Minimum Wage, Part 3:
$5.15 to $7.25 per hour, in stages

4 Jan 2007 in Regulatory Economics, Regulatory Policy

Last fall we began series on the minimum wage because thew leadership of the 110th Congress has made raising it a high priority. In our initial post we provided some background on the statutory origins of the federal minimum wage. We followed up with figures from the bureau of Labor Statistics on how many workers were paid at or below the federal minimum, and some demographic characteristics about them.

Today the 110th Congress meets, and it appears that they will pass a minimum wage on January 10. To date, no legislative text has been made public so it's hard to analyze its likely effects. So we've gone back to the leading minimum wage bills authored by Democrat members in the 109th Congress, on the plausible assumption that one of these bills will be dusted off and presented for a vote in the House. (A Senate vote is less likely, as the majority leader cannot control debate and it isn't clear whether there are enough votes for passage.)

What are the likely effects of the leading minimum wage bill proposed in the 109th Congress?

According to the website of Sen. Edward Kennedy, the leadership plans to increase the federal minimum wage from $5.15 to $7.25 per hour. This increase would not occur all at once, but would proceed in stages. S. 2725 (introduced on May 4, 2006 by Sen. Clinton on behalf of herself and Sens. Kennedy, Jeffords, Leahy, Harkin, and Obama) has the following schedule:

$5.85 an hour beginning on the 60th day after enactment
$6.55 an hour beginning 12 months after the 60th day after enactment
$7.25 an hour beginning 24 months after the 60th day after enactment

All but the first of these rates would be indexed by a statutorily-defined inflation rate equal to cost of living adjustments provided to Members of Congress pursuant to the Legislative Reorganization Act of 1946, which reads as follows in 2 U.S.C. 31(2):

Subject to subparagraph (B), effective at the beginning of the first applicable pay period commencing on or after the first day of the month in which an adjustment takes effect under section 5303 of title 5 in the rates of pay under the General Schedule, each annual rate referred to in paragraph (1) shall be adjusted by an amount, rounded to the nearest multiple of $100 (or if midway between multiples of $100, to the next higher multiple of $100), equal to the percentage of such annual rate which corresponds to the most recent percentage change in the ECI (relative to the date described in the next sentence), as determined under section 704(a)(1) of the Ethics Reform Act of 1989. The appropriate date under this sentence is the first day of the fiscal year in which such adjustment in the rates of pay under the General Schedule takes effect.
In no event shall the percentage adjustment taking effect under subparagraph (A) in any calendar year (before rounding), in any rate of pay, exceed the percentage adjustment taking effect in such calendar year under section 5303 of title 5 in the rates of pay under the General Schedule.

The keys to paragraph (A) are:

Section 704(a)(1) of the Ethics Reform Act of 1989.
The Employment Cost Index published by the Bureau of Labor Statistics.
The methods by which changes in the ECI are calculated for the purpose of indexing under section 704(a)(1).
The special calculation method that 2 U.S.C. 31(2) layers on top.

Section 704 states the version to use is the one for "wages and salaries, private industry workers" found on the top row here.

WHAT IS SECTION 704(a)(1) OF THE ETHICS REFORM ACT OF 1989?

The text is reproduced below. It provides a specific formula for calculating increases.

WHAT IS THE ECI?

The Employment Cost Index is actually a set of different measures of labor cost. Some include wages and salaries only; others include fringe benefits. Section 704 specifies the version capturing "wages and salaries, private industry workers."

WHAT METHOD DOES SECTION 704(a)(1) USE TO CALCULATE THE INDEX?

One thing is certain from reading the text: it's complicated. Let's work out an example. To get the value of the ECI for the "base quarter," which we will set to December 31, 2005, we need the following inputs:

The value of the ECI for the "last base quarter prior to that date," which would be December 31, 2004.
The value of the ECI for the "second to last base quarter prior to that date, which would be December 31, 2003.

The ECI for 12/31/2003 is subtracted from the ECI for 12/31/2004 and the result is divided by the ECI for 12/31/2003, and the result of that is multiplied by 100. Now, round that number to the nearest 0.1% and subtract 0.5%. The final result is capped at the low end by 0% and the high end by 5%. This means ECI increases are attenuated by one-half percent, but at the same time, any declines in the ECI are ignored. Assuming the ECI is an unbiased measure of private sector wages and salaries, salary adjustments based on section 704 will not necessarily "keep pace" with actual private sector wages and salaries.

Here is how the calculation works for January 1, 2006, using data obtained from BLS:

ECI for 12/31/2004	97.6
ECI for 12.31/2003	95.1
ECI for 12/31/2004 less ECI for 12.31/2003	2.5
Divide difference by ECI for 12/31/2003	0.026288
Multiply by 100 to obtain %	2.6288%
Round to nearest 0.1%	2.6%
Subtract 0.5 percentage point	2.1%
Apply cap (0% < X < 5%	2.1%
Section 704(a)(1) wage adjustment for 2006	2.1%

The the record, if the ECI for 2005:Q4 (which was not available at the beginning of 2006) is used instead, the simple year-on year adjustment would have been (100.0 - 97.6)/97.6*100) - 0.5 = 2.0%

WHAT ABOUT THE COST OF LIVING ADJUSTMENTS SET FORTH IN 2 U.S.C. 31(2)?

That's where we began, and now we have to sort out that language. Fortunately, all it does is direct that the percentage increases performed in the calculation above be applied to annual salary rates for Members of Congress and round them to the nearest $100. (Subparagraph (B) says these adjustments cannot be greater in percentage terms to those provided to federal employees serving under the GS schedule.)

SETTING WAGES BASED ON A WAGE INDEX

A general problem with paying wages and salaries based on a wage and salary index is that it establishes a perpetual raise-cycle independent of inflation or any other justification for increasing wages. Any increase in wages causes the ECI to rise, and if wages are set based on the ECI, they must rise again when the ECI increases. The problem is worse if the version of the ECI used includes fringe benefits; in that case, increases in, say, the cost of employer-provided health insurance would lead to increases in wages and salaries. In both cases, however, there is no equilibrium wage, and there is a built-in bias in favor of wage increases attenuated only by the arbitrary 0.5 percentage point reduction in the index.

For Members of Congress, section 704 uses a version of the ECI that does not have this attribute. It covers wages and salaries only of private sector workers, so increases in Members' salaries cannot affect the ECI used to set future Members' salaries.

SETTING FEDERAL MINIMUM WAGES BASED ON A WAGE INDEX

The built-in bias in favor of rising wages that is not found in section 704 would be retained under S. 2725. That's because rising minimum wages would be captured by the ECI, and as the ECI increases the minimum wage would subsequently increase to reflect the rising ECI. Thus, even if no other increases in wages and salaries occur, the $0.70 per hour increase that occurs 60 days after enactment will be reflected in subsequent ECIs. To the extent that this increases the ECI, it will cause the second and third statutory increases in the minimum wage to increase further.

It should be recognized that the proposed index would not provide "cost of living adjustments" for workers earning the minimum wage. The ECI has nothing to do with the cost of living; a doubling of wages without any increase in the cost of living would cause the ECI to double. With one important exception, what S. 2725 does is ensure that the federal minimum wage remains the same fixed fraction of general wages and salaries. And if the point is to make sure the lowest-paid workers continue to earn this fraction, In principle one could imagine that if enacted this would be the last time Congress changed the federal minimum wage.

That principle seems likely to run aground on the exception alluded to above -- the exception being the 0.5 percentage point subtraction from the calculation, as set forth in section 704 of the Ethics Reform Act of 1989. In our sample calculation above, that subtraction took away 20% of the potential value of the wage increase. The smaller annual wage and salary increases are, the greater would be the loss caused by the subtraction. For that reason, it should be expected that advocates for rising minimum wages will also soon to reduce or eliminate it.

There is another oddity in S. 2725 -- linking the federal minimum wage (which applies to the least experienced and least skilled workers in the market) to the salaries of Members of Congress. This appears to be a matter of political symbolism, as there are many other indices that could have been used instead but this is the only one that nominally places Members of Congress on the same plane as unskilled workers. There is certainly no obvious economic argument for the linkage. Trying to think in incentive terms, possibly advocates think that by linking the federal minimum wage to congressional salaries, S. 2725 could encourage Members to develop a personal interest in future changes to the minimum wage formula.

There is one other important economic difference. The market demand for Members of Congress is inelastic with respect to the salaries they are paid. There will always be 535 of them, whether their salaries are doubled or halved. For workers earning the minimum wage, however, increases will result in some of them losing their jobs.

Tech Tags: labor markets , minimum wage , 110th Congress , S. 2725 , wage indexing

Ethics Reform Act of 1989 (excerpts)

SEC. 704. REVISION IN METHOD BY WHICH ANNUAL PAY ADJUSTMENTS FOR CERTAIN EXECUTIVE, LEGISLATIVE, AND JUDICIAL POSITIONS ARE TO BE MADE.

PERCENT CHANGE IN THE EMPLOYMENT COST INDEX-
1. METHOD FOR COMPUTING PERCENT CHANGE IN THE ECI-
  1. DEFINITIONS- For purposes of this paragraph--
    1. the term `Employment Cost Index' or `ECI' means the Employment Cost Index (wages and salaries, private industry workers) published quarterly by the Bureau of Labor Statistics; and
    2. the term `base quarter' means the 3-month period ending on December 31 of a year.
  2. METHOD- For purposes of the provisions of law amended by paragraph (2), the `most recent percentage change in the ECI', as of any date, shall be one-half of 1 percent less than the percentage (rounded to the nearest one-tenth of 1 percent) derived by--
    1. reducing--
      1. the ECI for the last base quarter prior to that date, by
      2. the ECI for the second to last base quarter prior to that date,
    2. dividing the difference under clause (i) by the ECI for the base quarter referred to in clause (i)(II), and
    3. multiplying the quotient under clause (ii) by 100,

except that no percentage change determined under this paragraph shall be--

less than zero; or

greater than 5 percent.

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