California Raising Minimum Wage and the Economic Consequences

Once again California has thrust itself into the national spotlight as a leader in enacting the policy wish list of the American Left. This time, California’s legislature has voted to further raise the state’s minimum wage. California already has a minimum wage of $8 per hour ($.75 above the federal minimum wage) and the 5th highest unemployment rate in the nation.

The recently approved legislation would raise the minimum wage to $9 per hour in 2014 and again to $10 per hour by 2016. Although some cities and counties in California already have a local minimum wage of more than $10 per hour, this legislation will cement the California minimum wage as the highest in the nation.

Minimum wage rates will become the second economic figure in which California will achieve the infamous distinction of highest in the nation, along with the highest personal income tax rate (13.3 percent for top earners). In a state where high taxes and regulation already make for a tough business climate (47th in the most recent edition of Rich States, Poor States), the new wage rate just might push some business owners and would-be entrepreneurs over the edge and into other, more business-friendly states. This means fewer jobs and fewer opportunities for California’s neediest, the very people this effort was intended to help.

As California struggles to get its economy back on track, state leaders should take a page from the Hippocratic Oath’s “Do No Harm” principle and seriously evaluate whether the new policy will help or hurt Californians. Fortunately, one need not guess at the results of a minimum wage hike. It is well documented among economists that making something more expensive (in this case, labor) decreases the demand for that good (in this case, employment). In other words, if a state raises the cost that businesses must pay for labor, businesses will buy less of it and employment opportunities will decrease. Because unemployment generally increases as the minimum wage does, Rich States, Poor States, ALEC’s annual report on state economic competiveness, includes a state’s minimum wage as one of the 15 policy variables that has the largest effect on potential for future economic growth.

The negative effects of raising the minimum wage are particularly pronounced for two specific categories of people. The first being generally low-skilled or unskilled workers. As the below video illustrates, these workers have trouble finding jobs where the employer agrees to pay them this new artificially inflated wage and can still keep the business afloat. This is the same category of people that the minimum wage is designed to help and they are often the ones hurt the most.

The second category is on small businesses that cannot easily absorb the cost and whose primary expense is already operations, including workers’ salaries. Larger firms can more effectively pass increased costs on the consumers or invest in business capital that allows them to get more out of a smaller workforce. Smaller businesses, however, may have to resort to cutting hours of employees or be forced to lay them off altogether if their profit margin was already thin to start with. Worse still, they may be forced to shut their doors entirely due to their inability to compete given higher costs.

Additionally, raising minimum wage adversely affects businesses in lower income areas where businesses cannot pass on the higher cost of labor by raising the price of goods because their customers have less room in their budgets to adjust for this. Since the prices of their goods are difficult to raise, they are forced to make adjustments in other areas, such as employee hours. This causes the negative effects on employment to be more concentrated in already impoverished areas, disproportionately hurting low-income workers.

These economic facts are so well established that they used to simply be common knowledge. So much so, that the New York Times editorial page wrote an op-ed in 1987 called “The Right Minimum Wage: $0.00.” The core of the article’s argument is a sound economic principle that was (and still is in economic circles) accepted as a simple truth: “Raise the legal minimum price of labor above the productivity of the least skilled workers and fewer will be hired.” This fundamental truth has not changed in the 26 years since the editorial was published. Indeed, no amount of time can hope to change the responses that rational human beings will make when responding to clear economic incentives and disincentives

More specifically, the California Chapter of the National Federation of Independent Businesses (NFIB) projected the potential negative effects of raising minimum wage rates with the recently approved legislation. They estimated that it would shrink the California economy by $5.7 billion in the next ten years and result in as many as 68,000 jobs being cut from the state. They estimated further that 63 percent of the estimated 68,000 jobs lost would be from small businesses that could no longer afford to pay their employees. In addition to the NFIB report, the California State Chamber of Commerce called the bill a “job killer,” and the California Restaurant Association called the measure “a blow to small business.” Years of economic data show that they are indeed correct.

Further, a new study from economists at Texas A&M University reveals that the worst cost of raising minimum wages doesn’t come from a decrease in current employment but actually is a decrease in future employment. The study finds that because labor is more expensive, businesses have a rising incentive to invest in labor-saving technology over hiring low-skilled workers. Therefore, the real effect of raising the minimum wage should be measured not only in an uptick in unemployment figures but lackluster overall job growth over time compared to what it could have been.

These dire predictions do not bode well for the already struggling California economy. The state’s unfunded pension liability is estimated to be as high as $640 billion. Pushing more business out of the state and citizens into unemployment will lower tax revenue, swelling the states already deep budget crisis. Small businesses in California that file taxes through the personal income tax code (pass-through entities) face the highest state-level personal income tax rate in the nation (13.3 percent); combined with the top federal rate and other taxes, their total tax liability can be as high as 51.8 percent for sole proprietorships or 48.8 percent for S-Corporations. Large businesses in California face strict environmental restrictions and must pay the U.S. corporate income tax rate of almost 40 percent (in addition to the state corporate income and property taxes), the highest in the world since Japan lowered their corporate income tax.

All of these obstacles to economic growth have had the unsurprising result of draining human capital out California and into the open arms of Texas, Nevada, and Arizona; all states with lower taxes on investment, work, and capital. Over the past ten years, California, the state that has beaches, mountains, and a delightful climate, has lost over 1.5 million taxpayers on net. The drain of human capital out of California resulted in 2010 becoming first census since California achieved statehood in which it did not gain a single congressional seat. Texas, on the other hand, gained four congressional seats in 2010.

Unfortunately for California’s residents, raising the minimum wage simply will not help those they wish to help. Wages for some will indeed go up, but this will be at the cost of making the wages for many others $0 per hour from the inability to find work. Achieving real economic growth and expanding economic opportunity for all citizens is the best way to lift people out of poverty and into a thriving middle class.

As the New York Times editorial board concluded, “The idea of using a minimum wage to overcome poverty is old, honorable – and fundamentally flawed. It’s time to put this hoary debate behind us, and find a better way to improve the lives of people who work very hard for very little.” Perhaps that better way is growing the economic pie for everyone rather than making it more difficult for businesses to hire employees and for workers to find employment in the first place.

In Depth: Cronyism

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