The Other Side of $15 Per Hour

Over the past weekend I was traveling when two separate incidents caught my eye and made me start to think about the current push for $15 per hour federal minimum wage. The first was a visit to McDonald’s (my first in 20 years!) I visited a McDonald’s in Columbus, OH and found only a handful of employees working along side a phalanx of automated order machines. The other was an article showing that Bernie Sanders own campaign staffers were making less than $15 per hour, even though a large part of his campaign platform is $15 per hour minimum wage for all. I usually don’t wade into the political forefront, but I thought this would be an interesting thought exercise.

There has been a lot of noise about the Fight For $15 recently since multiple presidential candidates have taken up the banner. The movement stems from November 29, 2012 when over 100 fast food workers walked out of their respective restaurants in New York City to protest, creating the largest strike in the history of fast food. On July 29th of the following year, over 2,200 fast food workers went on strike. Since, the movement has expanded out of just the fast food industry to a national call of the federal minimum wage being raised to $15 (it currently sits at $7.25 per hour).

But is $15 per hour feasible? Is it even responsible? After all, we’re talking an increase of over 100%. According to presidential candidate Bernie Sanders’ campaign website feelthebern.org, he believes increasing the minimum wage actually benefits small businesses and will raise the standard of living. If raising the minimum wage is good for all, why not do it?

I own a business. I have several employees and contractors, and I determine their rate based on what my company is paid for a given job or contract. I also have to make sure my compensation is competitive for their skillset, or else I risk losing an employee to another business. I also have to take into account business expenses incurred to run the business and my own compensation as owner. These three factors play into what the employee is ultimately compensated. I pay too much, I risk the business and my own income; I pay too little, I risk losing the employee to better compensation.

But for this post, let’s assume I own a restaurant and pay five employees minimum wage. $7.25 per hour x 40 hours x 5 employees costs my company $1,450 per week in labor. The labor cost is factored into the cost of my business, which also includes the lease, utilities, insurance, ingredients, appliances and equipment, etc. My restaurant specializes in hamburgers which cost $1/ea. I take home a salary of $40,000 per year, which isn’t much but it makes running the business worth it to me and allows me to cover my own personal expenses. If minimum wage goes to $15, it would be a 106% increase in my labor costs or $2,987 per week. That’s a $1,537 increase per week, $6,148 a month, or $73,776 a year increase to my business. So now, I have to decide how this new increase can be afforded. I can’t cut back on equipment costs, because I need the equipment to make the hamburgers. I can’t cut back on ingredients, otherwise I won’t have hamburgers to sell. I could cut my own salary, but the increase is more than I even make and if I take a pay cut, I can’t afford to work there either. The lease and utilities must be paid or the restaurant closes down. I could increase the cost per hamburger to make up for the shortfall, risking a downturn in sales or losing customers to competitors (or home cooking) at which point I’m going out of business or cutting employees altogether. The only other alternative is to cut hours or go to automation (just like those kiosks in the Columbus McDonald’s)

This is exactly what business in cities with $15 per hour minimum wage have been doing. In Seattle, employers began cutting hours when the minimum wage hit $13 per hour. When his staffers complained of making under $13 per hour over the weekend, the Sanders campaign promptly cut hours to make the math equal $15 per hour.

Another unintended consequence of raising the minimum wage in Seattle was workers began requesting less hours because their yearly income increased to the point where they were at risk of losing welfare or various assistance programs. But wasn’t the intended effect? Wasn’t one of the speaking points of higher minimum wage to boost people off of welfare?

Another unintended consequence of high minimum wage is that it creates a barrier of entry to unskilled and young workers. If you’re 16 years old looking for your first job, you have no skills or experience. If an employer is required to pay over $30,000 per year for a full-time employee, the chances are they’ll never hire an unskilled teenager. I know I wouldn’t. If I had to pay that much for an employee’s salary, I want the best qualified person — this means skills, experience, and maybe a college degree. It makes it harder for teens to land that first job and begin acquiring skills and experience. From governing.com:

A long line of studies about the minimum wage has revealed that it can drive down employment at the low end of the wage scale, but those losses are made up for by increases in higher-paying jobs. The University of Washington findings, however, suggest that there’s some merit to the usual complaint that gets lodged against minimum-wage hikes — that they’re not only expensive for employers, but threaten to cut the first rung on the career ladder out from under teenagers or others just getting their start in the labor market. “The evidence that we’re picking up is consistent,” says Jacob Vigdor, an economist at the University of Washington. “We’re pricing out low-skill workers.”

“In Seattle, Minimum Wage Hike Comes at a Cost to Some Workers” Governing.com January 2019

This began happening in Seattle after the minimum wage began its journey to $15 per hour. In the linked article above from reason.com, “entry-level job growth stalled”:

Job growth continued in the rest of Washington state but not in Seattle.

“It’s presented by minimum wage advocates as a win-win…no negatives,” complains a skeptical Erin Shannon of the Washington Policy Center in my latest video.

Shannon points out the negatives. For example, stores that once hired inexperienced kids and trained them, giving them valuable starter experience, stopped doing so once Seattle raised its minimum wage.

If it’s not working so great (or, at least, as intended) in Seattle, why are presidential candidates pushing for it on a national level? First, it makes for great political rhetoric. It sounds appealing to low income workers while making the candidate appear as a fighter for the “little guy.” But there is also another reason for the government’s push for $15 per hour that no one is talking about.

It increases taxes.

If you’ve read any of my other posts about Robert Kiyosaki’s The Cashflow Quadrant, you know that employees get taxed the highest rates. A $15 minimum wage means increased payroll taxes from millions of American works. Workers will suddenly find themselves bumped up into higher tax brackets due to annual income increases. A 106% pay raise means a lot more in federal, state, and local income tax. But it’s not just income taxes — Social Security and Medicare taxes are also taken out of paychecks and based on a percentage of the paycheck. So with an increased minimum wage, the government gets a windfall of additional Social Security and Medicare income. According to IRS.gov, the 2019 withholding rates are 6.2% for each employee and employer for social security and 1.45% for Medicare. If you were making $7.25 per hour, your wages would be $290 for the week, $580 for the pay period and you’d pay $35.96 in Social Security and $8.41 for Medicare. Under a $15 per hour rate, you’d make $1,200 in the same pay period, paying $74.40 in Social Security and $17.40 in Medicare taxes. In case you missed it, the employee is only responsible for HALF of their Social Security and Medicare withholding (6.2% is half the 12.4% that is Social Security tax, 1.45% half the 2.9% Medicare tax) Under payroll taxes, the employer is responsible for the other half. So the employee pays $74.40 and the employer must ALSO pay $74.40 and $17.40 to the government.

So all governments — federal, state, and local — increase their take with a $15 per hour minimum wage. Maybe the government hopes that the higher wage relieves some of the the looming Social Security trust fund shortage. According to the 2019 annual report by the trustees of Social Security and Medicare, the program is already paying out less than it’s taking in and it will run out by 2035. A $15 minimum wage could help shore up that fund. In theory. But payroll taxes also incentivize employers to keep hours down to reduce their 50% share of the Social Security/Medicare tax cost.

Back to my little restaurant: If I cut back hours to compensate for the increase in wages, I suddenly don’t have enough coverage. I was paying $7.25/hr for 40 hours, but with a $15/hr wage, I’d have to cut it to 20 hours to get labor back to where it was in order to keep my hamburger price consistent. Now I have a shortage of 100 hours (5 employees x 20 less hours). What can I do now? I can either make up the 100 hours as the owner (working 140+ hours per week is equal to working almost every single hour of every day) or I cut back the restaurant’s hours. This means less hamburgers sold. Which means less revenue. Which means it becomes difficult to pay my 5 employees and myself. If I fight to keep the restaurant open, the next step is to cut an employee (I can’t raise hours because I can’t afford it and I can’t stay open longer because I can’t physically do it myself). Now I have 4 employees, and I’m forced to cover even more myself.

Do you see the death spiral here? Eventually, I’ll close either by insolvency or it not being worth it to me anymore. If I’m working 100 hours per week, it’s not definitely not worth it plus I’ll never have the time to expand my business or open a second location. And I’ll never be able to find someone to take over, because no one wants to work 100 hours in a struggling business. Eventually, I’ll shutter the restaurant and all of us will be unemployed.

The other alternative to cutting hours is to raise the price of my hamburgers to sustain the increased cost. Imagine being a customer of my restaurant: years of $1 hamburgers when suddenly you come in one day for lunch and find it costs twice (or more) to eat there. You’ll likely not come back or tell your friends. The human consumer is quite perceptive to price changes. Raising the cost of my hamburgers will expedite driving customers away…and less money coming in from sales. Which causes me to cut another worker…which causes me to reduce the hours the restaurant is open…which reduces sales…

The other question I began to think about is “Why do we have a minimum wage?” I mean this in the purest of thought experiments. Where did the minimum wage come from? Essentially, it’s a social safety net, ensuring American (or other national) employees make a certain amount of money. The first minimum wage appeared in the United States in 1912 in Massachusetts. Eventually, the federal government established a national minimum wage in 1938 under the Fair Labor Standards Act (FLSA), set at $0.25 per hour (adjusting for inflation, about $4.45 today). It was basically a protection for American workers during the Great Depression. The argument for raising it is that the current $7.25/hr isn’t a “livable wage.” Or, in other words, it doesn’t cover the cost of living.

Essentially what the government is doing is setting price controls — they dictate the absolute lowest an employee can be paid, regardless of skill or experience. So where did they get $15 from? Who chose this number? The only origin story I could find comes from SeaTac, Washington in 2013. It was the first city to have a $15 minimum wage and was a byproduct of an attempt by union organizer David Rolf to unionize workers at Sea-Tac airport. The $15 per hour rate was part of a bluff to get the airport to allow unionization. From the same Marketplace article:

There’s the $15 number itself, nice and round, easy to fit on a bumper sticker. The figure first came to people’s attention in a series of strikes by fast-food workers that started in 2012. The workers didn’t achieve their goal of unionization, but $15 stuck.

“The Accidental Origin of the $15 Minimum-Wage Movement” Ben Bergman, Marketplace Jan 30, 2015

So $15 was arbitrary: a randomly chosen number used by a union organizer to play hardball with an airport in Washington state. Eventually it caught on. To some, $15 isn’t enough. Just this past week Representative Rashida Tlaib (D-Mich) began calls to make the federal minimum wage $20 per hour. Jeff Spross of The Week published an article this week called “Is There a Case for a $20 Minimum Wage?” where he mentions that by some productivity measures, the minimum wage should be $22.49 per hour by 2024. If we’re chasing arbitrary numbers, why stop at $22.49? Wouldn’t $50 or $100 per hour cure all poverty? Wouldn’t we all be rich?

Part of the problem is such a high minimum wage disrupts a larger portion of the workforce. If you’re a McDonald’s worker making $20 per hour, that’s $40,000 per year over a full-time schedule. According to Glassdoor.com, the average McDonald’s Store Manager annual salary is $46,354. Someone taking orders or flipping burgers at McDonald’s makes almost as much as the Store Manager! The inevitability is that the Store Manager will now seek an increase as well. He has a lot more responsibilities, a higher skill set, and is in charge of several other employees, but his compensation now lags compared to those that work under him. To maintain the previous ratio, his salary would need to double to match the workers’ increase. Worse, it could lead to disillusionment or de-incentivizing to move up or learn new skills.

This is what happened in Venezuela after sharp raises in the country’s minimum wage in 2018:

“We all earn the same. I earn the same as the girl who presses a button to open the door,” said Arcaya, who has worked at the university for 19 years. “I studied and I worked hard. And now it turns out none of that was worth it.” 

Workers at hospitals, the Oil Ministry and insurance companies all said the pay hierarchy had been distorted following Maduro’s shock measure.

“‘We All Earn the Same’: Venezuela Minimum Wage Hike Angers Skilled Workers” Corina Pons, Reuters September 26, 2018

The other part of the problem has to do with economics, as countries like Venezuela and Greece can attest to. Let’s say that the minimum wage does go to $15 per hour and no jobs are lost. Let’s say every business can afford it and all low-wage labor gets a bump. (We can do this because it’s a thought experiment) This means that the amount of spending by millions of workers has now increased. More bills are paid. More loaves of bread and gallons of milk are purchased because they can be easily afforded. There’s a lot more money going out and spending is up. Prices will respond in kind. This “excess liquidity” will be mopped by up prices of goods and services. You have more money chasing the same amount of goods and services, the result inevitably being price inflation. In addition, companies will raise prices to maintain the higher hourly wage. This is called Wage Push Inflation. Soon, the $15 wages don’t buy as much as they used to and we’re back where we started. Why are politicians and workers complaining that the current $7.25/hr isn’t enough?

Because it doesn’t buy what it used to.

In effect, raising the minimum wage is a result of currency inflation. Because the value of the dollar decreases, it requires the minimum wage to be raised or else things become unaffordable. If things become unaffordable, they don’t sell. The choice is to lower the price so they do sell, or that item is replaced by one that does sell. Raising the minimum wage will ensure that goods becoming unaffordable remain purchasable. Investopedia gives an example of Wage Push Inflation: “If a state raises the minimum $5 to $20, that company must compensate by increasing the prices of its products on the market. But because the goods become more expensive, that raise isn’t enough to propel a consumer’s purchasing power, and the wage must be raised again, therefore causing an inflationary spiral. “

So what’s the takeaway from this thought experiment? My fictional little restaurant didn’t do so well. There’s no economic or logical choice for a $15 per hour minimum wage; I couldn’t find any economic studies that could show why that specific number is valid as a target. It seems to be chosen only because of the PR value and catchiness of “Fight for 15.” The other question is, will $15 per hour minimum wage really solve anything? The consequences could outnumber the (temporary) gains, and Wage Push Inflation and price inflation could quickly negate the sought after results.

I don’t deny the catchiness of “Fight for $15” or the hero status it gives political candidates. It sounds good to many people. But the math behind it just doesn’t seem to work. When it comes to government setting prices we must remember The Laws of Unintended Consequences: The actions of people, and especially government, always have effects that are unanticipated or unplanned for. On July 18, 2019 the House of Representatives passed a bill to raise the minimum wage to $15. The Congressional Budget Office reviewed the bill and admitted that the bill would produce a financial boost to nearly 30 million workers…but that “it would also result in 1.3 million jobs lost by 2025.”

Update Edit: Just after originally publishing this post, I came across the story of Emeryville, California’s minimum wage hike. Emeryville (home to Pixar animation) has the highest minimum wage in the country at $16.30 per hour (as of July 1, 2019). According to a Wall Street Journal article, Emeryville is the scene of a standoff between restaurant workers and their employees over the high minimum wage:

The economy is booming in the Bay Area, but at Patatas Neighborhood Kitchen, located in this small city just north of Oakland, owner Marcos Quezada recently eliminated the dinner shift and laid off six of his 10 workers.

He struggled with the decision but felt he had no choice after Emeryville increased its hourly minimum wage in July from $15 to $16.30, the highest in the U.S. “I just didn’t see how I was going to survive it,” said Mr. Quezada, who opened the eatery in 2017.

Remember what happened to my fictional restaurant? In several other cases mentioned in the WSJ article, the menu prices sharply increased to offset the new cost — in the case of Emeryville cafe Rudy’s, the price of their Crunchy Asian Salad went from $10 to $15.50, a more than 50% increase. From the same WSJ article:

“There is a tipping point,” said Erik Hansen, the owner of Moomie’s, who is deciding whether to raise sandwich prices by as much as $1.50 or lay off one of his three employees. “We may have the highest minimum wage, but I don’t think the people in Emeryville will feel like paying the highest prices in the country.”

Things have gotten even more complicated recently. In June 2019 Emeryville instituted a ‘pause’ in the wage hike for “small, independent restaurants.” The city council voted to halt increases for select restaurants meeting various criteria. So now the new minimum wage rate is only applicable to a certain size restaurant or above (according to July 26 update to the HR watchdog article, this ruling is now “in flux and may not be valid.”)

This article has been expanded into several parts. You can continue reading Part 2 here.