Effective Tax Rates and the Living Wage

Over the past decade, more than 110 ordinances have been passed mandating “living wages” for employees in businesses contracting with a locality and/or receiving financial assistance through tax breaks or economic development grants. The wage rates set by these ordinances often exceed the federal minimum wage by 150–200 percent. These original laws—which applied to very few businesses— had a limited effect on the overall economy of a city. Over the past year, however, these initial ordinances have been used as the basis for expanded citywide living wage ordinances. The first of these expanded city wide living wage ordinances to pass was in Santa Fe, New Mexico, where an $8.50 minimum wage went into effect (after a court challenge) in June 2004. This initial level will increase to$10.50 an hour by 2008 and will thereafter be indexed to inflation. In November 2003, voters in San Francisco passed an $8.50 minimum wage for city businesses, and the Madison, Wisconsin, city council passed a$7.75 minimum wage in that city soon after. While the “success” of living wage ordinances is often cited in support of citywide wage floors, there have been few rigorous studies analyzing the effect of these living wages on either the total income or living standards of low-income families. In this study, Dr. Aaron Yelowitz of the University of Kentucky and Dr. Richard Toikka of the Lewin Group utilized Survey of Income and Program Participation (SIPP) data to analyze the effect of living wage ordinances on earnings, income, and government assistance. In order to more fully analyze changes in the standard of living for low-income families, this study examines total income and not simply earnings. If living wage ordinances were to increase earnings but do so only at the expense of other forms of income, the policy would only change the composition of income and not increase the quality of life for low-income families— the stated purpose of these ordinances. Quantifying the ordinances’ benefits is critical because increasing the wage floor leads to disemployment as businesses either decrease their labor force, shift to more efficient employees, or leave the jurisdiction entirely. It would take a significant benefit to justify this cost. Previous work on this topic (Toikka, Yelowitz, and Neveu, 2003) found that low-income families face exceptionally high marginal tax rates and—as a result—living wage ordinances appeared to be badly targeted and ineffective at raising comprehensive disposable income. This study extends that earlier work by estimating the actual responses of households to living wage mandates by utilizing the 1996 SIPP data set.1 As mentioned above, previous work analyzing the effectiveness of living wage ordinances examined only cash income. For example, Neumark and Adams (2002) found a modest decrease in poverty rates utilizing data from the Current Population Survey Annual Demographic Files measure of cash income, which excludes in-kind benefits such as food stamps and subsidies such as Earned Income Tax Credit (EITC) payments. Failing to account for these income sources can dramatically distort the effect of a policy on the actual standard of living for a family. For example, a family with two children can qualify for more than $4,000 in tax-free cash assistance as a result of the EITC (and earn even more in states with supplemental state-run EITC programs). A benefit of this size would clearly affect the quality of life of lowincome families. As earnings increase, recipients can see the benefits from these programs decrease dramatically. For example, the marginal tax rate in the “phase-out range” for the EITC can reach as high as 21.06 percent and the tax rates for food stamps are generally 30 percent. Failing to include the loss of these benefits when evaluating the benefit of living wage ordinances can dramatically inflate the perceived effectiveness. Examining the effect of living wage ordinances, the authors found that the ordinances decreased cash transfer assistance. Specifically, the authors found that the enactment of a living wage ordinance decreased assistance by$34 per month. In addition, the authors found that the increase in earnings resulting from the ordinance was only $16 per month. This means that for every dollar in increased earnings from a living wage ordinance, families can expect to lose up to$2.12 in cash assistance—greatly limiting the ability of the policy to help low-income families. Controlling for factors such as the business cycle, state minimum wage levels, and welfare reform, the authors found that the enactment of a living wage increased total family income by only $55 per month. Due to lost benefits, 38 percent of this increase in income is crowded out. If the effect of important programs like food stamps is factored in, this tax rate would likely be higher. Overall, the authors have found that living wage ordinances do little to actually increase the standard of living for low-income families. The$55-a-month increase in total family earnings represents a less than 2 percent increase for the average family. In terms of an increase in earnings, the $16-per-month increase represents an increase of approximately one-half of one percent. The authors state, “a reasonable reading of our results is that the living wage has a limited capability in improving the economic status of the poor.” This limited capability is important because decades of studies clearly show that mandated wage floors create disemployment effects—particularly for the low-skilled employees these laws are intended to help. Pushing the intended beneficiaries out of a job while providing minimal benefits to remaining employees makes living wage ordinances an ineffective anti-poverty policy