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Optimal Minimum Wage Policy in Competitive Labor Markets

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Author Info
David Lee
Emmanuel Saez

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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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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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Handle: RePEc:nbr:nberwo:14320

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Find related papers by JEL classification:
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
J38 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Public Policy

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  25. Herwig Immervoll & Henrik Jacobsen Kleven & Claus Thustrup Kreiner & Emmanuel Saez, 2005. "Welfare Reform in European Countries: A Microsimulation Analysis," IZA Discussion Papers 1810, Institute for the Study of Labor (IZA). [Downloadable!]
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  29. 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. [Downloadable!] (restricted)
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  32. Lang, Kevin, 1987. "Pareto Improving Minimum Wage Laws," Economic Inquiry, Oxford University Press, vol. 25(1), pages 145-58, January.
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  34. Maya Bacache-Beauvallet & Etienne Lehmann, 2005. "Minimum Wage or Negative Income Tax: Why Skilled Workers May Favor Wage Rigidities," IZA Discussion Papers 1570, Institute for the Study of Labor (IZA). [Downloadable!]
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  35. repec:bep:eapcon:v:7:y:2007:i:1:p:1768-1768 is not listed on IDEAS
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