The cost of a higher minimum wage

A big jump in the minimum wage has got to be a good thing, right?

Not according to some economists, who say it could in fact be "extraordinarily destructive" to life as we know it. Imagine unemployment soaring, the price of goods and services going through the roof, and those who most need support being left behind.

The call for higher wages is not new, but in recent weeks, some commentators have stirred up the debate by suggesting that Working For Families (WFF) be scrapped at the same time. The idea is to improve everyone's lot in life, while also stopping the "discrimination" against those who have chosen not to breed.

To work out the impact such a shift might have on a typical family, we asked three economists to take a closer look. Our scenario uses a nuclear family of two parents and two young children, who we'll call the Smiths. John Smith works full-time as a labourer, and Jane's putting in 20 hours a week as a cleaner.

Before we start forecasting the Smith family's fate, let's take a look at how they're doing right now.

Scenario 1: The Status Quo

With both parents earning the minimum wage of $13.75 an hour, the Smiths are earning a combined after-tax income of $718 per week. That gets topped up by WFF payments of $185 courtesy of the taxpayer, bringing their total weekly income to $903. It's far from a fortune but fairly solid - and doesn't take into account other freebies like childcare and paid parental leave.

At present, families like the Smiths are effectively being subsidised by those who have not been blessed with the patter of small feet.

"Some subsidisation of lower-income families has public good aspects," says Eric Crampton, senior lecturer in economics at the University of Canterbury - for example, giving people the resources to invest in their kids' health and education helps reduce the chance that they'll end up in poverty later in life.

However, much of the current WFF scheme involves a direct transfer to middle-income families.

Whether that's worthy or not is up for debate - more on this later.

Scenario 2: Cut Working for Families, Hike the Minimum Wage

Living Wage campaigners think workers should be paid at least $18.40 an hour (revised to $18.80 this week), and with various politicians already pledging to put it into practice for government and council staff, there's a real chance it could happen.

If the Smiths got an instant pay rise to $18.40 an hour, their after-tax income would jump to almost $50,000, or $948 per week. Even without any WFF support, they're now much better-off.

The Government stands to save a fortune too: around $2.5-$2.6 billion each and every year, according to Treasury estimates, bolstered by an extra $2500 in annual tax revenue from our nuclear family, and from every other family like it.

So everyone wins, right? Well, not exactly.

First, Treasury's analysis of the Living Wage found nuclear families only accounted for 15 per cent of those earning below the threshold. Meanwhile, it would become illegal to pay a 16-year-old living at home with mum and dad and pumping petrol at the local service station any less than $37,000 a year. In reality, that simply wouldn't happen.

Employees that can't "create enough value" would get pushed out of the labour market, says Infometrics senior economist Matt Nolan, adding that the young and inexperienced would be among the first victims, as would the mentally and physically disabled.

Crampton says an $18.40 minimum wage would be "extraordinarily destructive".

Whether workers, consumers, or company shareholders would bear most of the brunt would vary greatly between industries.

If the Smiths did manage to keep their jobs, they'd obviously be better off- but who's to say John's employer won't go out of business, or Jane's casual hours won't be slashed?

"Being unemployed is far worse than being paid less than one might hope for," says Crampton.

Add to that the fact that the working poor are often the same consumers of the goods and services they produce, and "some of the cost of the higher wage rates would be passed along to those customers", says Crampton.

Nolan says a similar wage debate in the United States is different, in that the minimum wage is still relatively low compared to the average. In that context, many economists support the idea of a hike, with good evidence that there's not much short-term impact on employment. But American minimum wages tend to be about 40 per cent of the median wage, well behind New Zealand's 60 per cent, and light years behind the proposed living wage of roughly 90 per cent.

University of Auckland economics professor Tim Hazledine supports pushing up lower-end wages, "at least, for adults". But he doesn't see it as necessarily being a trade-off with WFF or other schemes.

Scenario 3: Cut Working for Families, Cut Taxes

Another way to compensate for removing WFF would be to cut taxes.

The $2.5-odd-billion tied up in WFF isn't too far off the amount needed to make the first $10,000 of everyone's income tax-free. Calculations based on the latest IRD figures from 2011 suggest doing so would cost about $3.2b in foregone tax revenue.

The Smiths are now paying $2100 less tax - an extra $40 in the hand for them each week. But with no WFF payments, they're still down overall by $145, which could make all the difference with four mouths to feed.

Is it dangerous to pull the rug out from under their feet?

Crampton says there's a reason the incoming government didn't scrap the scheme in 2008: with so many families now reliant on WFF support, it would be politically dangerous.

"They've taken out mortgages, made employment decisions, and maybe even made decisions about family size with WFF calculations at the back of their minds."

But it wouldn't be the end of the world. "We didn't have this transfer before WFF, so ending it isn't unimaginable or the stuff of the dark ages," says Crampton.

There would be some benefits, too, such as encouraging second-earners who currently have less incentive to return to work, because of reduced WFF payments.

And while a $10,000 tax-free threshold sounds nice, Crampton says it might not be the best approach. "For an equivalent cost to the government, we could reduce tax rates in the lower-income bands to let workers keep more of the next dollar earned."

Nolan reckons tax-free thresholds are "probably one of the worst-possible tax cuts that could ever be put in place" and if society has decided that WFF fills a certain need, swapping the scheme for an untargeted policy is likely to be a harmful change.

Conclusion: Tradeoffs and Value Judgments

We can safely conclude that the Living Wage is a bad idea, and that universal tax cuts are a poor way of targeting support. The grey area is where that targeted support should go: To poor families? To middle-class families? What about the childless poor?

If we choose families, we're essentially paying to have more children running around, as well as (hopefully) a better quality of life. Crampton says he simply can't say whether it's better to take money from childless people -both rich and poor - and hand it over to low- to middle-income parents.

Economists can talk about the trade-offs involved and the likely effects of the policy, but moving beyond that becomes a value judgment, Crampton says.

Hazledine is prepared to take a stand: "I have long believed that excessive population growth is one of the major contributors to the problems of the modern world," he says. "So I am opposed to any pro-natalist ‘buying babies' policies in any country, including our own."

Nolan has read literature saying we should have higher birth rates, and other material saying just the opposite.

"Ultimately, this is an open question, and one that I don't think is particularly useful for policy."

Instead, he says the best way to think about it is to consider people's needs, and the trade-offs from the policies which are trying to address them.