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Optimal minimum wage policy in competitive labor markets

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  • Lee, David
  • Saez, Emmanuel
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    Abstract

    This paper provides a theoretical analysis of optimal minimum wage policy in a perfectly competitive labor market and obtains two key results. First, 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. Importantly, this result remains true in the presence of optimal nonlinear taxes and transfers. In that context, a binding minimum wage enhances the effectiveness of transfers to low-skilled workers as it prevents low-skilled wages from falling through incidence effects. Second, when labor supply responses are along the extensive margin only, which is the empirically relevant case, the co-existence of a minimum wage with a positive tax rate on low-skilled work is always (second-best) Pareto inefficient. A Pareto improving policy consists of reducing the pre-tax minimum wage while keeping constant the post-tax minimum wage by increasing transfers to low-skilled workers, and financing this reform by increasing taxes on higher paid workers. Those results imply that the minimum wage and subsidies for low-skilled workers are complementary policies.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Public Economics.

    Volume (Year): 96 (2012)
    Issue (Month): 9-10 ()
    Pages: 739-749

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    Handle: RePEc:eee:pubeco:v:96:y:2012:i:9:p:739-749

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    Web page: http://www.elsevier.com/locate/inca/505578

    Related research

    Keywords: Minimum wage; Optimal taxation;

    References

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    Citations

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    Cited by:
    1. Lichter, Andreas & Peichl, Andreas & Siegloch, Sebastian, 2013. "Exporting and Labor Demand: Micro-Level Evidence from Germany," IZA Discussion Papers 7494, Institute for the Study of Labor (IZA).
    2. Skedinger, Per, 2014. "Effects of Payroll Tax Cuts for Young Workers," Working Paper Series 1031, Research Institute of Industrial Economics.
    3. Eliav Danziger & Leif Danziger, 2014. "A Pareto-Improving Minimum Wage," CESifo Working Paper Series 4762, CESifo Group Munich.
    4. Muravyev, Alexander & Oshchepkov, Aleksey, 2013. "Minimum Wages, Unemployment and Informality: Evidence from Panel Data on Russian Regions," IZA Discussion Papers 7878, Institute for the Study of Labor (IZA).
    5. Aart Gerritsen & Bas Jacobs, 2014. "Is a Minimum Wage an Appropriate Instrument for Redistribution?," CESifo Working Paper Series 4588, CESifo Group Munich.
    6. Heshmati, Almas & Kim, Jungsuk, 2014. "A Survey of the Role of Fiscal Policy in Addressing Income Inequality, Poverty Reduction and Inclusive Growth," IZA Discussion Papers 8119, Institute for the Study of Labor (IZA).
    7. Tomer Blumkin & Leif Danziger, 2014. "Deserving Poor and the Desirability of Minimum Wage Rules," CESifo Working Paper Series 4721, CESifo Group Munich.
    8. Jonathan Meer & Jeremy West, 2013. "Effects of the Minimum Wage on Employment Dynamics," NBER Working Papers 19262, National Bureau of Economic Research, Inc.
    9. Alexander Muravyev & Aleksey Oshchepkov, 2013. "Minimum wages and labor market outcomes: evidence from the emerging economy of Russia," HSE Working papers WP BRP 29/EC/2013, National Research University Higher School of Economics.
    10. Bas Jacobs, 2013. "From Optimal Tax Theory to Applied Tax Policy," CESifo Working Paper Series 4151, CESifo Group Munich.
    11. Laurence Jacquet & Etienne Lehmann & Bruno Linden, 2014. "Optimal income taxation with Kalai wage bargaining and endogenous participation," Social Choice and Welfare, Springer, vol. 42(2), pages 381-402, February.
    12. Blumkin, Tomer & Sadka, Efraim & Shem-Tov, Yotam, 2013. "A case for maximum wage," Economics Letters, Elsevier, vol. 120(3), pages 374-378.
    13. Richard A. Brecher & Till O. Gross, 2014. "A Minimum-Wage Model of Unemployment and Growth: The Case of a Backward-Bending Demand Curve for Labor," Carleton Economic Papers 14-05, Carleton University, Department of Economics.
    14. Danziger, Eliav & Danziger, Leif, 2014. "A Pareto-Improving Minimum Wage," IZA Discussion Papers 8123, Institute for the Study of Labor (IZA).
    15. Reich, MIchael & Jacobs, Ken & Bernhardt, Annette, 2014. "Local Minimum Wage Laws: Impacts on Workers, Families and Businesses," Institute for Research on Labor and Employment, Working Paper Series qt9pf1225f, Institute of Industrial Relations, UC Berkeley.

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