One of the difficulties in economics is isolating the effects of particular actions in a very complex world. If we cut income tax this year and next year tax revenues are a little higher, it’s tempting to attribute that to the tax cut.
We read today that the national minimum wage will increase by 20p an hour to £6.70 from October, and that this will benefit more than 1.4 million workers. What we hardly ever hear from politicians is how many people will feel the costs of this increase, in addition to the people who are already being hurt by having a minimum wage law in the first place. The problem with state-enforced minimum wage laws is pretty standard economic text book stuff: the minimum wage makes it harder for low-skilled workers to get a foot on the labour market ladder, it unfairly loads the burden on firms that employ low-wage earners (a burden that could be avoided by simply reducing the tax low-earners pay, or taking them out of tax altogether), and as a result it often causes inflation of prices and reduction in staff as firms try to recoup their losses.
With the announcement today, and with the Budget looming, I was very interested to stumble upon an article this week by Jeffrey Tucker about a Eugenics Plot Behind the Minimum Wage, in which we find out that in the early 20th century some eugenicists tried to introduce the minimum wage as a means of getting some of the lesser able people out of the employment market. Here are some relevant quotes that are bound to shock:
A careful look at its history shows that the minimum wage was originally conceived as part of a eugenics strategy — an attempt to engineer a master race through public policy designed to cleanse the citizenry of undesirables. To that end, the state would have to bring about the isolation, sterilization, and extermination of nonprivileged populations.
It was during this period and for this reason that we saw the first trial runs of the minimum wage in Massachusetts in 1912. The new law pertained only to women and children as a measure to disemploy them and other “social dependents” from the labor force. Even though the measure was small and not well enforced, it did indeed reduce employment among the targeted groups.
Leonard documents an alarming series of academic articles and books appearing between the 1890s and the 1920s that were remarkably explicit about a variety of legislative attempts to squeeze people out of the work force. These articles were not written by marginal figures or radicals but by the leaders of the profession, the authors of the great textbooks, and the opinion leaders who shaped public policy.
“Progressive economists, like their neoclassical critics,” Leonard explains, “believed that binding minimum wages would cause job losses. However, the progressive economists also believed that the job loss induced by minimum wages was a social benefit, as it performed the eugenic service ridding the labor force of the ‘unemployable.’”
So when we hear politicians make minimum wage commitments in the run-up to the election, bear in mind that those that preceded them were always fully aware that wage floors precluded people from the labour market, and that they were once deliberately implemented to expunge the demographic landscape of those they thought inferior citizens that were unworthy of earning a living. That they so readily endorse a policy that places a barrier to employment for so many people tells you just about all you need to know about the extent to which winning votes matters far more than aiding people’s job prospects.
I hope that, in my lifetime, politicians and social commentators begin to get the simple message that if you artificially remove the lower rungs on the labour ladder, you make it difficult (often impossible) for people to climb it, or in some cases, get on it at all.
When minimum wage rates per hour are set by law, it can raise the wages of those already in jobs and who manage to stay in those jobs. It has a negative effect on those who lose their jobs because firms no longer find them worth employing at the new rates. It has negative effects, too, on those trying to enter the labour market who do not yet have enough skills to be worth the minimum wage to potential employers. Firms employ people because they are worth more to the firm than the wages they cost it. For low-skilled people their value to the firm might be quite low. Very often it is by starting on low wages and acquiring on-the-job skills that people move up the employment ladder. Someone who has worked has learned the importance of good time-keeping and following instructions. They have learned how the firm likes to do things, and are more valuable than an unknown potential employee. If the minimum wage is set at a level above that of their value to the firm, they find it difficult to secure those starter jobs.
In many countries those with low skills tend to be young people and sometimes those from ethnic minorities, especially if they have not had an adequate education. When minimum wage rates are increased, there often tends to be increased unemployment among these categories.
When minimum wages were introduced in the UK, the level was initially set sufficiently low that it had a minimal impact on employment. Subsequent increases are believed to have increased its impact, leading some economists to suggest that a better way of raising the take-home pay of low earners is to stop taking tax off them. Raising thresholds for income tax and National Insurance increases their wage without it costing employers money and pricing their services out of the market.
The Office of National Statistics has just released figures on incomes in the UK. Giving us that interesting little chart above. Do note that that is income of those who are in the tax system. And also that it does not include the impact of the benefits system. So this doesn't include subsidy to housing or anything like that. And then have a look at the global rich list. Where you can plug in an income and the country to which it refers and see where that income in that country puts you on that global rich list. The reason you must add the source country is because they are calculating using PPP adjusted currency rates. That is, they're taking account of how much things cost in each country. So this isn't really a comparison of incomes, it's a comparison of living standards.
And here's the astonishing thing. That bottom 1% lifestyle in the UK is still among the top 20% globally. The UK minimum wage puts you well into the top 10% (almost top 5% in fact). And a little over median wage puts you into the global top 1%.
To repeat, this is not assuming that things are cheaper in other countries. This is after we convert to the prices you're paying at Morrisons.
We've nothing at all against those who would campaign about either poverty or inequality. But we would like to take this little opportunity to remind all that by any historical or global standard we here in the UK, yes even the relatively poor by local standards, are living pretty high on that income scale. And that feeds in to what we think is the important point about what we might want to do about inequality or poverty. Let's concentrate on that global picture, not gaze at our own navels. Encouraging poor country growth wit the aim of abolishing absolute poverty seems to be so much more productive to us than worrying about whatever gap there might be between the top 20%, top 10% and top 1% of the global income distribution.
Earlier today in Ipswich, Prime Minister David Cameron pledged to turn Britain into a nation of “full employment”, aiming to overtake Germany for the top percentage of people in work. From the BBC:
The PM is aiming for Britain to have the highest percentage of people in work of any developed nation.
Labour said the Conservatives' promises would sound like "empty words" to the unemployed or those on low pay.
Mr Cameron's goal of "full employment" would involve the UK, currently 72%, overtaking Germany's 74% in terms of the percentage of people in work, said BBC assistant political editor Norman Smith.
There is no timescale, but it is an "aspiration which he wants to achieve", he added.
It’s a nice ‘aspiration’ sure, but Labour’s not the only group to think these are ‘empty words’ coming from the PM.
His pledge to bring full employment to Britons includes measures to increase the number of start-up loans provided by the government, as well as plans to invest in infrastructure, which he hopes will attract business and support new apprenticeships. But no word about changes to the minimum wage. Not a word about the personal allowance or National Insurance tax.
Research that my colleague Ben recently highlighted shows what a negative effect the minimum wage can have on unemployment – it's estimated that “minimum wage increases reduced the national employment-to-population ratio by 0.7 percentage point(s)” in the United States during the late 2000’s.
What’s more, a job is significantly less valuable to the newly employed if she is still unable to provide for herself and her family. At the same time the PM scraps the minimum wage, he should raise the tax-free personal allowance to the Living Wage, taking the poor out of tax completely. National Insurance tax should also be scrapped for low-earners, as it works as just another form of income tax.
A backtrack on minimum wage increases combined with pegging the personal allowance and NI to a Living Wage would be a serious indication of Cameron’s commitment to ‘full employment.’ But while he continues to spout plans for increased government spending and building, I remain unconvinced.
The debate among economists over whether (higher) minimum wages cause (more) unemployment seems to go on forever. Most published results (and an even greater fraction of methodologically sound published results) find that minimum wages reduce employment. But this doesn't settle the result, and smart, eminent economists like Arindrajit Dube publish papers arguing that with different methodologies and/or correcting for appropriate trends, you cannot find a link. Though this seems to go against our basic model of the microeconomy, economists argue that employers of the low-skilled are monopsonists—single buyers, the converse of monopolies, single sellers—and may even want more labour when its price rises. Those who do believe that minimum wages put people out of work, when faced with results finding they don't, suggest that maybe this just a temporary effect; in the long run workers will be replaced with automation a la modern checkouts, or fewer higher-skilled people once they've had time to search. Or alternatively, less will be spent on working conditions or other benefits.
Given this morass of disagreement, a new paper from Jeffrey Clemens and Michael Wither is unlikely to change any minds, but it's still an interesting result. They use nifty controls to establish that binding minimum wages cause unemployment, lower wages from work, and worse work progression for the low-skilled. This dearth of work experience, the authors say, makes them less likely to join the lower middle class. What's more, because their sample is very broad and spread out across the entire US, they believe their results are uniquely good for extrapolating to the country as a whole.
We estimate the minimum wage's effects on low-skilled workers' employment and income trajectories. Our approach exploits two dimensions of the data we analyze. First, we compare workers in states that were bound by recent increases in the federal minimum wage to workers in states that were not. Second, we use 12 months of baseline data to divide low-skilled workers into a "target" group, whose baseline wage rates were directly affected, and a "within-state control" group with slightly higher baseline wage rates. Over three subsequent years, we find that binding minimum wage increases had significant, negative effects on the employment and income growth of targeted workers. Lost income reflects contributions from employment declines, increased probabilities of working without pay (i.e., an "internship" effect), and lost wage growth associated with reductions in experience accumulation.
Methodologically, we show that our approach identifies targeted workers more precisely than the demographic and industrial proxies used regularly in the literature. Additionally, because we identify targeted workers on a population-wide basis, our approach is relatively well suited for extrapolating to estimates of the minimum wage's effects on aggregate employment. Over the late 2000s, the average effective minimum wage rose by 30 percent across the United States. We estimate that these minimum wage increases reduced the national employment-to-population ratio by 0.7 percentage point.
We here at the ASI have been arguing for many years now that the most absurd part of our income tax system is that people working part time on the minimum wage are inside the income tax system. We've been arguing it so loudly that something is about to happen:
None of the four main UK parties are proposing a tax cut package that would predominantly benefit low earners, the Resolution Foundation thinktank said on Monday.
A report analysing the impact of the main tax cuts being proposed by the Conservatives, Labour, the Liberal Democrats and the UK Independence party (Ukip) said they would not benefit nearly 5m low-paid employees who do not pay income tax.
Although it found the Labour and Lib Dem proposals were less regressive than the Conservative and Ukip ones, it said that the poorest 50% of households would only get a quarter of the overall benefits even under the fairer plans. The foundation said a more progressive approach would be to raise the national insurance threshold and to lift the work allowance within universal credit. Even though the government is running a deficit of nearly £100bn, all the main parties will be proposing tax cuts in their election manifestoes.
The Conservaties and the Lib Dems both want to raise the basic rate income tax threshold to £12,500. The Conservatives also want to lift the higher rate threshold to £50,000. Labour wants to introduce a 10p tax band. And Ukip wants to raise the basic rate threshold to £13,500, and to introduce a new 35p tax band for those earning between £47,000 and £61,000.
Three of those four proposals to raise that personal allowance come from us here. No, not directly (in one case, yes directly) necessarily but we can point to the Lib Dem we convinced and the path of the proposal through that party. And of course the Tories are just following on. Hurrah! etc.
That the idea, that if we want the working poor to have more money we should simply stop taxing them so much, has caught on is lovely. That it annoys the Resolution Foundation so much is just icing on the cake.
However, they do make one good point:
Kelly also said it would be fairer to prioritise raising the national insurance threshold, because this would benefit the 1.2m people who earn enough to pay national insurance but not enough to pay income tax (for which the threshold is higher).
Yep, raise that NI limit (including the employers' part) to again that full time, full year, minimum wage. Sure, it would be "expensive" if you take that horribly statist attitude that all money really belongs to the State and thus that not taxing it off people is a cost. But out here in the real world most people do get the basic idea. If there is some minimum amount that it is righteous and just (an idea we're not sure about ourselves) that the State insists people are paid then it is equally righteous and just that the State doesn't dip its fingers into those wallets getting that righteous and just minimum amount.
Or, as we've been saying for these long years now. If you want the working poor to have more money then stop taxing them so bloody much.
The young are the new poorThe Independent - Cahal MilmoA study by the Joseph Rowntree Foundation has warned that young adults and employed people are now more likely than pensioners to be living in poverty in Britain because of the surge in insecure work and zero hours contracts.
The reason for this is the minimum wage, which also explains why we have nearly 1m youngsters out of work entirely.
While the minimum wage for young people does not seem high – £5.13 an hour for 18-20-year-olds, and £3.79 for under-18s – the fact is that many young people do not provide that much value to an employer. Indeed, when National Insurance and other costs are added, the value of an unskilled young person is often negative. Young people have to learn the habits of work, turning up on time each day, the skills needed in the job, and 'soft' skills such as how to get along in a team with colleagues, how to deal with customers, how to react when things go wrong, and so on. It may take many years of training and job experience to lean these skills.
That is why for centuries we have had apprenticeships in which young people earn very little but learn a trade. But minimum wages – plus the heavy burden of workplace regulation which makes it very difficult to let someone go once they have been hired, however inappropriate they turn out to be – make employers more reluctant to take on people with few or no skills and experience.
The result is that minimum wages hurt those they are supposed to help. Employers do not take on young people, or those without skills, or those nearing retirement, or people with poor social or language skills, or ex-prisoners, or people with mental health issues, because their business cannot carry the cost of giving them the support and training they need to become more productive than the cost of employing them.
Having a minimum wage is what makes ‘illegal immigration’ feasible. Most illegal immigrants are unskilled, poorly paid workers; Epstein & Hezler (2013) say that “Minimum wages play an essential role since they put a limit on local workers’ and legal migrants’ wages. Thus, under certain circumstances, the probability of employing illegal workers is increased.” Incidentally, the authors also suggested that one way to reduce illegal immigration would be to increase legal immigration (assuming a constant minimum wage). According to a survey commissioned by the Migration Observatory at the University of Oxford, “Among respondents who want immigration reduced overall, 54% said that they would like reductions either “only” (28%) or “mostly” (26%) among illegal immigrants”. Illegal immigrants fill a gap for employers who cannot survive by hiring people at or above the minimum wage and who also cannot attract legal residents that are willing to break the law and work for less than minimum wage. Firstly, if there were no minimum wage, then employers would have less incentive to employ illegal immigrants and would, instead, turn to legal residents to offer their labour for these rates. This would simultaneously empower the unemployed with more opportunities to offer their labour, make entrepreneurship increasingly feasible (especially that of the labour-intensive variety) and significantly reduce illegal immigration.
Whether the contempt toward illegal immigrants is from allegations of criminal activity, taking jobs, etc., this has a spill over effect on the perceptions of immigrants in general. There is an oft-documented tendency for people to stereotype and make sweeping generalisations (even if we are subsequently ashamed of doing so). Hence, any negative perceptions of illegal immigrants contribute to the general degradation of legal immigrants’ status in society.
Furthermore, and perhaps most importantly (depending on who you are), via a combination of both the inflexibility of the labour markets that it contributes toward (and, therefore, of price levels in various other markets) and the controversial illegal immigration that it makes feasible, the minimum wage is one of the greatest barriers to the possibility of free immigration and, therefore, of a world where greater understanding and co-operation between people flourishes.
The new Living Wage rate was announced today. I’ve written a bit about the Living Wage already. If it’s private, it’s probably not a big deal, although it could still lead to unemployment. I suspect it’s done by big firms that don’t have many low-skilled workers as a PR move but I quite like PR moves that involve paying low skilled people more. And I worry that people will generalize from those big firms to assume that the whole market could bear a mandatory Living Wage, which is almost certainly untrue and would be very harmful to many of the people it’s supposed to help. What’s more interesting is the problem of low pay in general. Even though unemployment has fallen a lot in recent years in the UK, real wages have barely risen at all. Even as wages do begin to rise on average, it’s possible that wages for low skilled workers may not as jobs for them are outsourced to cheaper countries. The ASI has proposed raising the personal allowance (including National Insurance threshold) to the minimum wage rate, but this doesn’t do much good for part-time workers or currently-unemployed people who would earn below the minimum wage if we scrapped that, as I think we should.
So low pay may be a problem without any clear solution, for which most popular ‘solutions’ don’t actually work.
But there may be a fix that does work – a Negative Income Tax or a Basic Income. As I’ve written before these are actually very similar even though one is almost exclusively supported by right-wingers and the other almost exclusively by left-wingers. As ever in politics, we’re speaking different languages.
A Negative Income Tax is a form of income top-up that only looks at an individual’s income, not whether they are in work or not, and tops that income up automatically if they are earning less than a given amount. The extra money is withdrawn at a tapered rate, so that for every pound you earn from work, you lose (say) fifty pence in top-up, ensuring that workers always have a clear incentive to demand higher wages, and that work always pays more than joblessness for unemployed people.
This would replace lots of existing working age benefits, including Jobseekers’ Allowance, council tax relief, the Employment and Support Allowance and tax credits. You could probably implement a decent one without increasing total expenditure. The exact rates can be determined by running trials across the country.
A Negative Income Tax like this would almost certainly be a boon to people on low pay, and would avoid most of the problems that minimum wages and current welfare schemes face.
Indeed the main objection may simply be that it is redistributive. That’s where I break with many of my fellow libertarians – I want free markets because they make poor people’s lives better, and I am OK with redistribution if it’s done in a market-friendly way that makes poor people’s lives better too. If this sounds surprising, remember that this puts me in the same boat as Milton Friedman (who campaigned for a Negative Income Tax) and FA Hayek, and indeed in the same utilitarian philosophical camp as Ludwig von Mises.
I suspect low pay will continue to be a problem for many years, maybe becoming even worse as automation renders some people permanently unemployable. It is necessary but not sufficient to simply rebut other people's bad ideas.
In the Negative Income Tax we have a policy that can actually go a big way to solving the problem, and hopefully replace some of the harmful policies we have right now. Rhetorically, I think we free marketeers need more positive solutions to policy problems, and if we could get over our squeamishness about endorsing certain forms of 'good' redistribution, we may be able to surprise people into listening to and maybe even agreeing with us. If low pay is indeed the long-term problem that it seems to be, the Negative Income Tax’s time may finally have come.