How Minimum Wages May Raise Unemployment

Minimum wage laws have been in effect in the United States since 1938. The rate has changed nationally more than 20 times since then. But some feel the increases haven't been enough, leading to heated debates over whether or not federal and state governments should raise the minimum wage.

The minimum wage is the minimum amount employers are legally required to pay their employees. Advocates who push for increases say those who work minimum wage jobs just can't afford to keep up with the rising cost of living; many of whom are living below the poverty level.

But according to leading economists—including famed billionaire investor Warren Buffett—minimum wages can actually raise unemployment by giving employers less incentive to hire and more incentive to automate and outsource tasks that were previously performed by low-wage employees.

Higher mandated minimum wages also force businesses to raise prices to maintain desired profit margins. Higher prices can lead to less business, which means less revenue and, therefore, less money to hire and pay employees.

Minimum Wage Rates

The United States federal government set the national minimum wage rate at $7.25 per hour in July 2009. But many states have minimum wage rates that are much higher, with the national average hovering around $12 per hour.

For example, Washington, D.C. steadily raised its minimum wage incrementally each year, setting the rate at $15.20 per hour effective July 1, 2021. Some states have adopted laws that would raise their minimum wage to $15 by target dates including California, parts of New York State, Massachusetts (by 2023), New Jersey (by 2024), Rhode Island (by 2025), Delaware (by 2025), Illinois (by 2025), Florida (by 2026), and Virginia (by 2026). Several large U.S. cities, including Seattle and New York, have also responded by raising their local minimum wages to $15 per hour or higher. West Hollywood, CA has the highest minimum wage rate in the country, at $17.64 an hour. 

So if there's a discrepancy between the federal and state rates, how do employees get paid? According to the U.S. Department of Labor, employees receive the highest minimum rate in cases where they are subject to both state and federal wage laws.

One important point to note, though, is that minimum wage rates are slightly different for employees who receive tips. Employers are only required to pay these employees $2.13 per hour if that rate plus tips equals the $7.25 federal minimum wage. If their hourly earnings are less than the federal rate, the employer has to make up the difference.

The Push for a Higher Minimum Wage

There is no question just how tough it can be to make a living and support a family on a minimum-wage income. Compounding the issue is the fact that minimum wage increases have not kept pace with the cost of living since the 1960s. Relative to living costs, the value of the minimum wage in the United States peaked in 1968 and has been on a downward trend ever since.

Here's an example to demonstrate. Let's say single-father Adam works a minimum wage job in Tennessee. The state's minimum wage is the same as the federal rate: $7.25 an hour. Adam earns $290 working 40 hours each week, or $1,160 each month.

This figure, of course, doesn't factor in any taxes or deductions from Adam's paycheck. According to Payscale, the average rent for an apartment in Knoxville is $780.47 per month, while the average monthly utility bill is $150.06. After he's paid his rent and utilities, he has only $229 for food and other expenses. This doesn't leave him with much money to save or to spend on any emergencies.

Feeling the pinch of lowered real income, minimum wage employees and their advocates have gone to great lengths since the 2010s to raise awareness about the plight of low-wage workers.

How Companies Respond to Higher Minimum Wages

In a perfect world, a higher minimum wage would mean nothing more than the lowest-paid workers at fast-food restaurants, grocery stores, and so forth making $15 per hour instead of $7.25 per hour. Everything else about these companies' business models would remain the same.

Most economists agree that the world is imperfect and confounded by many other variables that are affected by a minimum wage increase. Most businesses set their budgets at least a year in advance, designating a fixed amount of money to wage expenses. Changes in business volume throughout the year can obviously necessitate on-the-fly adjustments to wage expenses. For the most part, companies have a set idea of how much they want to spend on hiring workers.

When forced to pay workers more per hour, companies have to hire fewer workers or assign the same number of workers fewer hours to keep from going over their predetermined wage expense limits. Many companies do just that or, when possible, they ship jobs overseas, where the per-hour expense of an employee is significantly lower.

Automation is another alternative that many companies turn to in order to avoid higher wage expenses. This is particularly true in large cities like Los Angeles and Seattle. Rather than giving their order to a live employee at the counter, fast-food customers input what they want into a computer, which also accepts payment and even deposits the paper sack full of food when it comes out of the kitchen.

Higher Wages, Higher Prices, Fewer Employees

One of the most important metrics for a business is margin; another word for profit. Margin is the difference between revenues and expenses, and any successful business has a target margin it tries to maintain.

When expenses increase, which happens when a higher mandated minimum wage pushes up a company's wage expense, revenues must also rise for the company to maintain its margin. Therefore, many businesses respond to higher wages by raising prices.

When the cost of a fast-food hamburger increases to cover higher wages, many customers respond by not buying hamburgers. After all, most people don't eat fast food because it's delicious, they eat it because it's cheap. When customers jump ship, companies struggle to stay in business. Many Seattle restaurants have folded since the city's $15 minimum wage went into effect. When that happens, those $15 per hour jobs disappear as quickly as they came.