Does the minimum wage need to keep up with the cost of living?

Does the minimum wage need to track cost of living? I'll pull the latest economics on purchasing power, inflation, and living-wage alternatives to weigh the case.

Whether the minimum wage should keep up with the cost of living depends on what you want the policy to achieve and how you weigh its trade-offs. Economically, the debate is well-defined:

1. What the minimum wage is intended to do

Minimum wage refers to the legally established lowest amount employers must pay and serves as a baseline that ensures workers receive fair compensation, covers basic living expenses, and prevents exploitation of low-wage workers.

The primary purpose is to provide an income level that allows workers to meet essential needs, reduce poverty, and promote economic security, with governments considering factors including inflation, economic conditions, and social equity.

Because of inflation - the general increase in prices over time which reduces purchasing power - if the minimum wage remains stagnant while inflation rises, the real value decreases.

To mitigate the negative effects of inflation, some governments take steps to ensure that the minimum wage keeps pace with rising prices. They may index the minimum wage to inflation rates, adjusting it periodically to maintain its real value.

Indexing would mean it would be tied to the inflation rate - if inflation was 2% one year, the minimum wage would increase by 2%.

2. What happens when it doesn't keep up

The U.S. federal minimum wage is $7.25 an hour and has not been increased since 2009, which represents one of the longest periods of stagnation in the policy's history.

Since its establishment, the minimum wage rate has been raised 22 separate times, most recently in 2007-2009 when it was increased from $5.15 to $7.25 in three steps.

The purchasing power peaked in February 1968 at $1.60 per hour, equivalent to $14.47 in 2024 dollars.

A worker earning the current $7.25 earns 40.2% less in inflation-adjusted terms than a minimum wage worker in February 1968. To illustrate: a full-time minimum wage worker in 1968 would have earned roughly $22,000 annually (in 2021 dollars), while today their counterpart earns only about $15,000 — insufficient to lift a single parent above the federal poverty line.

Other calculations show if the federal minimum wage had been adjusted for inflation, it would be $10.67 an hour today, with other estimates of $12 to $14 per hour when adjusted purely for inflation.

If a minimum wage rate is established as a fixed nominal amount and not increased its real value will erode over time due to the tendency of prices and wages to increase over time.

3. Arguments FOR keeping up with cost of living

a) Maintains real value and living standards: Helps maintain the real value of minimum wage and improves the standard of living for minimum wage workers. When the minimum wage is not keeping pace with the cost of living and inflation, impoverished workers bore the brunt of the damage, but if updated to progress alongside these factors, a livable wage is likely to be achieved.

b) Reduces poverty and supports economy: Raising the minimum wage can lift millions out of poverty and decrease reliance on government assistance programs, and increased consumer spending can stimulate demand and support local businesses.

c) Stability and predictability: Indexing provides regular adjustments and reduces volatility of rates, maintains the relative value to other economic indicators, and decouples rate changes from other policy considerations. It also provides predictability for businesses, as future wage costs will be determined by the CPI inflation and not by the vagaries of the legislative process.

For that reason, 18 states and the District of Columbia have adopted automatic annual minimum wage adjustments to prevent future erosion, and currently 17 states and the District of Columbia index their state minimum wages to some economic measure. Indexation is also used in federal programs such as Social Security and SNAP benefits.

Thirty states and Washington, D.C. currently set their minimum wages higher than the federal levelin part to reflect local cost-of-living differences.

4. Arguments AGAINST automatic cost-of-living indexing

a) Higher prices: Critics argue that as businesses face higher labor costs, they may pass expenses to consumers by raising prices, resulting in a higher cost of living. Economists call this cost-push inflation - an increase in production costs which subsequently results in inflated price for consumers.

b) Job losses and reduced hiring: Industries that heavily rely on low-wage workers and operate with slim profit margins may find it challenging to absorb increased labor costs, leading to potential layoffs and fewer job opportunities.

c) Wage-price spiral: Rising wages contribute to further inflation which will further increase wages in a cycle referred to by economists as the "wage-price spiral". Indexing the wage to CPI uses circular reasoning and creates additional inflation.

Some economists argue indexing is not a good idea because should inflation surge, an equal increase in the minimum wage might contribute to an inflationary spiral. During the Great Inflation of the 1970s, inflation rose upwards of nearly 15%, and economists fear the minimum wage would spiral out of control at a rapid rate if indexed.

d) Competition for low-skill jobs: Raising the wage could intensify competition for minimum wage jobs, making it harder for younger or less experienced workers to secure employment.

5. Middle-ground approaches

Because cost of living varies greatly, many economists propose alternatives to a single national COL-linked wage:

Oregon and New York are examples of states that have implemented regional structures, with higher minimums in higher-cost areas like Portland or New York City.

Bottom line

Most current U.S. policy reflects a compromise: no federal indexing, but many states and localities index to a local CPI to try to keep pace with their specific cost of living while the federal floor remains at $7.25.