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Optimal Minimum Wage Policy in Competitive Labor Markets

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  • Lee, David
  • Saez, Emannuel
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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 re- sponses are along the extensive margin only, the co-existence of a minimum wage with a positive tax rate on low-skilled work is always (second-best) Pareto ineffcient. 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. Overall, our results imply that the minimum wage and subsidies for low-skilled workers are complementary policies. pa

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    Bibliographic Info

    Paper provided by Institute of Industrial Relations, UC Berkeley in its series Institute for Research on Labor and Employment, Working Paper Series with number qt07w2z7t6.

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    Date of creation: 29 Jan 2010
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    Handle: RePEc:cdl:indrel:qt07w2z7t6

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    1. Nichols, Albert L & Zeckhauser, Richard J, 1982. "Targeting Transfers through Restrictions on Recipients," American Economic Review, American Economic Association, vol. 72(2), pages 372-77, May.
    2. Besley, Timothy & Coate, Stephen, 1992. "Workfare versus Welfare Incentive Arguments for Work Requirements in Poverty-Alleviation Programs," American Economic Review, American Economic Association, vol. 82(1), pages 249-61, March.
    3. Immervoll, Herwig & Kleven, Henrik Jacobsen & Kreiner, Claus Thustrup & Saez, Emmanuel, 2004. "Welfare reform in European countries: a micro-simulation analysis," EUROMOD Working Papers EM1/04, EUROMOD at the Institute for Social and Economic Research.
    4. Edward L. Glaeser & Erzo F. P. Luttmer, 1997. "The Misallocation of Housing Under Rent Control," NBER Working Papers 6220, National Bureau of Economic Research, Inc.
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    6. Tomer Blumkin & Efraim Sadka, 2005. "Income Taxation and Wage Policy: An Application to Minimum Wage," International Tax and Public Finance, Springer, vol. 12(6), pages 713-722, November.
    7. Dolado, Juan J. & Felgueroso, Florentino & Jimeno, Juan Francisco, 2000. "The Role Of The Minimum Wage In The Welfare State: An Appraisal," CEPR Discussion Papers 2452, C.E.P.R. Discussion Papers.
    8. David Neumark & William Wascher, 2006. "Minimum Wages and Employment: A Review of Evidence from the New Minimum Wage Research," Working Papers 060708, University of California-Irvine, Department of Economics, revised Jan 2007.
    9. Emmanuel Saez, 2000. "Optimal Income Transfer Programs: Intensive Versus Extensive Labor Supply Responses," NBER Working Papers 7708, National Bureau of Economic Research, Inc.
    10. Neary, J. P. & Roberts, K. W. S., 1980. "The theory of household behaviour under rationing," European Economic Review, Elsevier, vol. 13(1), pages 25-42, January.
    11. Rebitzer, James B. & Taylor, Lowell J., 1995. "The consequences of minimum wage laws Some new theoretical ideas," Journal of Public Economics, Elsevier, vol. 56(2), pages 245-255, February.
    12. Foellmi, Reto & Zweimüller, Josef, 2006. "Mass Consumption, Exclusion and Unemployment," CEPR Discussion Papers 5824, C.E.P.R. Discussion Papers.
    13. David Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," NBER Working Papers 14320, National Bureau of Economic Research, Inc.
    14. Guesnerie Roger & Roberts Kevin, 1980. "Effective policy tools and quantity controls," CEPREMAP Working Papers (Couverture Orange) 8014, CEPREMAP.
    15. Herwig Immervoll, 2007. "Minimum Wages, Minimum Labour Costs and the Tax Treatment of Low-Wage Employment," OECD Social, Employment and Migration Working Papers 46, OECD Publishing.
    16. Acemoglu, Daron, 2001. "Good Jobs versus Bad Jobs," Journal of Labor Economics, University of Chicago Press, vol. 19(1), pages 1-21, January.
    17. David Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," Working Papers 1099, Princeton University, Department of Economics, Center for Economic Policy Studies..
    18. Hungerbühler, Mathias & Lehmann, Etienne, 2007. "On the Optimality of a Minimum Wage: New Insights from Optimal Tax Theory," IZA Discussion Papers 2957, Institute for the Study of Labor (IZA).
    19. David S. Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," Working Papers 1105, Princeton University, Department of Economics, Industrial Relations Section..
    20. Cahuc, P. & Saint-Martin, A. & Zylberberg, A., 2001. "The consequences of the minimum wage when other wages are bargained over," European Economic Review, Elsevier, vol. 45(2), pages 337-352, February.
    21. Joseph E. Stiglitz, 1982. "Self-Selection and Pareto Efficient Taxation," NBER Working Papers 0632, National Bureau of Economic Research, Inc.
    22. Freeman, Richard B, 1996. "The Minimum Wage as a Redistributive Tool," Economic Journal, Royal Economic Society, vol. 106(436), pages 639-49, May.
    23. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
    24. Lang, Kevin, 1987. "Pareto Improving Minimum Wage Laws," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 145-58, January.
    25. Guesnerie, Roger & Roberts, Kevin, 1987. "Minimum wage legislation as a second best policy," European Economic Review, Elsevier, vol. 31(1-2), pages 490-498.
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    Cited by:
    1. Mirco Tonin, 2007. "Minimum Wage and Tax Evasion: Theory and Evidence," William Davidson Institute Working Papers Series wp865, William Davidson Institute at the University of Michigan.
    2. Edmark, Karin & Liang, Che-Yuan & Selin, Håkan & Mörk, Eva, 2012. "Evaluation of the Swedish earned income tax credit," Working Paper Series 2012:3, Uppsala University, Department of Economics.

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