Minimum Wage – The Impacts of Wage Compression and the Benefits Cliff

Apr 5, 2023 | Talent

Artificial wage standards discourage job creation while harming workers most in need of assistance.

In an effort to achieve a so-called “living wage” for all workers, much attention has been given to establishing a local minimum wage in excess of the state standard of $13.65 per hour. While this may appear beneficial to entry-level and lower-skilled workers, the unintended consequences deserve far greater attention than has been granted.

Let’s first start with wage compression. Simply stated, this occurs when the wage differential shrinks between supervisors and the supervised. As a business owner, you establish the value of every member of your team according to job description, skill level, experience, and supply of suitable candidates for that position. These elements are informed by prevailing market and economic conditions. Ultimately, wages are determined by the ability of the business to cover all expenses. The same calculus is applied to all businesses, whether they operate to turn a profit or deliver community benefit as a non-profit corporation.

However, if the local government determines that low-wage workers must be paid more, the business must consider multiple implications in an attempt to regain equilibrium across the enterprise. To illustrate this challenge, when the wage paid to a new cashier increases, more experienced cashiers will demand a raise, thus shrinking the wage differential between the frontline worker and the shift manager. This likely requires the employer to raise that wage as well just to retain the more valuable employee. The situation repeats itself on up the ladder. What’s often overlooked is further distortion outside of that chain of authority. The bookkeeper will now feel entitled to a raise, as will the marketing team and logistics crew.

So does all this mean revenue will increase to offset this reverse cascade of personnel expense? There’s little evidence to support such a notion, but we do know the business owner will respond in one of three ways: reduce capacity (i.e. cut hours, eliminate positions), raise prices to the extent the market will allow, or some combination of the two. Ironically, this means a “living wage” will be available to some workers, though actual take-home pay may decrease or go away completely for others. Even for the fortunate, a vicious cycle is released as businesses are forced to raise prices and therefore increasing the cost of living for all consumers.

A sometimes-separate issue is created when wages are artificially increased at the low-end of the wage scale. The so-called “benefits cliff” occurs as household income exceeds the threshold at which they are eligible for public support programs. In Colorado, these programs include: federal and state earned income tax credits (EITC); federal childhood tax credits; Supplemental Nutrition Assistance Program (SNAP); Women, Infants, and Children (WIC); Temporary Assistance for Needy Families (TANF); Colorado Child Care Assistance Program (C-CAP); Colorado Low-income Energy Assistance Program (LEAP); Housing Choice Vouchers (HCV); Child Health Plan Plus (CHP+); and Medicaid.

While each of these programs have different eligibility standards that often vary according to household size and circumstance, income thresholds apply in all cases. While some, such as EITC, phase out as income increases, others terminate completely once the threshold is crossed, such as Medicaid. Key elements to this minimum wage issue are the fact that nearly 70% of public benefits go to non-elderly employed individuals, while over half of workers in the bottom 20% of the wage distribution receive benefits from public programs.[1]

The cliff effect has the most severe impact on workers with incomes between 100% and 250% of the federal poverty level. As reference, this translates to individuals earning between $14,580/year and $36,450/year. For a family of four, that range is $30,000 to $75,000/year. A full-time worker earning $16/hour equates to $33,280/year. The harshest cliffs involve the loss of childcare and housing subsidies, as these typically represent the highest personal expenditure and the most challenging needs to secure within the marketplace. Those non-taxable benefits alone can be worth $2,000/month or more, whereas a $3/hour increase in wages equals $6,240/year before taxes. In essence, the value of public benefits well-exceed the value of a modest increase in hourly wage.

In the coming weeks, Common Sense Institute will release a report focused on how minimum wage policy and public benefits impact the state, employers, and employees[2]. Your Chamber will be eagerly consuming that report, translating it to local context, and sharing that information with our members and elected officials.

While most employers recognize the inherent problem when their full-time, adult workers are unable to afford housing, childcare, transportation, food, etc., the greater challenge is how we can collectively improve the economic well-being of our workforce. The response to that challenge will require far greater cooperation and collaboration than simply dictating the lowest possible wage.