Policy Basics: The Minimum Wage

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August 27, 2014

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What Is a Minimum Wage?

Minimum wage laws set the lowest hourly rate an employer can legally pay workers covered under the law.  The federal minimum wage is currently $7.25 per hour.  Where states and municipalities have enacted their own, higher, minimum wage laws, employers must pay at least the state or local minimum.  As of August 1, 2014, 23 states and the District of Columbia have minimum wages above the federal minimum wage.

Who Is Covered by the Minimum Wage?

Employees of any business or enterprise with gross annual sales or business done of at least $500,000 and employees of any business that participates in interstate commerce must be paid the minimum wage.  So too must employees of federal, state, and local government agencies, hospitals and schools, and most domestic workers.  Certain exceptions apply to young workers, full-time students and student learners, and disabled workers.  Further, tipped workers have a minimum wage of $2.13 per hour.  If such a worker’s tips in a given pay period do not add up to the minimum wage, however, the employer must pay the difference.

Who Is Paid the Minimum Wage?

The Congressional Budget Office (CBO) reports that in 2013, 5.5 million workers earned within 25 cents of the federal minimum wage.  Three-quarters of these workers were at least 20 years old and two-fifths of them worked full time.  The median family income of workers in this range was about $30,000.

History of the Minimum Wage

The first U.S. minimum wage was instituted under the Fair Labor Standards Act of 1938. Since then, Congress has raised the minimum wage a number of times and changed who is covered under it.

Because the minimum wage is not adjusted automatically for inflation, its real (inflation-adjusted) value tends to fall in the years between enacted increases — as happened during the 1980s and from the mid-1990s until 2007 (see chart).  Such declines in the purchasing power of the minimum wage lower minimum-wage workers’ living standards.

Economic Effects of Raising the Minimum Wage

According to standard economic theory (supply and demand), an increase in the minimum wage reduces employers’ demand for labor, reducing employment.  Empirical studies generally find, however, that any such employment effects are modest, and some studies have found no impact or even an increase in employment — at least for minimum- wage increases within the range of historical experience and the range contemplated in recent proposals to raise the federal minimum wage. 

Economists offer several reasons for these findings.  Consistent with simple supply-and-demand theory, employers may:

  • pass on some of the cost of higher wages to their customers in the form of higher prices,
  • absorb some of the cost of higher wages in the form of lower profits, and/or
  • reduce the number of hours their employees work rather than reducing the number of employees.

CBO estimates that low-wage workers as a group gain more income from the higher wage than they lose from reduced employment.  The same can be true for most individuals, as well, if the employment losses are spread broadly over the low-wage population.

Outside the simple supply-and-demand framework, an increase in the minimum wage may spur businesses to operate more efficiently and employees to work harder.  Employers may look for ways to increase productivity, such as setting higher standards of performance for their employees or investing more in employee training.  A higher wage may motivate employees to work harder because they feel they are being paid fairly and they have more to lose by getting fired.  This combination of efficiency improvements from both employers and employees decreases job turnover, reduces employers’ hiring costs, and may lead to employment gains.

Current Proposals

President Obama proposed raising the minimum wage to $9.00 an hour in his 2013 State of the Union address.  More recently, the Obama Administration announced its support for the Fair Minimum Wage Act, a bill introduced by Sen. Tom Harkin (D-IA) that would raise the minimum wage in three increments over the course of two years, from its current $7.25 an hour to $10.10 an hour.  After that, the minimum wage would be indexed to inflation, eliminating the gradual erosion of minimum-wage workers’ purchasing power and the need for periodic, potentially contentious legislative debates to restore it that have been a feature of the minimum wage since its inception.

For more on the minimum wage, see:

Proposal to Strengthen Minimum Wage Would Help Low-Wage Workers, With Little Impact on Employment http://www.cbpp.org/cms/?fa=view&id=4075

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