Should minimum wage track living costs? I'll pull recent research on purchasing power, inflation indexing, and both sides of the debate.
There is no single answer, but economically the purchasing power of a fixed minimum wage erodes if it does not keep up with cost of living.
1. What happens if it does not keep up
•The federal minimum wage is set by the Fair Labor Standards Act (FLSA). The FLSA does not require employers to adjust pay for inflation.
•The federal rate has been $7.25 per hour since 2009. That is 17 years without a raise, the longest period without an increase in the history of the federal minimum wage.
•Generally 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.
•Thus if the minimum wage rate remains fixed, the real value of the minimum wage will decline over time.
•Adjusted for inflation, $7.25 had already lost 27% of its purchasing power by mid-2022 and is now at its lowest real value in 70 years. In 1968 the inflation-adjusted value was $10.98 in 2016 dollars, far higher than today.
•The purchasing power of the minimum wage will continue to decline as long as "inflation increases", wages remain stagnant or not adjusted for inflation, and the cost of living rises.
One of the goals of the FLSA and the minimum wage specifically is to "correct and as rapidly as practicable to eliminate" labor conditions "detrimental to the maintenance of the minimum standard of living necessary for health, efficiency, and general well-being of workers."
2. Arguments that it should keep up - Indexation
Indexation is linking one variable's value to changes in another, independent variable (e.g., an average wage, cost of living).
•To maintain the relative value of a wage over time, that wage may be indexed to some measure in the economy. Indexation is one method of maintaining the relative value of the federal minimum wage to the price of other goods and services in the economy.
•For this reason, several states, but not the federal government, have attempted to maintain the value of their minimum wage rates by indexing the rate to some measure of inflation. This mechanism provides for automatic changes in the minimum wage over time as the index changes and does not require legislative action to make periodic adjustments.
Examples:
•Massachusetts passed a law in 2019 that requires the state's minimum wage to be adjusted annually based on inflation. This means that the minimum wage will continue to increase each year to keep up with rising costs of living.
•Florida will return to indexing its wage floor to inflation: September 30, 2027 will calculate adjusted wage based on CPI-W, January 1, 2028 newly calculated inflation-adjusted wage takes effect.
•New York: Indexing the minimum wage 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.
Arguments for this approach:
•Proponents argue that as the cost of living rises, the current minimum wage may not be enough to cover essential expenses such as housing, food, and healthcare.
•To prevent the 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.
•International standard: According to ILO Convention No. 131, minimum wage levels need to be "adjusted from time to time to take into account the changes in the cost of living and other economic conditions".
Advocates also claim indexing helps low-wage workers keep up with rising cost of living and gives employers "certainty" regarding when to expect wage increases, and that it provides relatively less volatile, more uniform changes, given that indices tend not to vary widely year to year.
3. Arguments against automatic cost-of-living indexing
•Initial value locks in erosion: Because there is a tendency for any index to increase over time, the initial value "locks in" past growth. If a minimum wage is set at one point and not increased through high inflation, then it loses real value. If indexation begins after inflation without adjusting initial value, then it locks in the erosion.
•Inflation feedback loop: Some economists argue should inflation surge, an equal increase in the minimum wage might contribute to an inflationary spiral. Related concern is that wage indexing can be seen as inflationary itself, and raising the minimum wage exerts inflationary pressure.
•Business costs and employment: Raising the minimum wage would increase the cost of labor for businesses, which could lead to layoffs or reduced hours for workers. Some argue businesses would increase their prices to cover the increased labor costs, or struggle to absorb additional labor costs, particularly small businesses.
•Reduced flexibility: With automatic wage increases, businesses might find it harder to adjust labor costs in response to changing market conditions.
•Policy process: Indexation would deemphasize congressional consideration of the minimum wage because changes would become automatic. It would generally decouple rate setting from other policy considerations related to wage setting, while requiring congressional action allows for the role of the minimum wage in the larger context of the economy (e.g., its relationship to poverty) to be considered with each rate change.
For these reasons, many indexed systems include limits - a "hold harmless" provision not to adjust downward, or a cap- and triggers that allow consideration of unemployment or economic growth before increase takes effect.
Bottom line
Legally, the federal minimum wage does not have to keep up — it changes only when Congress amends the FLSA. Economically, if it does not keep up, its real purchasing power falls. Whether it should is a policy choice about balancing maintaining a minimum standard of living against potential costs for employment, prices, and business flexibility. Most states that have adopted automatic indexing have chosen a middle path: periodic small inflation adjustments, often based on CPI-W or CPI-U, with off-ramps for economic downturns.