The Minimum Wage is a Regressive Tax

In "The Minimum Wage is a Targeted Tax, Some Win, Some Lose" we learned that the minimum wage could be analyzed as an employer tax.  In this post we learn that that tax is a very regressive tax.

A regressive tax is a tax paid by the poor at higher rates than the more wealthy.  It can also be seen as a tax that impacts the poor much more than the rich.  The minimum wage tax fits both definitions of regressive.

Increases in the minimum wage receive considerable support from the notion that employers deliberately underpay workers if they can get away with it.  The minimum wage would prevent that, or at least that is the assumption.

It is not surprising that workers earning less that the proposed wage would welcome the increase, not suspecting that they might actually lose their job should the increase occur.

To see that the minimum wage is a regressive tax, again assume that government places a tax on all wages below $20 per hour.  All wages above $20 per hour are not taxed; all wages below $20 per hour are taxed at a rate equal to $20 less the actual wage rate.  The less paid, the higher the tax rate.  This situation clearly meets the first test of a regressive tax, the tax increases as the wealth (wage) decreases.

The minimum wage tax also impacts the poor much more than the rich, meeting the second definition of a regressive tax.  The less able persons in society are the younger people, the less trained people, the less talented people, the very aged people.  Each of these groups is likely to be unable to command a high wage by ability to perform well in the work place.  Each of these groups is more likely to be receiving less than the proposed $20 minimum wage, with the least fortunate being most likely to be in this sub-minimum wage group.

Some readers will protest at this point that the minimum wage workers will get the tax, so they will really be winners!  Yes, the government can collect the tax from employers and immediately give it to workers.  Government can also require that the tax be paid immediately to workers in their pay check.  Both methods of returning the tax to employees are identical in the calculation made by the employer deciding to create a job or not.

By placing a tax on all wages below $20 per hour, government has decided that employers should be penalized for assigning such low value tasks to workers. Government has decided that tasks worth less than $20 per hour should not be done, with the exception that if employers DO decide to perform such a low value task, the employer will be penalized by the difference between actual wage and $20.

Clearly, with the minimum wage, government is setting an economic standard. Each change of the minimum wage is a shift between two standards.  The economy can be expected to adjust to each standard as time passes.  Those within the economy best able to adjust will prosper, those least able to adjust will fall behind.

As the minimum wage increases, the least able will fall increasingly behind.

The Minimum Wage is a Targeted Tax, Some Win, Some Lose.

The minimum wage can be considered as a direct tax on specific employers.  Here is the logic that supports this conclusion:

There is no doubt that government can tax employers based on criteria selected by government.  Assume that government claims a tax based on wages paid under a target wage.  Assume the target wage is $20 per hour.  An employer paying $14 per hour would calculate his tax by recording the hours worked at $14 per hour and multiply that number by $20 less $14  equals $6.

For example, if the employer had 2040 hours worked at $14 per hour, his tax would be 2040 * 6 = $12,240.  Government would get a check for $12,240, and could spend the money for purposes of government.

Now, the purpose of government could be to ensure every worker receives $20 per hour.  To that end, government could directly refund the entire tax collected to every worker who filed an income tax return.  The program could be called "The Fair Wage Recovery Program", and could be administered by issuing a refund to each worker equal to the claimed (and supported) wage deficit.

The purposes of government could be alternatively achieved by requiring all employers pay wages at the $20 per hour rate or higher.  This method would bypass the refund claim process.  Left unchanged would be some procedure to monitor employer paying practice and taxation verification.

It is safe to assume that the employer works for gain, with the expected gain to be an after-tax profit.  Periodically, the employer would make a decision as to whether continue business or discontinue business.  The size of the after-tax profit would be a major consideration in that decision.

Every employer would face the same decision of whether to continue business or not.  In every case, the after-tax profit is a major consideration.  With a uniform tax on labor for wages under $20 per hour, the labor component of every business could be calculated as if it were at least $20 per hour, with some business paying more if they could support the higher numbers.

One question often asked is the effect of the minimum wage on employment.  It should be safe to say that over a long time period of unchanged wage minimum, a steady pattern should evolve.  The minimum wage would become a standard yardstick for evaluating the cost effectiveness of laboring effort.  Jobs returning less than minimum wage would be a drain on the capital of the employer.

The economic effect immediately after implementation would reflect the shock impact of a sudden increase in wage.  Sudden price changes must be expected. Employers would require more capital to operate when the same number of employees generate an increased tax burden.  Employees-continuing-to-work would have increased income allowing them to change their spending patterns.  To the extent that workers actually receive more average income, everyone would see increased competition for consumptive goods, which might result in higher prices and higher employment.  Higher prices and increased competition for consumptive goods would be noticeably negative for retired people on fixed income.

The measurable short run effect would be a balance of the forces identified above and more.  Each effect would act over a different time frame with the result that employment is likely to become unstable during an adjustment period.  Following the adjustment period, employment should return to the original distribution that existed prior to the minimum wage change.

The change in minimum wage, when considered as a tax, can be seen as a shift in standards. Shifts-in-standards are particularly difficult for people who lived, worked, and saved under one standard, only to find that new standards have been put into place as they retire, much to their disadvantage.

In this analysis, changes such as the minimum wage change are seen as a shift between two economically referenced plateaus, each with stable characteristics.  The final winners and losers are found by locating participants within age groups, with each winner being able to adjust to the new conditions and each loser being unable to adjust advantageously to the new conditions.

The National Income Balance

In this post, Dissecting Money will build the equation used to calculate a nation's GDP. 

 GDP is the simple sum of all measured components of all participants in the economy.

GDP can be calculated from two perspectives, spending and income.  These two perspectives can be considered as evaluating two economic participants, or,  as establishing the income and expenditures of a single participant as might be found on a financial balance sheet. 

The balanced version of the equation is

(0)   C + I + G + (X – M) = C + S + T

Where C represents Consumption, I is Investment, G is Government expenditures, X is eXports,  M is iMports, S is Savings and T is Taxes (government revenue).  These terms will be used consistently throughout this post.

Equation 0 is known as the National Income Identity or sometimes as the National Income Balance.  The idea here is that the left side of the equation is expenditures and the right side is how the expenditures are redeployed by recipients.  The two sides are equal but each side describes a different mix of distribution.

We would like to build Equation 0 from the ground up.  We can begin by assuming that spending upon consumption is received by the consumption supplier who immediately redeploys the money  As a receiver of money, the supplier will consume and probably save some of the money.   We could write the resulting equation as

(1)      C = CS + S

where CS is secondary consumer spending..  Equation 1 has the defined assumption that the left hand spender is NOT the right hand spender.  

We may wish to consider only ONE participant.  If we consider that all spenders must first receive income, then we can reduce the number of participants from two to one.  We can consider the participant as an accounting unit with income and expenses carefully recorded.  Equation 1 would still apply to the one participant situation.

After studying Equation 1 for a while, we might consider that savings would be spent at some time.  In fact, the spending of the left side of Equation 1 could all come from previous savings.  More importantly, consumers are not considered as having the ability to create money.  As a result, all consumer spending MUST come from previous savings unless earned and then re-spent within the measurement period.  

With this limitation on money creation in mind, we would abandon Equation 1 and substitute

(2)    C + I = C + S

where consumption is identical on both sides of the equation.  Equation 2 makes clear that Investment is equal to Savings.  Unfortunately, the building of Equation 2 highlights a strange problem.

Consumers can not create money so all money spent upon savings must first be saved!  The simple logic of savings as the result of deferred consumption found in Equation 1 has been replaced in Equation 2 with the logic that all savings must first exist and will always be equal to investment!  Where might the money identified as Savings (and Investment) come from?

There is a second logical difference between Equations 1 and 2.  Equation 1 is a flow equation and Equation 2 is an accounting equation.  We would evaluate the terms in Equation 2 by simply counting each savings and consumption event within a measurement period.  Equation 2 has no information as to the source of money used in the transactions.

Bank loans as a money source can be considered at this point in the discussion.  Bank loans result in bank deposits held by third parties.  As a result, every loan can be considered as an Investment by the bank and Savings by the current third party holder of the dynamic deposit. Bank loans will result in both sides of Equation 2 increasing equally.

After studying equation 2 for a while, we might want to split consumption between private and government.  We could then add government spending (G) on the left side and government receipts (T) on the right side to get

(3)    C + I + G = C + S + T

We can re-arrange and simplify equation 3 to read

(4)    S = I + G - T

Notice that G - T is the government deficit.  We therefore see that S = I + government deficit.

We can also re-arrange equation 3 to read

(5)    I = S + T - G = S - (G - T)

Equation 5 is confusing because a deficit is shown as a negative investment.  The confusion is mitigated with the observation that S is increased by the amount of the deficit. A government deficit is considered as if it was an Investment.

From Equation 4, we see that a government deficit has increased Savings which is the identical effect we previously attributed to bank loans.  Economist usually consider increases in Savings as an increase in money supply.  The exact definition of money supply remains a controversial subject.

After studying Equation 3 for a while, we might want to add the export sector.  We can do this by writing

(6)   C + I + G + (X - M) = C + S + T

which is the beginning Equation 0.