Sunday, April 27, 2014

Wage Limitations

EDIT: This is a response to an article on Yahoo!: Why We Need a Maximum Wage

Minimum wage is a labor restriction created and maintained by the US Federal Government. The rationale for its existence is to keep employer from driving down the cost of wages to the point where the wage no longer benefits the laborer. This is absurd. People don’t work when they don’t receive adequate compensation. In economics jargon we would say that the marginal benefit of the pay must exceed the marginal cost of the labor input. There are several problems with the concept that minimum wage laws help the poor or under employed, and they are standard fare for economics coursework. By artificially raising the price of labor, employers employ fewer workers and find alternative solutions. 

This is because of the nature of employment in a market environment. A business will not, and indeed, cannot, employ a workforce that costs the organization more than that work force increases revenue. This cost accounting must include payroll, healthcare, taxes, and all other costs associated with the employment. If any of these areas increases in cost, the profitability of each employee decreases and raises the ceiling for increasing or maintaining the size of the workforce. 

These cost increase can be in the form of higher pay, higher taxes, and increasing benefit requirements; indeed, we have seen this take place over the past decade with disastrous results on the employment level of the US labor force. It is apparent that mandating increasing the cost of employment has damaged the labor market.

In short, the relationship between an employee and an employer is a win-win relationship. The employee is receiving compensation in excess of value of their input. The organization is receiving more value from this employees work then they are compensating the employee. This is a wonderful arrangement as both sides willingly forego value in order to acquire a greater value offered by the counterpart.

There is a growing concern that income inequality in the US is a problem spot that requires remedy. Critics of high levels of income point to the disparity of wages at the very top when compared as a ratio to the wages of the average worker, or indeed, the minimum wage level of the US. The current solution to this perceived dilemma is a progressive marginal tax rate, where greater levels of income are taxed at a higher rate the income bracket beneath it.[i] This has the effect of permitting high wages while punishing those increased wages with higher levels of taxation. This results in lower taxes for the lower marginal tax rate brackets, so that the lower levels of income pay far less then do the higher levels of income. The current rate of income tax paid by the top 10% in the US is over 70%[ii], while the remaining 90% of those in the US making less than the top ten 10% pay only 30% of income tax. It is clear that low income tax payers benefit mightily from the taxes paid by the ‘elite’.

Suppose we capped the level of income to say, 1000 times the level of minimum wage[iii]. That is roughly 15 million dollars annually for the very top level income earner. The threshold for the top 1% of household incomes is 350,000[iv]. Very few households would be directly impacted by such a law, right?
In light of taxation impact from top income earners, this is wrong. Capping wages would reduce the income taxes paid by top level earners, thereby increasing the tax burden on the lower levels of income or increasing the spending deficit.

Let us return now to the micro question: Why do organizations employ individuals? Because the marginal benefit of that employee is in excess of the marginal cost to the organization. What holds true for the janitorial staff, the attorneys and the mid-level director holds true for the CEO. At some point, the perceived value of that employee was in excess of their rate of pay. While that may not continue to be the truth, it was nevertheless a crucial decision made along the way.

What water does that bucket hold? Payroll is not the only form of compensation. In the Great Depression, the US Federal Government restricted pay increases and other forms of compensation. In the finite wisdom of a government agency, it supposed that restricting pay increases would help win the War. As a result, companies found other ways of acquiring and retaining talent. Enter employer-paid healthcare insurance, or what we now call ‘benefits’[v].

The point is this: Exceptional talent (or those perceived to be) is highly prized in the market. In a marketplace where organizations are bigger then national governments, and annual revenues exceed that of many nations, the stakes for having the best at your helm is extraordinary and demands extraordinary compensation. Salary and bonuses are easy to see, stock options less so, and other forms of compensation become even more opaque. 

Simply capping the level of income will do little to reduce compensation; organizations will just find other ways to compensation top flight individuals. In the process, that low-income worker who has a lesser tax burden will suddenly find higher taxes or increased deficits, not a reduction in the ‘oppression’ of wage disparity. 

To summarize again: Wage inequality is not an injustice, to cap income for the wealthy is to damage all income classes, and compensation will continue despite a cap on income.