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Economics, Governance, Investing

New thinking needed for low income earners

Workers on low incomes are losing out

Workers on low incomes are losing out, says John Humphreys in the Canberra Times, 29 June 2009

The Australian Fair Pay Commission decided last July to increase the minimum wage by $1126 per year, from $27,150 to $28,276.

At first glance, this appears like good news for low-income workers. But there is a catch. In fact, there are two.

Firstly, minimum-wage workers do not get to keep the entire wage increase. They have to pay $186 to the government in income tax and the Medicare levy. Not to mention GST and further taxes on fuel, alcohol, cigarettes, and foreign made clothes. After tax, a minimum-wage worker would have about an extra $800 to spend.

At the same time, with inflation running at 3.6% during 2007/08, the cost of living for a minimum-wage worker would have risen by about $800 per year.

Secondly, a rise in the minimum wage will rise the cost of labour and, consequently, decrease the demand for labour. This will lead to slightly higher unemployment.

The nominal minimum wage increase was 4.1%, but the real minimum wage rise (adjusted for inflation) was 0.5%.

Using a minimum wage elasticity of -0.29 (as determined by Australian National University economist Andrew Leigh) gives us an estimate of about 16,000 jobs lost (or not created) as a consequence of the 2008 minimum wage decision.

The heavily regulated labour market system, which is supposed to help poor people, has left low income workers no better off and 16,000 people out of work.

The commission will decide next month by how much it will increase the minimum wage. The economic situation facing the commissioners is very different to last year, but the basic trade-off remains the same. Whatever gains it gives to workers will be substantially reduced through tax and inflation, and will lead to relatively lower employment.

Instead of concentrating on minimum wage, the government could use the tax and transfer system. Tax cuts and transfer payments directly help workers and they don’t destroy jobs.

If the commission had gone on holiday last year instead of doing its job, the real minimum wage would have fallen by 3.6% (the inflation rate).

Most workers would still have received a pay rise at or above inflation, but those left on the minimum wage could be compensated by a reduction in taxes (or rise in transfer payments) to ensure their disposable income was stable or rising.

At the same time, the lower cost of labour would lead to a rise in the demand for labour. Using the same minimum wage elasticity as above, this would be expected to result in 113,000 new jobs. This represents a drop in unemployment of 1% in just one year, while ensuring low income workers are still protected.

The focus of the commission needs to change to achieve such a result. Instead of targeting a pre tax minimum wage, it should focus on after-tax disposable income. Once its annual after-tax goal has been set, the commission can offer alternatives for how this can be reached either through nominal minimum wage increases or tax cuts and transfer payments.

The final decision could then rest with the government, depending on its fiscal position and the priorities of the day.

While this would be a relatively minor change to one bureaucratic agency, it has the potential to change the dynamic of government wages policy. The goal of helping low-income workers would stay the same. But the new approach would not simply assume the only means to that end was the minimum wage.

Instead, the government could use whichever approach achieved its goals at the lowest cost.

John Humphreys is a Research Fellow with the Economics Program at the Centre for Independent Studies.

Full article here


About steveblizard

Steve Blizard commenced his financial planning career in 1988 from a background of life insurance broking, a field in which he still works. He is a member of the Financial Planning Association and the Responsible Investment Association. His experience ranges from administration of Superannuation to advice regarding insurance, retirement, remuneration and investment planning. Steve is an accredited Remuneration Consultant, specialising in salary packaging. He is a columnist for the Swan Magazine and the WA Business News


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