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Optimal Minimum Wage Policy in Competitive Labor Markets

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  • 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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14320.

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Date of creation: Sep 2008
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Publication status: published as “Optimal Minimum Wage Policy in Competitive Labor Markets,” with Emmanuel Saez, Journal of Pub lic Economics, 96(2012), 739 - 749.
Handle: RePEc:nbr:nberwo:14320

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Minimum wages and optimal taxes
    by Economic Logician in Economic Logic on 2009-02-23 14:11:00
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Cited by:
  1. Laurence Jacquet & Etienne lehmann & Bruno Van Der Linden, 2012. "Optimal Redistributive Taxation with both Labor Supply and Labor Demand Responses," THEMA Working Papers, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise 2012-26, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  2. Laurence Jacquet & Etienne Lehmann & Bruno Linden, 2014. "Optimal income taxation with Kalai wage bargaining and endogenous participation," Social Choice and Welfare, Springer, Springer, vol. 42(2), pages 381-402, February.
  3. Chetty, Nadarajan, 2009. "Sufficient Statistics for Welfare Analysis: A Bridge Between Structural and Reduced-Form Methods," Scholarly Articles 9748528, Harvard University Department of Economics.
  4. Hungerbühler, Mathias & Lehmann, Etienne, 2009. "On the optimality of a minimum wage: New insights from optimal tax theory," Journal of Public Economics, Elsevier, Elsevier, vol. 93(3-4), pages 464-481, April.
  5. Lee, David & Saez, Emannuel, 2010. "Optimal Minimum Wage Policy in Competitive Labor Markets," Institute for Research on Labor and Employment, Working Paper Series, Institute of Industrial Relations, UC Berkeley qt07w2z7t6, Institute of Industrial Relations, UC Berkeley.
  6. Lee, David & Saez, Emmanuel, 2012. "Optimal minimum wage policy in competitive labor markets," Journal of Public Economics, Elsevier, Elsevier, vol. 96(9-10), pages 739-749.

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