I have a friend, Mark (not his real name), who would be considered in the top 1% of income earners. Mark has a large home and recently has been making substantial improvements to the 10 acres in his back yard. Every day Mark hires day laborers to help him build walls, pour concrete and landscape the grounds. These workers are a mix of low-skilled US citizens, Mexicans and Central Americans. The going rate for day laborers in the north Texas market is $120 per 8 hour day, plus lunch, plus transportation to and from the job site. If offered less, $100 per day for example, these workers typically respond by saying that they will wait for the next employer to come to the corner where they wait each day for a job.
Without an understanding of the labor market in this time and place, one might expect that an employer could easily take advantage of these low-skilled workers by paying the current minimum wage of $7.25 per hour. Such is not the case.
Who makes minimum wage in the United States? In May 2009, when the minimum wage was $7.25 per hour, the US Bureau of Labor found approximately 6 million US workers in the following, lowest paid sectors of the economy. At this same time, there were 155 million people in the US labor force.
The last increase in the federal minimum wage was in July, 2009. As of January, 2015, 29 of the states have a minimum wage which is higher than the federal minimum wage. The following chart shows that the purchasing power of the current federal minimum wage in 2013 dollars is near the peak since approximately 1985. However, from 1956 to 1985, the purchasing power of the minimum wage was consistently higher than today’s minimum wage, between $8 and $11 per hour. Based on purchasing power parity, therefore, an increase in the minimum wage to $8 – $9 per hour is easily justifiable.
Prior to 1938, there was no compulsory minimum wage law in the United States. In 1918, Congress passed a law to set a minimum wage for women and children in the District of Columbia. In 1923, the Lochner Supreme Court ruled this law unconstitutional in Adkins v. Children’s Hospital on the grounds that it would interfere with the freedom to contract included within the guaranties of the due process clause of the Fifth Amendment to the Constitution. The court argued that if Congress could set a minimum wage, it would also set a maximum wage. In his majority opinion, Justice Sutherland wrote, “That the right to contract about one’s affairs is a part of the liberty of the individual protected by this clause is settled by the decisions of this court and is no longer open to question.”
President Franklin D. Roosevelt had a different opinion. In 1933, he declared, “No business which depends for existence on paying less than living wages to its workers has any right to continue in this country.”
That year, President Roosevelt signed the National Industrial Recovery Act, which was the first attempt to establish a national minimum wage at $0.25 per hour. However, in the 1935 court case Schechter Poultry Corp. v. United States (295 U.S. 495), the United States Supreme Court declared the act unconstitutional, and abolished the minimum wage.
Roosevelt did not give up. In 1938, he signed the Fair Labor Standards Act and re-established the minimum wage again at $0.25 per hour. In United States v. Darby Lumber Co. (1941), the Supreme Court upheld the Fair Labor Standards Act, holding that Congress had the power under the Commerce Clause to regulate employment conditions.
This was a turning point away from the constitutional liberty argument to limit government regulation in the labor market toward the liberal social justice argument for establishing minimum wages in this country. Today, there are calls to raise the federal minimum wage again up to $10.10 per hour, even up to $15 per hour. None of the current arguments I find against increasing the minimum wage include the constitutional liberty or due process argument used before 1941. The liberal social justice argument has become an accepted part of our culture and gives certain politicians ammunition for their campaigns. Proponents argue that raising the minimum wage is an effective anti-poverty tool and increases economic activity as well. In recent years, the argument to increase the minimum wage is also justified based on a desire to attack growing income inequality in this country.
The growth in income inequality in the United States is well-researched and understood. This table summarizes the increase in pre-tax income going to the top 1% and top 0.1% of the population.
|Pre-tax income||Top 1%||Top 0.1%|
There are many factors which contribute to the growth in income inequality. Decline of labor unions and manufacturing, globalization, immigration, and public policies. The minimum wage level actually has a minor impact on income inequality. Indeed, I have found research published in 2015 that suggests that a minimum wage above $11.77 would actually lead to an increase in income inequality.
The other tool of politicians to combat income inequality is a progressive tax system. Making the wealthy pay their “fare share” is commonly used code for increasing effective tax rates at the highest end of the income scale.
Is it true that a progressive tax system decreases income inequality? Should supporters of increasing the minimum wage, who also want to reduce income inequality, favor a progressive tax system or a flat tax system?
In order to answer these questions, let’s create a world of perfect income equality. We start by counting the number of U.S. tax returns filed in 2013. The following chart shows the number of returns filed at each tax bracket effective in 2013. Out of the 138,000,000 tax returns filed, 77% paid taxes in the 0%, 10% and 15% brackets. Only 2% of the total paid taxes in the brackets at 33%, 35% and 39.6%. Finally, approximately 21% are in the middle brackets of 25% and 28%. In 2013, the federal government collected a total of $2.442 trillion in income and payroll taxes. Taking all the tax returns together, this means that the average tax payer paid $17,708 in federal income, Social Security and Medicare taxes.
In a world of perfect income equality, in order for the federal government to collect the same amount of tax in 2013, every income tax filer would have earned an annual income of $88,539, approximately $44 per hour, and paid a 20% effective income tax rate.
In this hypothetical scenario, where everyone has the same income, there are no progressive tax rates. There is only one tax rate. Thus, anyone who supports increasing the minimum wage and is against income inequality has to be a supporter of the flat tax in order to be logically consistent. I doubt, however, that you could ever find someone to admit this. Therefore, let me support my argument with an additional example about the progressive vs. flat tax.
Let’s say that my friend, Mark, needs to make this year $1 million after tax in order to support the lifestyle he desires. Nice home, luxury cars, country club membership, winter ski trips, etc. It is not unusual for people in this class to be able to determine the amount of income they report as they exercise their decision-making authority over the operation of their business. In a progressive tax system, Mark has to report a gross income of $1.67 million in order to earn $1 million after tax. However, in a flat tax system, Mark has to report a gross income of only $1.25 million in order to have $1 million after tax.
|Gross Income ratio @$15/hr.||55.6||41.7|
As long as Mark can determine his gross income, which is he likely to choose? Under the flat tax system, Mark should choose the lower gross income because he pays less tax. Which tax system is likely to lead to greater income inequality? The progressive tax system. The ratio of gross income to someone making $15 per hour under the progressive system is 55.6, whereas the same ratio under the flat tax system is only 41.7. Under this hypothesis, increasing the effective tax rate on the wealthy leads to greater income inequality.
Thus, we have the basis for political bipartisanship. The supporters of raising the minimum wage and the supporters of the flat tax are natural allies. To the extent that increasing the minimum wage redistributes wealth, and in desirable to reduce poverty, combining this action with a flat tax makes a higher minimum wage more politically palatable and financially feasible for business owners who employ the minimum wage earners.
Hard core supporters of the progressive tax system will object by saying that Mark should still pay a higher tax rate than those who make far less. Is this a moral argument? What if Mark realized an increase in his salary from $1.25 million to $1.667 million? This is a 33.34% increase. Mr. Wage Earner sees an increase in his gross pay from $12 per hour to $16 per hour. This is exactly the same percentage increase – 33.34%. Under a progressive tax system, Mark is penalized by higher tax rates, as though he did something wrong by earning more money. However, no one argues that Mr. Wage Earner did anything wrong, even though his income increase is the same as Mark. Therefore, I conclude that there is no strong moral argument to justify a progressive tax system.
Instead, the justification is a political judgment. There are more voters who fall into the lower tax brackets, so it makes sense politically to attack the wealthy in order to win elections. Under the progressive tax system above, Mark pays an additional $416,667 to the government. However, the federal government is overspending and continually adding to the national debt, which is dangerously high at nearly $20 trillion. Even though it is legally required, is it moral to pay taxes to a government which is not managing tax payer money responsibly? Under a flat tax system, Mark would be able to decide himself how to spend or invest his money. Either decision would increase economic activity.
I will ask you to answer this question yourself with the following hypothetical situation. You receive a windfall of $50,000 from an unexpected source. You decide to donate this money to charity and you have two choices. Choice A is a non-profit which has a lean organization, has a good reputation of transparency and accountability, and delivers a high percentage of donations to the target beneficiaries. Choice B is a non-profit which pays high executive salaries, is not transparent or accountable, and delivers a low percentage of donations to the target beneficiaries. Do you choose A or B?
Any person with common sense, whether rich or poor, would choose A. Therefore, commons sense should also lead one to conclude that a flat tax system is better than a progressive tax system. Flat tax supporters should join forces with supporters of a $15 minimum wage to achieve the objective of greater income equality in our society.