Minimum wage vs. negative income tax

Bank of Israel and Israeli Finance Minister oppose minimum wage increase out of fear that it will increase unemployment.

Construction (photo credit: Courtesy)
(photo credit: Courtesy)
THE HISTADRUT LABOR FEDERATION AND MAJOR employer organizations started the new year with a new collective agreement raising the minimum wage paid by about 11 percent, from 3,850 shekels ($1,090) a month to 4,300 shekels per month by October 2012. Under the terms of the agreement, the minimum wage will rise by 250 shekels a month in July, and then a further 200 shekels in October 2012 to reach the 4,300-shekel target.
Signing on to the deal with the Labor Federation were the Federation of Israeli Economic Organizations, the Federation of Israeli Chambers of Commerce, and the Lahav Israel Association of the Self-Employed, and all employees of companies affiliated with these organizations are bound to honor the agreement. The Histadrut and employers organizations intend to ask Industry, Trade and Labor Minister Binyamin Ben-Eliezer to extend the agreement to cover the entire economy, and to submit a bill before the Knesset to legislate the agreed-upon minimum-wage hike.
The Finance Ministry, however, said in a press statement that it opposes raising the minimum wage in the entire economy because it is concerned that doing so would lead to an increase in unemployment.
“As the employment rate is deteriorating in many countries, and many governments are having to cut their budgets, we believe the decision to raise employment costs in the industrial sector quickly is likely to... cause an undesirable rise in the unemployment rate,” stated the Finance Ministry. “Such a move would hurt the competitiveness of the Israeli economy, especially during a period of appreciation of the local currency.”
The Bank of Israel has also in the past voiced opposition to proposals to raise the minimum wage, favoring, instead, the adoption of a negative income tax (under which people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government) to improve the financial situation of low-income earners.
It is easy to see where the idea that raising the minimum wage leads to higher unemployment comes from. Labor costs factor into business decisions just as any cost does. Raise fuel costs or printer ink costs high enough, for example, and business will cut back on their spending on those items. Similarly, an imposed hike in wages will induce businesses to cut labor spending, which is another way of saying unemployment will rise.
The problem with that analysis is that it fails to take into account factors such as elasticity of demand and spending. Increased labor costs might, for example, be registered as an overall increase in costs, leading businesses to cut spending on some items but not others – and not necessarily to cut staff.
There have been empirical studies conducted on the issue. Two economic professors at Princeton University, David Card and Alan Krueger, compared unemployment and wages in New Jersey and neighboring Pennsylvania, after New Jersey raised the minimum wage in 1990, while Pennsylvania did not, taking most of their data from the leading employers of low-wage earners in those states. According to Card and Krueger, in contrast to the conventional wisdom, “employment actually expanded in New Jersey relative to Pennsylvania, where the minimum wage was constant.” In follow-up studies using data from other states, the Princeton professors uncovered further positive correlations between higher minimum wages and employment.
There have also been studies that have linked higher minimum wages with increased unemployment, but the correlation has been minimal, with drastic wage increases creating only a small rise in unemployment.
And none of these analyses take into account the effects of ensuring a livable wage for workers.
Nor should having a minimum wage necessarily block consideration of some sort of a negative income tax – an idea that was supported by renowned US economist Milton Friedman.
In theory, a negative income tax guarantees a minimum level of income for all without the theoretical disruptions of markets caused by minimum wages, while also reducing administrative overhead. But no country in the world has ever implemented a full-scale negative income tax, and it is unlikely that Israel will become the first.