Working Paper: NBER ID: w14320
Authors: David Lee; Emmanuel Saez
Abstract: This paper provides a theoretical analysis of optimal minimum wage policy in a perfectly competitive labor market. We show that a binding minimum wage -- while leading to unemployment -- is nevertheless desirable if the government values redistribution toward low wage workers and if unemployment induced by the minimum wage hits the lowest surplus workers first. This result remains true in the presence of optimal nonlinear taxes and transfers. In that context, a minimum wage effectively rations the low skilled labor that is subsidized by the optimal tax/transfer system, and improves upon the second-best tax/transfer optimum. When labor supply responses are along the extensive margin, a minimum wage and low skill work subsidies are complementary policies; therefore, the co-existence of a minimum wage with a positive tax rate for low skill work is always (second-best) Pareto inefficient. We derive formulas for the optimal minimum wage (with and without optimal taxes) as a function of labor supply and demand elasticities and the redistributive tastes of the government. We also present some illustrative numerical simulations.
Keywords: minimum wage; redistribution; labor market; optimal taxation
JEL Codes: H21; J38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| binding minimum wage (J38) | unemployment (J64) |
| unemployment (J64) | affects those with the lowest surplus first (D63) |
| binding minimum wage (J38) | redistribution towards low-wage workers (F66) |
| optimal minimum wage (J38) | decreases with demand elasticity (D12) |
| optimal minimum wage (J38) | increases with supply elasticity (H31) |
| minimum wage and positive tax rates (H29) | second-best Pareto inefficient (D61) |
| reducing taxes on low-income workers while decreasing pre-tax minimum wage (J38) | Pareto improvements (D61) |