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

Should the minimum wage track living costs? I'll examine current data on inflation, purchasing power, and policy arguments.

Does the minimum wage need to keep up with the cost of living? Legally and economically, it depends on what you want the minimum wage to do.

1. What the minimum wage was designed to do

When Congress created the federal minimum wage in 1938 at 25 cents per hour through the Fair Labor Standards Act, it was described as protecting workers from "the evils and dangers resulting from wages too low to buy the bare necessities of life".

Original proposals would have updated the wage according to changes in the standard of living and inflation, but the version that became law left future increases to Congress and the president. That political system has led to inconsistency.

2. What happens when it doesn't keep up

If the nominal wage stays the same while prices rise, its purchasing power erodes.

That has happened:

•The federal minimum wage has been $7.25 per hour since July 2009, which is also the current federal rate noted as unchanged since 2009.

•Consumer prices have risen by more than 30% since the minimum wage was last adjusted in 2009.

•The minimum wage's 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.

In that sense, the legal floor bears no relation to the cost of living and is described as an arbitrary amount. Because the policy has not kept pace with inflation, the federal minimum wage fails to provide a minimum standard of living in many areas.

A full-time worker at $7.25 for 40 hours x 52 weeks grosses $15,080 per year before taxes, just slightly above the $13,590 poverty guideline for individuals. Advocates therefore distinguish between a minimum wage - the floor required by law - and a living wage - the pay sufficient to meet basic needs like housing, food, medical care, transportation and childcare without government assistance.

Advocates who support indexing argue:

•Tying the wage to inflation was more fair and addresses the difficulty of raising a family on the current minimum

•Indexing ensures the wage keeps pace with the cost of living, with a 2% inflation rise leading to a 2% wage rise

•It protects low-wage workers from declines in their standard of living due to eroding real value and offers employers predictable and steady changes

•Poverty reduction is cited as a benefit

In practice, 18 states and the District of Columbia have adopted automatic annual adjustments to prevent future erosion.

Examples:

•In Washington, the minimum wage is subject to Cost of Living Adjustments (COLA), which means it automatically increases based on changes in the cost of living

•In Montana, the minimum wage is adjusted annually by the COLA based on changes in the Consumer Price Index (CPI)

•Some states do not: The Florida minimum wage does not automatically adjust for inflation or changes in the cost of living

3. Arguments for not automatically tying it to cost of living, or doing so cautiously

Opponents and some economists raise different concerns:

•Job losses: Higher minimum wages can lead to job losses, particularly among low-skilled workers

•Higher labor costs for businesses: Raising the minimum wage would increase the cost of labor for businesses, which could lead to layoffs or reduced hours, and make it more difficult for small businesses to compete

•Inflation pass-through: A study concluded there is a moderate pass-through effect with a 10% minimum wage hike leading to a 0.36% increase in overall prices, and critics argue businesses would increase prices to cover increased labor costs

•Locking in a low wage: Indexing the minimum wage from a low level will keep it at a low level, valuing work too little and leaving workers unable to support themselves. It locks the wage in place rather than raising it relative to prices.

•Runaway during high inflation/recession: During periods of high inflation, price-based indexing will lead to a runaway minimum wage that causes economic harm. Economists fear that if inflation rose to nearly 15% as in the 1970s, the minimum wage would spiral out of control, and average wage growth can lag price increases during recessions.

•Permanency effect: Firms may respond to the permanency of increases, knowing those increases won't be eroded by inflation, by changing production to rely less on low-wage labor.

Some research suggests the employment effect is small. A poll by the Chicago Booth School found a majority of top economists agreed that "the distortionary costs of raising the federal minimum wage to $9 per hour and indexing it to inflation are sufficiently small compared with the benefits to low-skilled workers who can find employment that this would be a desirable policy". Other studies find strong earnings effects and no employment effects in some contexts, but the debate remains alive.

4. Bottom line

•If the goal of the minimum wage is to be a wage floor that preserves purchasing power - so that full-time work keeps a worker out of poverty and buys the same basket of goods year to year - then yes, it needs to be indexed to some measure of the cost of living, like CPI-U or CPI-W, or to average wages.

•If the goal is to allow the labor market, regional cost differences, and business conditions to set entry-level wages with government setting only a bare minimum, then automatic cost-of-living indexing may be seen as unnecessary or harmful, especially at the federal level where living costs vary widely by state.

That is why the U.S. has a patchwork: the federal wage has not kept up, now at its lowest real value in decades and longest period without an increase, while states that view keeping up as essential have adopted their own indexing.

Citations (2)

1politiverse.comNews and media
The Federal Minimum Wage: Eight Decades of Declining Purchasing Power
Backs: “Legally and economically, it depends on what you want the minimum wage to do. 1. What the minimum wage was designed to do”
2epi.orgNonprofits and think tanks
Securing the wage floor: Indexing would maintain minimum wage value, provide predictability to employers
Backs: “When Congress created the federal minimum wage in 1938 at 25 cents per hour through the Fair Labor Standards Act, it was described as protecting workers from "the evils and dangers resulting from wages too low to buy the bare necessities of life". Original proposals would have updated the wage according to changes in…”