Minimum Wage Increase – Employee Impact

This post is from PaulL, regular commenter and occasional poster here at Kiwiblog. It follows on from the previous series on Effective Marginal Tax Rates (EMTR), looking at the minimum wage increase, who it benefits, and by how much. That series can be found here.

The government is increasing the minimum wage from $21.20 to $22.70 from 1 April next year. At the headline level this is a 7% increase, which is roughly the CPI increase in the past year. So this is an inflation adjustment, in real terms people on the minimum wage will stay exactly where they were.

But is that true? We know from the EMTR series that the abatement rates are a problem. We also know that the minimum wage is getting awfully close to the 30% tax rate, so bracket creep may mean that we’re not getting full inflation compensation.

Who is really getting the bulk of the minimum wage increase. Spoiler alert – for many of those most in need, the government will be pocketing 80% of the minimum wage increase. They’re asking businesses to pay more, but the lion’s share of that money is going directly into government coffers, not to the people they would profess to be helping.

Let’s dive into the numbers.

Firstly, we’ll look at a person working 40 hours per week. Their gross pay before was $848 per week, after the change they are getting $908 per week. That’s a 7.1% increase, so they are basically in the same place they started after allowing for inflation.

Their after tax pay was $718.45 per week before, after the increase their pay is $767.95, a 6.9% increase. They’re maybe 0.2% worse off after inflation, which isn’t much to worry about.

That’s pretty much as expected – at 40 hours you don’t break into the next tax bracket, and we’re not looking at any abatements.

Next, consider someone working 43 hours per week, relatively common for someone on minimum wage. Their gross before is $911.60, after it’s $976.10. As expected, they have been compensated for inflation. However, their after tax pay is $770.92 before, and $817.50 after, a 6% increase. Their after tax pay in real terms is 1% lower than before. This is entirely due to bracket creep. In real terms their gross pay hasn’t changed, but they’ve crept into a higher tax bracket – and all their additional pay is taxed at 30%. Their average tax rate is around 15%, so their additional pay is taxed higher than their average. Their total tax paid has moved from 15.4% to 16.2% because of bracket creep.

This is a problem, and it’s caused by the failure to index tax brackets (and because we now have much higher inflation than in the past). Going backwards by 1% isn’t massive, but for someone on the minimum wage that’s $8 a week in real terms that they’ve lost.

The bigger problem is when we get into people who are receiving any government support – a partial benefit, accommodation supplement, or working for families tax credits.

Consider someone who is a sole parent with two children, one between 3 and 5 years old, and one over 5 years. Because the youngest child isn’t in school yet they’re working 20 hours a week. Their household income before the minimum wage change was $869.14. After the minimum wage change their income is $874.14, an increase of $5 per week. Their $30 pay rise has mostly been clawed back by the government in abatements. While their pay went up 7% (the inflation rate), their household income has only increased 0.6%. They are 6.4% worse off in real terms, or $55 a week worse off than before the inflation and minimum wage increase. That would be a big impact on a household with two young children.

Of course, these people would be worse off still without the minimum wage increase. I’m not suggesting that there shouldn’t be a minimum wage increase. What I’m saying is that when the government claims it’s compensating the lowest paid for inflation, they’re not. Many of these people are worse off, whether because of bracket creep or because of abatements on government programmes. The people who aren’t worse off are the people with no other income, and who are working part time – i.e. students living at home, second income earners in a high income household. The poorest and those most in need are worst off.

This chart shows the impact, in real terms, on gross wage income, after tax wage income, household income for a sole parent, and household income for a single person with no dependents but with an accommodation supplement.

As can be seen:

• After tax from around 43 hours per week a worker is falling behind inflation by around 1%, this is caused by bracket creep
• A sole parent with two kids is going backwards by 5-6% almost irrespective of hours worked. The bulk of the increase in the minimum wage has been consumed by the government, almost none of it is turning into household income
• A single person with no dependents working part time is also losing most of their increase to accomodation or benefit abatement. As they get closer to full time it gets better, but still they’re falling behind by 2-3%, government is consuming half their minimum wage increase. This only improves once all their benefit and accommodation supplement abates – at around 44 hours per week of work.
• The dip to a loss of 10% for a sole parent at 42 hours work is due to them crossing an income threshold that reduces the subsidy for child care. I covered a solution to this in considering whether child support should be universal.

What is the point of all this? A few things:

1. People think that inflation hurts rich people. It doesn’t. Inflation has a major impact on poor people for exactly these reasons. Even with a very significant minimum wage increase many poor people are still much worse off. This is why the right wing, and economists in general, think inflation is bad. Not because they’re evil and hate the poor. Because they know it hurts the poor
2. Every generation seems to need to learn again that inflation is bad. It’s been 30 years since we had serious inflation, most people in power have forgotten about it. There’s still plenty around who know – Helen Clark, Don Brash, Richard Prebble, Jenny Shipley would all be able to articulate why we should have been careful about our monetary policy. We weren’t, we have a mess, and now it’s going to hurt a lot of low income people. We can’t change that now, but we can learn.
3. Inflation adjusting the minimum wage is better than nothing – I’m in no way arguing we shouldn’t have done it. These people would be worse off without that change.
4. Actually compensating these people for the cost of living pressure requires changing more than just the minimum wage – all these abatement rates/thresholds need to be touched, and the benefit rates will need to be changed. When inflation is only 2% you can get by with doing it every couple of years. At 7% it’s too big an impact – it will need to be done soon.
5. When the Labour government claims that they’ve inflation adjusted the minimum wage and it’s fine, realise that that’s not true. And when the media or people on twitter claim that these people are now OK for cost of living pressure, that’s also not true. And it’s especially not true for those most in need – sole parents with kids, people living on their own – those people receiving support from other government programmes.

The model used to create this chart is attached below: