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Thursday, January 11, 2007

Minimum Wages and Small-Business Tax Breaks

Lots of talk in the news about the min wage after yesterday's big margin in the House to increase it. By all accounts, the Senate will be a tougher sell given the greater powers of the minority there.
News reports suggest that the price of passing the bill in the Senate will be adding tax breaks for small businesses.

I don't know the details of these tax breaks, so I don't have an opinion about whether they're a good idea.

But one very interesting economic point seems not to have been discussed. The usual rationale among opponents* of minimum wage increases is that they will cause disemployment. Binding price floors do indeed cause surpluses this in competitive markets, and the model these opponents have in mind for the labor market is the competitive model. Thus disemployment is the same as a surplus of available labor at the binding minimum wage. Now, there is considerable evidence that any disemployment effects are small. (In fact, some empirical work suggests zero or even positive employment effects, which could happen when the labor market is not competitive, with employers having some market power---my understanding is that the jury on this question is still out.)

But suppose we thought that disemployment effects were substantial. Then the argument for the minimum wage is that one values the gains to the winners---via higher wages---more than the losses to the (job) losers.

What do small business tax breaks do to ameliorate such disemployment? Well, that will depends on whether those tax breaks tend to increase the value of the marginal revenue (VMR) produced by the firms' workers. This is true because in a competitive labor market, a firm's labor demand curve is the same as its VMR curve. At one extreme, a reduction in the tax rate on firms' profits would, indeed, shift the VMR curve up, since it would increase the after-tax value of a sale at a given pre-tax price. At the other extreme, just dumping money on these firms (economists use the term "helicopter drop") would basically do nothing to employment levels---yes, it would increase the value of the firm, but it wouldn't affect optimal employment levels.

Thus it seems possible that there are two different questions here. One is, what are these tax breaks really about--minimizing disemployment effects that worry minimum wage opponents, or simply transferring wealth to firm owners?

Second, is there any reason to transfer wealth to firm owners? If the low-wage labor market is indeed competitive (so that there are disemployment effects), then firms make zero economic profits in equilibrium. Thus the only reason for low-wage employers to care about the minimum wage would be that it reduces the value of their sunk capital. Giving helicopter-droppish tax breaks to offset such a reduction might seem fair--why should small businesses handle the redistributive burden of the minimum wage--but doing so ultimately involves transferring dollars from taxpayers as a whole to these specific ones. Depending on what the set of affected small business owners look like in wealth terms, this policy could be either desirable or undesirable on equity grounds.

I don't know this literature well, but it would be interesting to know if anyone has looked at
this second question.

6 Comments:

Anonymous Anonymous said...

"Second, is there any reason to transfer wealth to firm owners? If the low-wage labor market is indeed competitive (so that there are disemployment effects), then firms make zero economic profits in equilibrium. Thus the only reason for low-wage employers to care about the minimum wage would be that it reduces the value of their sunk capital. Giving helicopter-droppish tax breaks to offset such a reduction might seem fair--why should small businesses handle the redistributive burden of the minimum wage--but doing so ultimately involves transferring dollars from taxpayers as a whole to these specific ones. Depending on what the set of affected small business owners look like in wealth terms, this policy could be either desirable or undesirable on equity grounds."

Because it effectively puts the minimum wage into the general budget, so it is financed largely through income/corporate taxes, and spreads the loss throughout society. This is, of course, one of many reasons why increasing the EITC is a vastly superior way of doing this.

1/12/2007 8:27 AM  
Blogger Jonah B. Gelbach said...

anonymous,

i don't think it's at all clear that you're right about your claim. you *might* be, but your reasoning doesn't have to imply that you are. eitc costs are "spread...throughout society" as well. and it's not clear that the eitc is a more efficient way to transfer resources to people with low *lifetime* income. i've always wondered what fraction of eitc dollars go to people whose income is low for lifecycle, rather than permanent reasons. of course, the same might be true about the min wage, but that's an empirical question.

moreover, i don't really understand your point here. the question of mine to which you respond was not about whether the min wage *itself* is a good way to redistribute. rather, it was whether there's a *normative* basis for compensating small-business owners for the burden that the min wage places on them via reduced value of their sunk capital. suppose for a moment that small business owners are more wealthy than avg, so that, roughly speaking, a ramsey-style analysis would suggest that optimal redistributive policy taxes these folks. in that case, raising the min wage and _not_ compensating small business owners is an arguably sensible way of redistributing, whereas across-the-board increases in taxes to fund an eitc might be *less* desirable.

all of these points involve empirical questions, the answers to which i don't know. that was, of course, my point in posing the question you quoted.

my point in response is that your reply doesn't really answer my question, since it just begs these empirical questions. in other words, you might be right, but you also might be wrong.

1/13/2007 4:07 PM  
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