Congressional Budget Office

Americans need more than a minimum wage hike

February 25, 2014: 10:23 AM ET

Paying workers more could lift nearly 1 million out of poverty, but low-skilled workers need more than that to thrive in today's job market.

By Isabel Sawhill

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FORTUNE -- Over the years, economists have produced countless studies either supporting or disputing the wisdom of raising the minimum wage. And last week's report by the non-partisan Congressional Budget Office added to the growing body of research: An increase from $7.25 to $10.10 an hour, phased over three years, would cost the nation 500,000 jobs, according to the CBO. However, it would also lift almost 1 million people out of poverty and increase earnings for 16.5 million people.

The trade-offs are clear. There is no free lunch, but this lunch is pretty cheap. The ratio of winners to losers is high; whatever the effects on jobs, they are likely to be small. Studies of retailers don't find adverse effects on employment for those operating in states with higher minimum wages.

Most people learned this lesson when they took Economics 101. If you raise the price of labor, demand will drop. But the real world is a bit more complex than that: For one, employers may respond not by laying off, or failing to hire lower-skilled workers, but instead alter the way they do business, such as raise prices on whatever goods and services they provide or change the mix of higher to lower paid workers or automate tasks.

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Raising the minimum wage could also encourage workers to work harder and stay on the job longer. Businesses with a reputation for treating their workers well tend to attract good employees and retain them longer. That's why some retailers, such as Costco (COST), already pay more than the minimum and why even Wal-Mart (WMT) is considering supporting a higher minimum wage. If any one firm raises its wages, and passes this along to consumers in the form of higher prices, it may lose business to its competitors. But if all businesses are required to meet a new standard, this can't happen -- although competition from abroad can still be an issue.

Although a modestly higher minimum wage will help a lot of people at very low costs, it's only a temporary solution to our problems at best. We also need to focus on how low-skilled workers cope in today's labor force. At the current minimum wage, a single mother with two kids working full-time earns less than $15,000 a year. With wages this low, she may choose not to work at all, getting by instead on public benefits or help from friends and relatives. That costs taxpayers for such things as welfare, Food Stamps, and housing assistance -- not to mention a loss of payroll taxes on her earnings.

Over the longer-term, there are two possible solutions: One is to slash the safety net, thereby forcing people to work more. The other is to improve their productivity so that they are "worth," say, $10 an hour.

Reforming the vast array of existing anti-poverty programs is a challenge. I am somewhat attracted to Florida Republican Sen. Marco Rubio's proposals to transfer money used to fund existing programs to a "flex fund" for the states, and replace the earned income tax credit with a wage subsidy. He has added that he would maintain spending for such programs at current levels initially and then increase spending if needed to keep up with inflation or the growth of the poverty population. Wage subsidy programs, like the earned income tax credit, have increased employment, and sending money to the states would enable them to experiment with policies that are tailored to local needs.

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More importantly, the fact that there are people who are not worth even $10 an hour to an employer is an indictment of our education and training system and a reflection that there are a lot of people in America who have serious employment problems from low levels of literacy to mental health issues or prison records. Employers may not want to hire them at any wage and are unlikely to be influenced very much by a modest change in the minimum wage. An affluent society should, in my view, provide them with a temporary safety net or other kinds of help while working harder to improve their competencies and self-sufficiency over time. We have to choose between being a society of low-productivity, low-wage workers or a society of high-productivity, high-wage workers.

A higher minimum wage might just nudge us in the latter direction, but it would be a pyrrhic victory if it allowed us to ignore the essentials: the need for a better educated and trained workforce capable of adding real value to the economy's output.

Isabel Sawhill is a Senior Fellow in Economic Studies at The Brookings Institution.

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