other hand, is very different.

Cost is the abstract concept of how much you have to give up in order to produce something. Cost is that work/effort you have to put in to get the things that you want. I want to give some examples here too:

  • I am writing this post sitting on a couch next to a coffee table with a water bottle on it. The cost of me drinking water from the bottle that’s on my table is the muscular effort I have to put in to raise my arm, grab the bottle, open it, drink from it, and then put it away (either closer to me or back on the table). As you can see, I tried to be very explicit in this example but you still can’t know the “cost” I paid to drink that water (I literally couldn’t tell you myself).
  • To use the book Basic Economics as an example again, the cost of producing that book is the sum of the cost of everything that went into creating that book. That includes the years of research that Thomas Sowell had put in, the years of printing press progress that helped mass produce books, etc. If you think about all that cost, it’s easy to see that $25.49 is really a bargain for the kind of knowledge you can gain from that book.

No one can really measure cost, and that’s why economists came up with “opportunity cost”—which is the opportunity one gives up in order to do something. For example, some of the many opportunity costs of buying BTC (among many) are to buy TSLA stocks or to use that money to buy food at a restaurant. How opportunity cost helps is by identifying various options and weighing them against each other. From that one can derive whether the price of something aligns with the cost involved to get that thing.

Cost of Minimum Wage

Now, the title in this section is misleading because it looks like I’m about to tell you the cost of minimum wage. Sadly, I can’t tell you that. As I said in the previous paragraph, cost is super abstract and it’s hard to measure. However, what I am hoping to have you agree with me is that minimum wage has a cost.

I’ll give a completely absurd example to illustrate my point. In the US, the average pay for a lawyer is $122,960/year (according to US News [3]). Let’s just say that the US makes a special minimum wage for lawyers that they have to be paid at least double that at $245,920/year. Outside of the revolt that will ensue, I can guarantee to you that some law firms will probably shut down (or at the very least lose a lot of clients). Why? Because the cost of paying lawyers double their average salary is too much to bear for law firms. They’d have to completely change how they operate in order to adjust to such a drastic change. That change (which will lead to some closing down) is the cost they have to pay. Many lawyers will probably be laid off. Similarly, if the change was only 1.5x (instead of 2x), some firms would still be affected (maybe not as much as 2x) because the cost would have increased.

It then stands to reason that any increase in payments that a company or firm must pay that they didn’t have to pay has a cost to that business, and as that payment increases, so does its cost. This cost could be operational changes, laying off people, increasing their prices, or any other ways that can help that firm bear the extra added cost.

In the same fashion, minimum wage, whatever it is, has a cost. Minimum wage is the same as the lawyer example but with a smaller increase in payment but a larger target group: all businesses—but more specifically businesses that would pay at or below minimum wage had it not been a law.

The Law Around Minimum Wage

The way the current law is set up is that the employer must pay its employees at least whatever the minimum wage is. If the minimum wage was $10 while the employer would pay $6 without minimum wage laws, then it is forcing the employer to bear the cost of providing the extra $4.

Now, hold that train of thought for a second. Let’s talk about the “fair” wage first.

Defining the “Fair” Wage

One of the reasons I mentioned cost above is that everything has a cost, including paying people. From the viewpoint of the employee, they want to be paid as much as possible for the job they take. From the viewpoint of the employer, they want to earn as much as possible in net return from the employee that they hire, and this incentivizes employers to pay people as little as possible. For me, the argument that the employer is somehow greedy for wanting to pay as little as possible while the employee is somehow not greedy for wanting to get paid as much as possible is just nonsense. Both the employer and employee are greedy in this case, and the reality is, in the real world both will accomplish their greedy needs to the extent that they can.

So, how does pay get resolved? It gets resolved through supply and demand—or at least in a free market economy (which I’ve previously written about) that’s how this is done. More specifically, if a given labor (the job) is in high demand, employers will offer to pay higher for that job. Employees, on the other hand, will use their bargaining power to supply the labor for a cheaper price to the extend which they are comfortable (e.g., if Mark will accept $10/hour to do the job while Steve is willing to do the same job for $9/hour, Steve is more likely to get the job).

The assumption I want to make here is that the salary (which is really the price of that labor) is set through supply and demand in a voluntary, non-coerced transaction between the employer and employee where neither party has unfair advantage and both parties have equal access to market information.

  • An example of an unfair advantage would be an employer paying illegal immigrants a lot less than they would were they not illegal. The employer has an advantage that they can pay the immigrant less because of their legal situation.
  • An example of a coerced situation would be if an employer had something they could hold against the employee. E.g., the employee having committed some crime that they didn’t get caught for and the employer saying, “you’ll work this job for less or otherwise I’ll rat you to the police”.

None of the above two situations are happening in this case. The transaction had the full consent of both parties. Finally, what I mean by market information is that both parties know how much everyone else is paying for this job. Under these assumptions, the wage that we get for each job would be fair, and thus we define that wage as the “fair” wage.

In the U.S. most Wages are Fair

Because of the capitalistic nature (and I do mean proper capitalistic nature as I wrote about here) of the United States, most wages are fair. That is because coercing someone into doing a job or having unfair advantage for a job is extremely difficult because of the market competition. If one employer tries to cut corners, it will either break the law or be swallowed by the competition.

In terms of market information, this info is technically out there (for example the way I found the average wage of a lawyer [3]). However, it’s not really fully there because we don’t really have historical data about how much people are getting paid for different jobs. Still, neither do companies have this information. What usually happens is that all companies do extensive market research to ensure they are providing the right wages for the jobs that they are offering. People can also do market research to make sure they are getting the right salary.

The only place I can think of where wages are not fair are when things are illegal. For instance, if a place pays people under the table or hires people who are not legally allowed to work, they can get away with paying less. At the same time, this also involves not paying taxes so the net results might still be a “fair” wage.

Why Have a Minimum Wage

I want to dive a little bit into why we have the minimum wage. From what I read in the Fair Labor Standards Act of 1938, it seems like the motive was to protect employees from employers who might want to take advantage of them. So, in this case it’d be kind of like the unfair advantage and coerced situations I’ve mentioned above. There could be other ways too for an employer to take advantage of employees and the minimum wage is just one form of protection against that (another one being the maximum of 40 hours per week and counting anything over that as overtime).

Another reason I see for why have the minimum wage is to have a wage that is high enough to allow the employee to live and sustain themselves with what they get from their salary. This can include food, shelter, and perhaps leisure. Being paid a higher wage allows one to have a better standard of living and live a happier life.

Who Wants the Minimum Wage?

There are many other reasons why people want to have a minimum wage, but while we’re at it, a question that I want to ask is, who wants this minimum wage?

I’m going to assert here that it’s the “society” at large that wants this minimum wage. I.e., if the fair wage (given consent and negotiation as mentioned in the previous section) is $6 and the minimum wage is $10, the society at large wants that person to be paid $10 even though their “fair” wage is just $6.

Unfairness of Minimum Wage Laws

We’ve established already that minimum wage has a cost. Really, we’ve established that paying someone more for their job is not free—it has a cost. Whether or not that cost can be outweighed by the benefits gained by increasing the wage (could be workers being more productive or being happier, etc) is not relevant to where I’m going with this.

Secondly, we’ve established that the minimum wage is only applicable for “fair” wages that are below this minimum wage. That is, in the example I gave of minimum wage of $10 when the fair wage is really $6, the minimum wage demands that the employee gets a pay that is $4 more than the fair wage.

The reason why the minimum wage is unfair is because it demands that the employer bears the full cost of the minimum wage. That is, it demands that the employer bears the cost of paying its employees the extra $4. The reason that’s unfair is because the whole society that demanded this policy is really forcing the employer to bear its cost. I think it’s unfair to ask a small minority group to bear the cost of what the majority demands no matter what that demand is.

Let’s go over some objections that you may have.

“The employers are greedy in charging a low cost”

We’ve already established this in that the employees are also greedy—not just the employers. Everyone is greedy, everyone wants more. The way this was “fixed” was through supply and demand resulting in the “fair” wage.

“The employers can handle it”

Just because someone can handle something does not mean that they should do it.

An example of this is that most people can handle not eating food every other day. If everyone did it, we would consume a lot less food, and that would help reduce the consumption of meat and other animal products, which would eventually help the environment and slow down the industry that powers meat consumption. Why not make a law that says that you can’t eat food every other day so that we help save the environment?

If that wasn’t absurd enough for you, let me give you another example. The majority of people can handle doing a 30 minute running session every day. If everyone did it, everyone would be more fit and healthy. So, why not make a law that says that 15–45 year olds will get a $3,000 fine if they don’t complete at least 30 minute of running every single day?

If there was an attempt to force people (as the minimum wage law actually forces employers to pay their employees at least the minimum wage amount) to do things just because they could handle it, people would absolutely revolt. There are many things that people can handle, but they do not do those things for a reason. So, it is absurd to apply this logic to minimum wage just because some employers can handle it.

“The employees need that money more than the employers”

This is another variant of “the employers can handle it”.

Let me bite. While I believe no one knows everyone’s situation, let’s be fair and say that in most cases, YES the employee will need the extra money more than the employers. It still doesn’t make it fair for the employer to bear the cost of what everyone in society wants.

Remember, the issue at play is about fairness—not about need. If one employer paid a higher wage out of their own volition, then more power to them for being a kinder employer. However, it’s unfair to force every other employers to pay the cost of something society wants.

How to Make Minimum Wage More Fair

The framework for making minimum wage more fair is by acknowledging that if all people (and thus the government) want everyone to earn at least a given amount (the minimum wage), all people (and thus the government) must contribute to the additional amount that businesses must pay to reach that minimum wage. In an ideal world, whatever forced pay that is above the fair wage (as defined above) should be equally shared among and completely paid by all taxpayers because that amount is the additional burden that is forced upon the employer for something that everyone wants.

I have two propositions to make minimum wage fairer. It’s hard to determine when either proposition make things more fair vs. make things too good in favor of businesses (because determining the true fair wage is difficult in the presence of all the other factors that affect someone’s wage today), but I believe that something along these lines should help with improving the unfairness of how minimum wage is today. Both propositions are essentially the same in that they encourage the government to somehow pay some of the money involved in the minimum wage, all of which helps achieve the goal laid out in the above paragraph.

Proposition 1: Business Income Tax Deductions by Businesses for Wages Up to Minimum Wage

As is currently set up, businesses have to pay the business income tax—the corporate tax—on their profits (revenue minus expenses) [4]. This corporate tax comes down to an average of 25.8% in the U.S. [5]. What this proposition would do is allow businesses to claim income tax deduction for each employee for wages paid to them in the minimum wage range.

Let’s say the minimum wage is set to $15 where an employee would be earning at least an expected $31,200/year (working 40 hours/week for 52 weeks). In this case, a business can claim tax deductions in business income tax of some determined rate R times $31,200. Here’s an example with setting R = 0.4, assuming $15 minimum wage, and assuming all employees work minimum wage:

Number of Employees: 15
Business Income: $1,200,000
Business Expenses (Excluding Wages): $500,000
Wages Paid to Employees: 15 * $31,200 = $468,000
Profit: $1,200K - $500K - $468K = $232,000
Eligible Deduction: R * $468K = 0.4 * $468K = $187,200
Taxable Income: 232,000 - 187,200 = $45,000
Taxes Paid at 25.8% = $45K * 0.258 = $11,610
Taxes Paid without Deductions at 25.8% = $232K * 0.258 = $59,856
Income Saved by Business = $48,246

This results in the government missing $48,246 in income from the business above and in that business saving it. The R value of 0.4 and the numbers from the example above were all chosen arbitrarily. However, note that an R value of 0.4 is equivalent to saying that the average fair wage for jobs below the minimum wage of $15 (in the absence of minimum wage) is (1-R)*15, which is $9.

Proposition 2: Government Must Pay A Share of Wage Below Minimum Wage

The second proposition is a twist on the first proposition. Instead of offering corporate tax deductions to businesses for the pay they give to employees up to minimum wage salary (Proposition 1), the government will pay a part of minimum wage jobs for those employees. The simple way to do this is to pay a rate of the minimum wage.

In other words, using an R value, the government will pay R * Wage for wages below minimum wage. If R = 0.4, someone is paid $50,000/year, and the minimum wage is $15/hour, then the government will pay $31,200 * 0.4 = $12,480, which it will reimburse to the business in the form of tax credits. That is equivalent to saying that for every employee that a business hires, the business gets a tax credit of $12,480.

Why Both of These Propositions are Good

Let’s assume that minimum wages go up with inflation every year (like why aren’t they already doing that?!). Assuming that, these are the reasons why the following two propositions are good:

  • GOOD FOR CITIZENS: Both propositions incentivize businesses to hire and/or pay their employees more. At the end of the day, this helps everyday Americans find a job more easily because some employers won’t be force to have less staff in order to cover the cost of minimum wage.
  • GOOD FOR BUSINESSES: This is good for businesses because it reduces their operational costs and allows them to invest that money to innovate further. This, again, can mean that they might hire more people.
  • ALL BENEFITS OF MINIMUM WAGE: We still get all the benefits of a minimum wage. The following article from the Economic Policy Institute lists many benefits of raising the minimum wage, and the policies I proposed here still provide all those benefits [6].
  • BETTER ECONOMY: This is a consequence of the first 3 benefits. It follows that the unemployment rate will go down and improve minimum wage.
  • MORE RESPONSIBLE GOVERNMENT: If the government increases the minimum wage in good faith, it will be responsible for paying for it. This puts more skin in the game of government officials because raising the minimum wage will involve cutting spending in other places or raising taxes.
  • MORE RESPONSIBLE CITIZENS: Every time a citizen pushes for higher minimum wage, they are also pushing for higher taxation. This gives citizens more skin in the game because that means that they really are willing to chip in to ensure that minimum wage employees get paid the desired amount.

Choosing the Right R Value

As stated above, in an ideal world, whatever forced pay that is above the fair wage (as defined above) should be completely shared among all taxpayers because that amount is the additional burden that is forced upon the employer for something that everyone wants. Therefore, R should try to get as close as possible to the share of this value (i.e., if average fair wage was $9 while minimum wage was $15, then R = (15–9)/15 =0.4).

Because we do not have access to the fair wage, we must try to estimate it, which is a really hard problem. It’s easy to see that depending on many factors, this value can change. Some years, that average fair wage might be $8 while in others it might be $11. Practically anything that can influence the market can influence this.

With that said, I think that this R value must (1) be tied to some external factor that the government can’t really control (because if the government did, it would try to reduce R down to 0—bringing us back to today’s situation) and (2) tied to something such that improving that thing would be both good for the government officials and for citizens. For instance, it could be tied to the unemployment rate such that as unemployment rate goes to 0, R also goes to zero (good for the government not having to foot as much of the bill and good for people because more employment is good). Another factor it could be tied to would be inflation rate. This can be good because inflation rate doesn’t vary too much (except in extreme times like Covid), and that would give more certainty around what this R value can be. Finally, it would probably be good if this R value was tied to a number of these factors together to make it difficult to tweak.

In Concluding…

Throughout the United States, people are not born equal. Some are born with more wealth than others. What minimum wage tries to do is to even out the opportunities for everyone, and it is because of that that it is a noble concept.

With that said, minimum wage is something that *all* Americans vote for (in theory at least—by treating Congress as representative of people), and it is unfair that business owners are the ones forced to foot the bill. That is, by forcing business owners to pay a given minimum wage that is higher than what they have to pay, the entire society (a majority) is forcing all business owners (a minority) to pay for something that it wants. That is unfair and that is why there should be a reform in the way minimum wage is set up.

In an ideal world, all of society would foot the bill equally. This article proposes a solution to make society more fair by making society pay for what it wants through a form of the government compensating businesses for having to foot the bill.

Sources

[1] Wikipedia - Fair Labor Standards Act of 1938
[2] DOL - Fair Labor Standards Act of 1938, As Amended
[3] US News - Lawyer Salary
[4] Investopedia - Income Tax
[5] Tax Foundations - 25 Percent Corporate Income Tax Rate Would Make U.S. Above Average Compared to Peers
[6] Economic Policy Institute - Raising the Federal Minimum Wage to $15 by 2025 Would Lift the Pay of 32 Million Workers

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Robert M. Vunabandi

Robert M. Vunabandi

124 Followers

I’m a human, living on earth, and doing Software Engineering. I enjoy reading thoughtful posts, and I like to write! So, here we are.