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Optimal Minimum Wage Policy in Competitive Labor Markets

  • Lee, David
  • Saez, Emannuel
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    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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    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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    Web page: http://www.escholarship.org/repec/iir_iirwps/

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    1. 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.
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    5. Reto Foellmi & Joseph Zweimüller, 2006. "Mass Consumption, Exclusion, and Unemployment," IEW - Working Papers 296, Institute for Empirical Research in Economics - University of Zurich.
    6. Emmanuel Saez, 2000. "Optimal Income Transfer Programs: Intensive Versus Extensive Labor Supply Responses," NBER Working Papers 7708, National Bureau of Economic Research, Inc.
    7. Jesse Rothstein, 2010. "Is the EITC as Good as an NIT? Conditional Cash Transfers and Tax Incidence," American Economic Journal: Economic Policy, American Economic Association, vol. 2(1), pages 177-208, February.
    8. 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.
    9. Herwig Immervoll & Henrik Jacobsen Kleven & Claus Thustrup Kreiner & Emmanuel Saez, 2007. "Welfare reform in European countries: a microsimulation analysis," Economic Journal, Royal Economic Society, vol. 117(516), pages 1-44, 01.
    10. Guesnerie Roger & Roberts Kevin, 1980. "Effective policy tools and quantity controls," CEPREMAP Working Papers (Couverture Orange) 8014, CEPREMAP.
    11. Mathis Hungerbühler & Etienne Lehmann, 2007. "On the Optimality of a Minimum Wage : New Insights from Optimal Tax Theory”," Working Papers 2007-17, Centre de Recherche en Economie et Statistique.
    12. 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..
    13. Freeman, Richard B, 1996. "The Minimum Wage as a Redistributive Tool," Economic Journal, Royal Economic Society, vol. 106(436), pages 639-49, May.
    14. 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.
    15. 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.
    16. Joseph E. Stiglitz, 1981. "Self-Selection and Pareto Efficient Taxation," NBER Working Papers 0632, National Bureau of Economic Research, Inc.
    17. David Lee & Emmanuel Saez, 2008. "Optimal Minimum Wage Policy in Competitive Labor Markets," NBER Working Papers 14320, National Bureau of Economic Research, Inc.
    18. Acemoglu, Daron, 2001. "Good Jobs versus Bad Jobs," Journal of Labor Economics, University of Chicago Press, vol. 19(1), pages 1-21, January.
    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. Guesnerie, Roger & Roberts, Kevin, 1987. "Minimum wage legislation as a second best policy," European Economic Review, Elsevier, vol. 31(1-2), pages 490-498.
    21. 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.
    22. Lang, Kevin, 1987. "Pareto Improving Minimum Wage Laws," Economic Inquiry, Western Economic Association International, vol. 25(1), pages 145-58, January.
    23. 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.
    24. 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.
    25. Juan J. Dolado & Florentino Felgueroso & Juan F. Jimeno, . "The Role of the Minimum Wage in the Welfare State: An Appraisal," Working Papers 2000-12, FEDEA.
    26. 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.
    27. Cahuc, P. & Michel, P., 1992. "Minimum Wage, Unemployment and Growth," Papiers d'Economie Mathématique et Applications 92.35, Université Panthéon-Sorbonne (Paris 1).
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