Real Action to Reduce Unemployment: Abolishing Minimum Wages and Suspending Payroll Taxes

Americans’ top concerns these days are unemployment, deficits and debt.  The rate of unemployment seems stuck at a level economically and ethically unacceptable, and efforts to bring it down appear ineffective and extremely expensive, especially in the context of runaway deficits and debt.  It’s time to re-evaluate government policies.  A good place to start is minimum-wage laws, with payroll taxes a logical second.  Alone, wage floors create more problems than they solve, and all of these unintended consequences are compounded by the extra burden of payroll taxes, which raise employer costs even further while also reducing employee take-home pay.

MINIMUM WAGES
In May of 2007, during the Bush 43 Administration, Congress passed legislation that raised America’s hourly minimum wage in three stages from $5.15 to $7.25 – an increase of 41% in slightly over two years. The stated purpose of minimum-wage requirements is laudable: it’s to give every worker a living wage.

“How nice,” good-hearted readers may respond; “it’s hard enough to get by on $7.25 an hour, but making due with $5.15 is nearly impossible these days.  And imagine trying to feed yourself, much less clothe and shelter yourself, if some fat-cat boss could get away with paying you even less!”  They’re right.  And low-skilled individuals who keep their jobs are decidedly better off with the higher minimum wages.

The problem is the unintended consequences.  Not everyone gets to keep his or her job when the rules change.  Because the government cannot force private enterprises to hire new workers or continue employing existing labor when the cost of doing so goes up, raising the minimum wage prices people with unexceptional skills out of the market.  For all their good intentions, minimum wages accordingly create more unemployment and more poverty for society as a whole.

The third increase in the minimal wage, the one that raised the rate from $6.55 to $7.25, took effect in July of 2009.  The timing was terrible.  In the midst of high and rising unemployment, and halfway through a year where cost-of-living indices actually declined, we made old jobs and new hires even less affordable to companies that were already losing sales and cutting back their workforces.

It’s much harder to get by with $0.00 an hour than with a market-determined wage.  But the consequences for the future may be even worse than the poverty of the present. When the starting wage gets too high, not only do some workers get laid off, but others can’t even join the workforce in the first place.  Their entry-level job skills simply aren’t worth $7.25/hour.  Educating one’s way out of poverty occurs just as much in the office as it does in the classroom.  When people fail to find employment, they don’t just lose wage income today, they also lose the on-the-job training that makes future advancement to better jobs possible – all this on top of the destructive effect unemployment has on existing skills and attitude.

This problem is particularly acute for individuals seeking their first jobs. The Wall Street Journal’s lead editorial on March 5 is entitled “The Lost Wages of Youth” and has some stern and startling unemployment statistics for teenagers in general and teenagers of color in particular. The situation is so bad that the Journal condemns in no uncertain terms going through with last summer’s last step in 2007’s three-stage wage legislation:

To raise the cost of unskilled labor precisely when the jobless rate is heading towards 10% is an act of almost willful economic stupidity.  A Congress that has spent $862 billion to create jobs thus managed to harm tens of thousands of entry-level job seekers.  And it did so in the name of “compassion” and a “living wage.”

The WSJ could have said much more.  Because it’s a national standard, the wage floor is even more destructive for teenagers in parts of the country with low costs of living than the averages indicate for the United States as a whole.  Teenagers living in rural Mississippi, for example, have a much harder time finding employment when the starting wage is $7.25 than their counterparts in Anchorage, Alaska, where the cost of living is so high that the minimum wage may be below market rates and therefore irrelevant.  Mississippi itself suffers even more than loss of employment and associated production.  It also loses some of the competitive advantage it would otherwise gain from lower labor costs.  In a sense, minimum-wage legislation is a subsidy to the pricier states and cities in our nation.

PAYROLL TAXES
The Wall Street Journal also could have, and should have, extended its critique to payroll taxes and the disincentives they add to an already ugly picture of market distortion and unintended consequences.  The omission is surprising for a newspaper of its conservative nature and caliber.  Each of the five taxes has a raison  d’etre, but none of the benefits at this time is worth the associated costs.

All wages up to a ceiling of $106,800 are taxed to “fund” Social Security and Medicare.  The idea is to “smooth” consumption and make people “save” for the days when they’re too old or too sick to work.  But the revenues are not in fact saved, and they aggravate unemployment and poverty issues.

Employers pay half these payroll taxes themselves and withhold the other half from the checks they cut for their employees’ take-home pay.  When markets set wages, it’s highly likely that companies shift some of their payroll-tax burden to their employees by reducing their pre-tax wages.  When workers are paid minimum wage, none of this shifting is possible.  While shifting at first glance seems morally opprobrious, it’s a heckuva lot less heinous than firing.

Social Security payroll tax rates are currently 6.2% for both employer and employee, and Medicare adds another 1.45% to both sides.  The $106,800 ceiling is irrelevant for minimum-wage workers, and there’s no exemption for low incomes.  The result is to increase employers’ hourly-wage cost for each of their lowest-skilled workers to more than $7.80, while reducing take-home pay initially to less than $6.70.

Fortunately, low-paid employees with a certain savvy can file an Earned Income Credit (EIC) form with the IRS and, depending on their income and number of dependents, restore part, if not most, all or even more than all, of their gross earned income.  (Sometimes they can even get more money from the government than was withheld from their paychecks.)  Unfortunately, there’s no such program to reduce taxes on the employers’ side, where heightened labor costs continue to cause layoffs and deter job creation.

Add to this business burden Workmen’s Comp taxes, paid by employers, with rates based on how many previously employed workers have filed for injury claims. Keep going with Federal and State Unemployment Tax Acts (FUTA and SUTA).  FUTA levies another 6.2% employer tax on the first $7000 each employee earned. Although much of this “unemployment insurance funding” can be offset by a refund if paid in a timely fashion, it still remains regressive because of the salary ceilings. And isn’t it ironic in all times, but particularly these, that companies creating  and maintaining employment are also penalized through payroll taxes that make them fund unemployment programs?

Could there be more obvious deterrents to new hires in precarious economic times than the chaotic array of legislation we’ve now discussed?  Actually, yes: continuing to make health insurance a required, regressive, and tax-subsidized perk of employment for businesses over a certain size.  But that’s step three in addressing economic reforms to reduce unemployment, deficits and debt, and the purview of another piece.

CONCLUSION
Minimum-wage legislation is an abomination for society as a whole.  While it benefits some low-skilled workers, it does so at the expense of the even more vulnerable, whose poverty it only deepens.  Minimum wages should be abolished.

Five different payroll taxes add to the damage.  They further discourage employment, and for some workers they also take away sizeable chunks of incomes that are already perilously low.  The good-hearted readers who – at least initially – applauded the concept of the “living wage” as achieved through minimum-wage legislation should now rise up in outrage over policies that take money back from those who keep their jobs but either don’t qualify for full refunds through EIC or don’t know enough to file.  Payroll taxes should be suspended for both sides, at all wage levels, at least while unemployment rates are so high.

The goals for all six of these wage and tax policies are admirable.  But the best of intentions often create the worst of programs.  They do so because of unintended consequences.  They do so because we cannot overturn the laws of economics, we can only work with them.

The best way to help poor people is to help them help themselves.  We should reform formal education so that everyone can read, write, and think.  We should encourage employment not only for the earned income but for the on-the-job education that leads to better jobs.  And we should ease the transition to a living wage.  For those of us who believe in the ability of poor people to make decisions on their own and to learn from their mistakes, the best transitional tool is the negative income tax.  For those of us who prefer to protect them and guide their choices,  vouchers are the way to go.  Minimum wages and payroll taxes are getting in the way for both sides.

The problem that holds back reform is that we must also work with the laws of politics.  Unions, for example, love minimum wages: they keep some nonunion labor competition at bay.  And the majority of politicians in power today – the Democrats — are deeply indebted to unions.  How else to explain the government bailout-takeovers of Chrysler and General Motors?

If there is ever a time when we can overcome the political power of vested interests and eliminate minimum-wage laws and suspend payroll taxes, that time is now. Rates of unemployment that all of us find ethically and economically unacceptable demand solutions, and alternative approaches are not working well. A lot of the “stimulus” programs have yet to be implemented, well over a year into recession.  For those that have, it looks as if each job “saved” has cost six-figure sums of added deficits.  These results are appalling at all times, but particularly when soaring deficits and debt undermine confidence and credit ratings.

Eliminating minimum-wage laws is fast and free.  Suspending payroll taxes is a quicker, more equitable, and arguably much cheaper approach to reducing unemployment than the government spending the Administration has endorsed and pursued so far.  And let’s be clear: EIC has already nullified, reduced or reversed half of the biggest payroll taxes — those associated with Social Security and Medicare — for many with low income.  Let’s give the same break to businesses for all of the payroll taxes they pay.  Suspension would have to be fairly long term to generate results, and it also provides an opening wedge to eliminating these highly regressive taxes altogether.

For a man who admires speed, pledges fiscal sobriety, and talks the populist line as much as President Obama now does, the obstacles to these suggested reform are political, not economic. Each government program, whether it be taxing, spending or regulating, creates its own protective constituency. If our President can bring to Washington the change we once believed in, we can emerge from recession in better – stronger, more equitable – shape than ever before.  The time to act, Mr. President, is now.