Tuesday, 11 February 2025

Minimum wage increases and employer noncompliance

As noted in yesterday's post, one of the ways that employers may respond to an increase in the minimum wage is to increase noncompliance (by paying a wage that is below the new, higher, minimum wage). Is there evidence for employers changing their behaviour on that margin? 

This 2022 article by Jeffrey Clemens (University of California at San Diego) and Michael Strain (American Enterprise Institute), published in the journal Labour Economics (open access), provides some evidence. They look at wage data from the Current Population Survey, where:

The first key piece of information is an indicator for whether respondents are paid on an hourly basis. When they are, respondents are asked for their hourly wage rates. When they are not, hourly wage rates can be inferred by dividing an individual’s usual weekly earnings by his or her usual weekly hours.

Using this survey data, Clemens and Strain are able to determine whether the hourly wage rate for each person in the survey is below the minimum wage in their state, suggesting that their employer was noncompliant with the minimum wage. To avoid overstating the amount of noncompliance, they only consider noncompliance in the case where the wage is more than 25 cents per hour below the minimum. 

Now, because of the potential for measurement error and other biases, the absolute level of noncompliance is not instructive. Instead, Clemens and Strain look at the changes in noncompliance when the minimum wage rate changes. They distinguish between large minimum wage rate changes (more than US$1), small minimum wage rate changes (less than US$1), and indexed rates (that change annually in step with inflation). Focusing their main analyses on workers aged 16 to 25 (who are most likely to be affected by changes in the minimum wage), they find that:

...a one-dollar increase in the minimum wage predicts, on average, a wage gain of 29 cents and a 3.6 cent increase in underpayment... On average across the country, we estimate that each dollar of minimum wage increase would, if applied nationally, have generated an increase in subminimum wage payment of roughly $1.16 billion and an increase in realized wage gains, among the employed, of roughly $6.86 billion. Our results thus suggest that compliance with the minimum wage is the norm, but that avoidance and evasion are nontrivial.

Comparing the different types of minimum wage rate change, Clemens and Strain find that there are:

...far larger increases in subminimum payment following increases that were enacted through new legislation than following increases that came about due to pre-existing laws that call for annual, inflation-indexed updates to states’ minimum wages.

In other words, when minimum wage rate changes are small and expected and can be planned for (as indexed minimum wage rate changes are), then noncompliance is low. However, when minimum wage rate changes are unexpected, and especially if they are unexpected and large, there are significant increases in noncompliance.

Finally, Clemens and Strain look at the effect of enforcement regimes, and find that:

...increases in the minimum wage predict larger increases in the prevalence of subminimum wage payment under strong enforcement regimes than under weak enforcement regimes.

This is quite a counter-intuitive result, which they explain in relation to models of enforcement, where:

...strong enforcement regimes encourage reporting and compliance when the minimum wage is low, such that enforcement is in the worker’s interest. If the minimum wage rises beyond the level an employer would be willing or able to pay, however, enforcement may cease to be in the worker’s interest. As the minimum wage crosses this threshold, reductions in compliance will tend to be larger under strong enforcement regimes because these were precisely the regimes in which workers had an incentive to report noncompliance at baseline.

So, states get higher noncompliance in strong enforcement states because higher minimum wages turn those states into weak enforcement states. In contrast, noncompliance is already higher in weak enforcement states and enforcement there cannot get weaker. I'm not sure that I find this argument convincing, as the way that the enforcement regimes (strong or weak) are defined in the data is not related to workers' actions, but to the penalties that minimum wage violators face, and the authority of enforcement agencies. These aspects would not necessarily be affected by the change in the minimum wage rate.

Aside from that, Clemens and Strain are very careful in presenting various robustness checks based on different samples of workers, and different types of models (as you would expect, if you read the article by Clemens that I referred to in yesterday's post). They are also quite worried by the potential for measurement error in wages (arising from people misreporting their wage, or their hours worked), but their additional analyses suggest that measurement error is not likely to be driving their results.

What we can take away from this article is that, again, employment is not the only margin along which employers adjust to a higher minimum wage. Some (not all) employers may respond by not complying with the higher minimum wage, leaving their workers working for a lower wage (but still working, at least). If the increase in noncompliance is large, then that would reduce any negative employment impacts of a higher minimum wage.

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