The minimum wage and cost of living is a contested economic question - I'll review current research on purchasing power and indexing.
Whether the minimum wage should keep up with the cost of living is a policy debate, not a legal requirement at the federal level. "Keeping up" generally means indexing the wage to a measure of inflation, such as the Consumer Price Index (CPI), so its purchasing power stays constant.
What "keeping up" means
Indexing ties the wage to the general price level, rather than setting it in nominal terms. As one analysis notes, because hourly minimums are set in nominal terms rather than being indexed to the general price level, inflation reduces their adverse effects on employment.
Proponents describe the goal as ensuring the value of minimum wage will remain constant and wages will not lose value over time. Indexing is described as a popular tool for legislators to make sure that wages, once they are passed, are not eroding due to inflation.
In practice, many jurisdictions already do this:
•About 12 states have a minimum wage that rises automatically each year based on a cost-of-living formula.
•Of the 47 states, cities and counties raising minimum wages, about half are doing so automatically based on the consumer price index.
•That will be the case in 24 jurisdictions early next year, including Alaska, Florida, Minnesota, Montana, Ohio, South Dakota and Vermont, as well as Seattle and a host of cities in California.
Historical context for the purchasing power question
The federal minimum wage has been $7.25 per hour since Congress last raised it in 2009.
•Adjusted for inflation, the federal minimum wage peaked in 1968 at $8.68 (in 2016 dollars). Since it was last raised in 2009, to the current $7.25 per hour, the federal minimum has lost about 9.6% of its purchasing power to inflation.
•Another calculation found since it was last raised by Congress in 2009, inflation has cut its purchasing power by 17%.
•The real value of the federal minimum wage in 2022 dollars has decreased by 46% since its inflation-adjusted peak in February 1968.
•The minimum wage would be over $14 in 2024 dollars if its real value had remained at the 1968 level.
Arguments for keeping the minimum wage tied to cost of living
1.Maintain purchasing power and avoid periodic erosion: Supporters argue local minimum-wage laws can help ensure that workers can afford housing, food, and other basic necessities in locations where the cost of living is higher. Without indexing, additional large increases will not be required in the future and major economic impact will be avoided if adjustments are gradual and automatic.
2.Stability and fairness: Pros of indexing described include stability and predictability, inflation protection, wage fairness, and the reduction of economic shocks and uncertainty.
3.Reduced reliance on public assistance and stimulus: Some research cited argues increasing the minimum wage lifts earnings for low-wage workers, with little to no impact on employment, and decreases poverty by increasing incomes of low-income families. Other work finds businesses adjust through channels such as reduced worker turnover, consumer price increases, and reallocation of workers to higher-paying establishments.
4.Political and administrative efficiency: Making the annual minimum wage hike a routine administrative function enables legislators to not have to delve into the controversial issue of the minimum wage.
Arguments against automatic cost-of-living indexing
1.Employment effects: Opponents argue raising the minimum wage will reduce low-wage workers' employment, and that the body of evidence points strongly toward negative effects of minimum wages on employment of less-skilled workers. One economist argues that where the minimum wage is $13, $14 or $15 per hour, it’s hard to imagine many businesses being able to absorb that cost only through higher prices, higher productivity and reduced turnover.
2.Price increases and inflation: Critics argue the likelihood that businesses may raise prices as a result of raising the minimum wage is one of the drawbacks, as it will encourage inflation. Higher wages increase the cost to employers of producing goods and services, and any increase in salaries will be at least partly offset by higher prices they have to pay as consumers. This price effect may harm the very people whom a minimum wage is supposed to help.
3.Risks of automatic indexing: Cons of indexing cited include the risk of over-indexing, the possibility of increased inflation, and the potential for wage and price stagnation.
4.Regional variation: A nationwide minimum tied to a national cost of living may not reflect local conditions. Labor markets across America vary enormously, with arguments that a single federal floor is a blunt policy that does not reflect local productivity, prices, and labor market conditions. Conversely, some evidence cited by supporters finds there is very little evidence of businesses migrating to lower minimum-wage states, and that there is well-documented evidence of workers crossing state lines to higher minimum wages.
5.Alternative tools: Some economists argue policies like the Earned Income Tax Credit (EITC) are better targeted than the minimum wage toward low-income families, noting many low-wage workers are not in poor families and many poor families have no workers.
In short, if the policy goal is to preserve the real purchasing power of the lowest-paid workers without requiring new legislation every few years, indexing to cost of living achieves that. If the goal is to maximize employment flexibility, avoid potential price-wage pressures, and allow wages to reflect local labor market conditions and productivity, an automatic national cost-of-living increase may be seen as counterproductive. Many states and localities have chosen a middle approach: setting a higher base than the federal minimum and then indexing that base to inflation.