Wage growth - or a persistent lack thereof - has become something of a hot topic in America.
Thanks to the nationwide push for a higher pay floor (personified by mobs of angry fry cooks demanding $15/hour and Democrats on Capitol Hill who are pushing hard for "$12 by ‘20") and wage growth’s role as an input in Janet Yellen’s mental "liftoff" model, everyone from Main Street to Wall Street feels compelled to weigh in.
The standard criticism of hiking the minimum wage is that forcing employers to pay more will simply result in layoffs and/or a reduced propensity to hire, but as we saw with Dan Price and Gravity Payments, there are a whole lot of other things that can go wrong. For instance, higher paid employees may not understand why everyone under them in the corporate structure suddenly makes more money and if people who are higher up on the corporate ladder don’t receive raises that keep the hierarchy proportional they may simply quit.
But while politicians, pundits, and economists run in circles perpetuating a debate that’s better suited for an undergrad introductory economics course than it is for the national stage (it’s really quite simple, as New York Burger King franchisee David Sutz made clear when he told CBS that "businesses are not going to pay $15 dollars an hour [because] the economics don't work in this industry [given that] there is a limit to what you're going to pay for a hamburger"), there’s a far more troubling situation unfolding behind the scenes and it harkens back to an issue we discussed at length almost three years ago.
In short, the welfare system punishes work and incentivizes dependency. More concretely, the structure is such that rational actors will eschew hard work, because the more they earn, the poorer they will effectively be in terms of total resources (calculated as welfare benefits plus earnings).
In the simplest possible terms: for many Americans, wage growth is a very, very bad thing.
We encourage readers to go back and read "When Work Is Punished: The Tragedy Of America's Welfare State," and not only because it serves as a helpful primer, but because it also underscores the degree to which exactly nothing has changed in the 30 or so months since it was written. At issue is the so-called "welfare cliff" beyond which families will literally become poorer the higher their wages, as the drop off in entitlements more than offsets the increase in earnings.
A study by the Illinois Policy Institute shows just how dramatic the effect of "falling off the cliff" (so to speak) can be. In one of the most startling findings for instance, if a single mother raising two children were to accept a pay raise from $12 to $18 per hour, her total resources would fall by nearly 33%. Here's more:
For single-and two-parent households in Illinois, there is a significant welfare "cliff" where the household may become worse off financially as they work more hours or as their wages increase. That is because the available welfare benefits decline by a greater amount than the increase in earned income.
This study analyzed a potential welfare benefits package for single- and two-parent households, both with two young children, in Cook, Lake and St. Clair counties. The potential means-tested benefits included tax credits, cash assistance, food assistance, housing assistance, child-care subsidies and health care.
The study’s findings for Cook County include:
- A wide range of benefits provides a large magnitude of support. The potential sum of welfare benefits can reach $47,894 annually for single-parent households and $41,237 for two-parent households. Welfare benefits will be available to some households earning as much as $74,880 annually.
- Welfare cliffs are significant and can trap families. A single mom has the most resources available to her family when she works full time at a wage of $8.25 to $12 an hour. Disturbingly, taking a pay increase to $18 an hour can leave her with about one-third fewer total resources (net income and government benefits). In order to make work "pay" again, she would need an hourly wage of $38 to mitigate the impact of lost benefits and higher taxes.
- The system is inequitable. A minimum wage increase to $10 an hour would push a household where both parents work for minimum wage over the welfare cliff. They would suffer a net loss in household resources of about $9,000 as reduced government benefits more than cancel out the higher wages.
As bad as this sounds on paper, it's even more stunning visually. The following graphic for Cook County shows just how financially destructive it can be for low-paid workers to try and break free of their dependence on the public purse:
There are several things to note here. First, as mentioned above, for a single mother of two, going from $12/hour to $18/hour would be a disaster, economically speaking. Her total resources (net income plus benefits) would collapse $24,840 from a peak of $63,597 to just $38,757. But perhaps the most distrubing part of the entire equation is that in this case, the single parent would have to make $38/hour before "recovering" from the welfare cliff.
And this isn't confined to Cook County:
In all cases, net earned income and welfare benefits climb quickly from no income through part-time work at minimum wage until full-time at minimum wage ($8.25 per hour). Net earned income and benefits then plateau until a peak of $12 per hour, which is only slight greater — and probably unnoticeable — than at minimum wage. Thereafter, net earned income and benefits begin to decline until they reach a trough at $18 per hour. The drop from peak to trough is highly significant, reducing disposable income resources by more than one-third. Table 6 provides the values for each locality for the drop. For Cook County, net earned income and benefits drop $24,840, from a peak of $63,597 to a trough of $38,757. The values are nearly identical for the city of Chicago: a drop of $24,830 from a peak of $63,586 to a trough of $38,757. Although the values are lower for Lake County and St. Clair County, the drop is relatively the same, i.e., more than one-third. For Lake County, the drop is $23,396, from a peak of $61,655 to a trough of $38,259. For St Clair County, the drop is $19,408, from a peak of $58,473 to a trough of $39,065.
For Cook County and the city of Chicago, the parent would have to earn $38 per hour before she would make up for loss of benefits when she earned only $12 per hour.
In other words: in Illinois, a rising minimum wage is actually negative (and severely so) unless it's hiked enough to make total compensation around $80,000!
For the purpose of simplification, here is a generalized illustration of welfare cliff dynamic:
The full report is below and you're encouraged to have a look as it goes into quite a bit of detail on the perverse incentives that emanate from the current system. For our part, we'll close with what we said on the subject in November of 2012:
We realize that this is a painful topic in a country in which the issue of welfare benefits and cutting (or not) the spending side of the fiscal cliff have become the two most sensitive social topics. Alas, none of that changes the matrix of incentives for Americans who find themselves facing a comparable dilemma: either remain on the left side of minimum US wage and rely on benefits, or move to the right side at far greater personal investment of work, and energy, and... have the same (or much lower) disposable income at the end of the day.