Advocates for the living wage tend to ignore that workers that currently receive the minimum wage also receive a lot of other government support, in the form of various rebates and subsidies, that they may not be eligible for if they earned a lot more. That means that increasing the minimum wage to the living wage would not necessarily lead to gains in net earnings that are as high as those advocates expect.
A worked example, based on U.S. data, is provided in this article by Craig Richardson. Here is the key figure:
Increasing the hourly wage from US$7.25 per hour to US$15 per hour would net a full-time worker only US$198.94, after accounting for all of the social benefits they would lose, and the additional taxes they would pay. Richardson writes:
There are some uncomfortable truths about raising the minimum wage from its current level of $7.25 per hour to $15 per hour that are revealed by an online tool created by our Center for the Study of Economic Mobility (CSEM) at Winston-Salem State University, along with our local research partner Forsyth Futures.
The tool, which we call the Social Benefits Calculator, enables anyone to go online and experience for themselves what it is like to be receiving social benefits and experience a monthly wage increase. Designed for Forsyth County, the calculator shows that with more than a 100% rise in the minimum wage, many people who currently receive social benefits will barely experience a change in their standard of living...
Let’s use the calculator and create a hypothetical example: a full-time working parent earning the minimum wage, who is unmarried with two children in subsidized day care. As seen in Table 1, after his or her wages more than double from $7.25 an hour to $15 an hour, earnings rise from $1,160 to $2,400, or a $1,240 change.
Sounds good, right? That’s an enormous bump up of wages by 106%. But after subtracting the decrease in benefits and higher taxes, that $1,240 increase erodes to just a $199 net improvement, or just a 16% change.
Imagine getting a big raise and seeing 84% of it go away.
The effective marginal tax rate (EMTR) is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements. Taking the example of the table above, increasing the worker's wage from US$7.25 per hour to US$15 per hour increases their monthly before-tax-and-transfers income from $1160 to $2400. In other words, their income increases by $1240. With that higher income, they pay more federal and state taxes. Their monthly tax payments increase from $88.74 to $314.70. In other words, they pay an additional $225.96. The marginal tax rate over that interval is 18.2% (calculated as [225.96 / 1240]). But wait! Their entitlement to social benefits decreases from $3110.10 to $2295 monthly. In other words, they lose $815.10 in entitlements, as well as the additional taxes they pay. So, their effective marginal tax rate over the interval is 84.0% (calculated as [(225.96 + 815.10) / 1240]).
EMTRs are something that policy makers should keep a close eye on. When the EMTR gets too high, it can create some perverse outcomes. In some cases, workers could actually be financially better off by working less (this happens whenever the EMTR exceeds 100%). The problem is that every program has its own eligibility rules and thresholds, and keeping track of how the interaction between all of those works is incredibly difficult. You can try out the Social Benefits Calculator tool mentioned in the article here (it is based on data for Forsyth County, North Carolina). We really need a similar calculator for New Zealand.
[HT: Marginal Revolution]
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