Minimum-Wage as a Tax

by Don Boudreaux on February 21, 2013

in Competition, Economics, Work

Discussing in the halls with some of GMU’s finest econ students this earlier post on the minimum-wage, I’ve decided to elaborate a bit on it.  I thank especially, again, GMU student William Bruntrager for his comment, on that earlier post, that prompted this discussion.

Because this post is especially wonkish, I put it beneath the fold.

My goal in that post was to probe people’s intuitions.  Many people – including a seemingly growing number of economists – intuitively sense that a mandated higher minimum-wage will have little or no negative impact on unskilled-workers’ employment options.  For the person-in-the-street, this intuition, I suspect, springs from the common perception that employers generally have some sort of undue power over both workers and consumers and, as a result of that power, rake in excess profits.  These profits can therefore be tapped into by government diktats such as minimum-wage legislation without causing employers to adjust their operations in response.  For example, a minimum-wate diktat simply effects a redistribution of wealth; employees’ gains are employers’ losses, but losses only of some surplus that serves no economic function.

The intuition of economists who support the legislated minimum-wage is not much different from that of the person-in-the-street, although it is expressed more analytically.

Specifically, the economists’ intuition is expressed in the form of a model of monopsony behavior that, allegedly, characterizes the employment of unskilled workers.  Having – presumably over some relevant long-run span of time – monopsony power to employ unskilled labor, these employers employ such labor at wage rates below the value of these workers’ marginal product to their employers.

My goal in that earlier post was to probe the strength of people’s intuitions about the alleged surplus.  My probing was done by asking proponents of the minimum-wage if they are just as confident that a tax imposed on the employment of unskilled workers would be just as unlikely as a rise in the minimum-wage to reduce the employment options of unskilled workers.  Insofar as a sanguine attitude about the minimum-wage springs from a belief in the long-run existence of such a surplus, a tax on the employment of unskilled workers should be no more likely than a hike in the minimum-wage to affect the employment of such workers.

My suspicion – and that is all it is, a suspicion – is that some of the more thoughtful proponents of the minimum-wage would pause to realize that, when seen as a a kind of tax upon the employment of unskilled workers, a minimum-wage hike might not be so lacking in negative consequences after all.

‘Analyticalling-up’ this probing in order to address economists’ monopsony argument can be done at two levels.  The first, and simplest, is the one that I had in my mind when composing my earlier post.  It is as follows.  The monopsonist employer of unskilled workers reaps a surplus on each unit of unskilled work hired, namely, the difference between the value of the workers’ marginal product and the monopsonistically low wage paid for each unit of such labor.  Therefore, a tax designed to strip away that surplus should have no effect on the employment options of unskilled workers.  That’s what the blackboard model says.

But I suspect that most economists would be reluctant to conclude that any such tax on the employment of unskilled workers can be depended upon, in fact, not to shrink the employment options of unskilled workers.  Most economists would intuitively understand that any such surplus that might have existed for some short period of time would likely long ago have been competed away along some other dimensions (if not competed away in the form of competition with other employers for unskilled workers).  Therefore, a tax on the employment even of monopsonistically employed unskilled workers will likely reduce the employment options of these workers.

Pointing out that a legislated minimum-wage acts much like a tax on the employment of unskilled workers seems, in this context, to have some merit.

….

At a deeper analytical level the same conclusion holds, but through a more roundabout chain of reasoning.

In the monopsony model the alleged grand-slam umpph! of a legislated minimum-wage is that it makes the supply curve of unskilled workers perfectly elastic at the minimum-wage.  Therefore, employers of unskilled labor do not, when hiring additional units of such labor, suffer a marginal cost of hiring additional units of unskilled labor that is higher than the (legislated minimum-)wage that must be paid to hire those additional units.  The model (which any decent undergrad economics student can draw and manipulate) ‘proves’ that an appropriately set minimum-wage will not only not reduce the employment options of unskilled workers, but will increase those options.

Had I addressed this analytically deeper point in my earlier post my hypothetical tax would not have been a lump-sum tax but, rather, would have been a tax the amount of which would be, for each different quantity of labor hired, the difference between the supply curve of labor and the desired minimum-wage.  This dollar amount of this tax would fall the higher is the wage paid to unskilled workers; the tax would become $0.00 at the desired minimum-wage.

The effect of this tax, from the perspective of employers, would be identical to that of a minimum-wage: this tax would effectively flatten out – make perfectly elastic – the supply-curve of unskilled labor.  Voila!  An adjustable tax on the employment of unskilled workers would increase the employment options of unskilled workers.

That’s what the simple monopsony model – the one used to justify the legislated minimum-wage – predicts.  But my suspicion is that when posed as an outright tax, many economists who might otherwise nod in agreement that Science counsels government to impose a minimum-wage, would balk.  Or, at least, that’s the intuition that my earlier post sought to probe.

….

In everything above I accept the plausibility of the assertion that unskilled labor is employed by employers who enjoy long-run monopsony power.  But in fact I find that assertion to be wildly implausible.

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