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

This question touches on economics, history and policy — I'll gather current data on how the minimum wage relates to cost-of-living trends.

Does the minimum wage need to keep up with the cost of living? There is no single economic answer - it depends on what you want the minimum wage to do, and how you balance trade-offs. Here are the main considerations:

1. What "keeping up" means

Keeping up usually means indexing - adjusting the wage automatically to keep pace with the rising cost of living so that workers do not lose purchasing power each year.

Without such adjustments, if a minimum wage rate is fixed as a nominal amount and not increased, its real value will erode over time due to the tendency of prices and wages to increase over time. In general, to maintain the relative value of a wage over time, that wage may be indexed to some measure in the economy.

Put another way, not indexing or increasing it implicitly lowers its value.

2. Historical context

In 1938, the Fair Labor Standards Act established a federal minimum wage of $0.25 per hour. The minimum wage has been raised 22 separate times, most recently in 2007-2009 when it was increased from $5.15 to its current rate of $7.25. The federal minimum wage changes only when Congress amends the FLSA.

Accounting for inflation, the real value peaked in February 1968 at $1.60, which is about $9.70 in May 2021 dollars. The value since 1968 has eroded due to wage increases not keeping up with inflation.

Other calculations show today's $7.25 is worth about 33 percent less than it was in 1968, the year of its peak adjusted value, and has not kept pace with the cost of living.

3. Arguments for keeping up with cost of living

Proponents argue:

•Protect purchasing power: Indexing to inflation will ensure that workers' wages keep up with the rising cost of living, which is especially important for low-wage workers who are often the most vulnerable to economic challenges. To prevent erosion of purchasing power, minimum wage levels could be automatically adjusted based on inflation rates. This ensures that wage growth keeps pace with the cost of living.

•Reduce poverty and inequality: The arguments for raising the minimum wage include reduced in-work poverty, a reduction in inequality, an incentive to increase labour productivity and higher wages leading to increased economic growth.

•Help incomes keep pace: Proponents argue that changes are needed to help incomes keep pace with increasing costs of living, and a higher minimum wage will lift millions out of poverty.

•Predictability and less volatility: Indexing provides regular adjustments to and reduces the volatility of minimum wage rates, maintains the relative value to other economic indicators, and decouples rate changes from other policy considerations.

Evidence from states is often cited: Indexing in the states has been a success - in states that index wages have maintained purchasing power without adverse effects.

4. Arguments against automatic cost-of-living increases

Opponents caution:

•Business costs, employment, and prices: On the negative side, increasing minimum wages too fast could cause a rise in business costs, a rise in unemployment, and higher prices for consumers.

•Inflation and competitiveness: Opponents believe higher wages could lead to inflation, making companies less competitive, and resulting in job losses. Raising the minimum wage would increase the cost of labor, which could lead to layoffs or reduced hours.

•Regional differences: Even proponents would have to concede that a universally applied minimum wage, without adjustments for significant differences in cost of living across the country, has to have disproportionate effects by location. A nationwide minimum wage suitable for a high-cost city may have a greater impact on poor, low-wage regions where a rise will have a greater effect on unemployment.

•Loss of legislative oversight: Indexation may also reduce regular oversight of minimum wage changes because it automatically adjusts the rate.

•Tipping point: Research suggests that while moderate increases have had negligible employment effects, there is a tipping point at which increases will have a negative effect - particularly if minimum wages are increased over 60% of median wages.

5. How "keeping up" is actually done

If policymakers decide the wage should keep up, there are different ways to design it:

•Most common indices: The most common proposed indices include different versions of the Consumer Price Index, personal consumption expenditures, employment costs, and hourly earnings.

•Current state practice: Currently 20 states and DC that currently or eventually will use indexation. Specifically, 6 states index to the national Consumer Price Index for All Urban Consumers (CPI-U) and 7 states index to the national Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). By one count, 19 states plus D.C. automatically raise their minimum wage each year based on inflation (usually CPI-W).

•Policy features: Some laws include an "off-ramp" available in the event of certain economic or budget conditions. This provision ensures the minimum wage can be adjusted to accommodate unforeseen economic conditions.

Bottom line

•If the goal of the minimum wage is to be a living wage or wage floor that maintains the same purchasing power over time, then logically it needs to be indexed or regularly raised to match inflation. Otherwise, inflation will gradually erode it.

•If the goal is to be an entry-level or starter wage that balances employer costs, employment opportunities for low-skill workers, and regional economic differences, then automatic cost-of-living increases may be seen as too rigid, especially at a single national level.

For that reason, many recent proposals and state laws combine both approaches: a scheduled increase to a target level, followed by automatic indexing to a price index like CPI-U or CPI-W, sometimes with regional variations and off-ramps for recessions.

Citations (3)

1congress.govGovernment
The Federal Minimum Wage: Indexation
Backs: “Keeping up usually means indexing - adjusting the wage automatically to keep pace with the rising cost of living so that workers do not lose purchasing power each year. Without such adjustments, if a minimum wage rate is fixed as a nominal amount and not increased, its real value will erode over time due to the…”
2econofact.orgAcademic
Fact Check: Is the federal minimum wage today low by historical standards? | Econofact
Backs: “The federal minimum wage changes only when Congress amends the FLSA. Accounting for inflation, the real value peaked in February 1968 at $1.60, which is about $9.70 in May 2021 dollars.”
3economicshelp.orgCommercial contentquality 0.84
Pros and cons of raising the minimum wage - Economics Help
Backs: “Regional differences: Even proponents would have to concede that a universally applied minimum wage, without adjustments for significant differences in cost of living across the country, has to have disproportionate effects by location. A nationwide minimum wage suitable for a high-cost city may have a greater impact…”