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

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

Does the minimum wage need to keep up with cost of living is a policy question, but economically there are strong arguments for and against linking it to inflation. The debate is not just about the level, but whether it should automatically adjust.

1. What happens if it doesn't keep up

If a minimum wage is set at one point in time and not increased through a period of high consumer price inflation, then it loses real value (i.e., purchasing power) despite having the same nominal value.

More 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.

For example:

•The U.S. federal minimum wage remains at $7.25 per hour, a rate that has not been increased since 2009 and now represents the lowest purchasing power for American workers in over 70 years when adjusted for inflation. In 1968 the minimum wage reached its peak purchasing power, worth roughly $15 in today's dollars.

•To maintain the relative value of a wage over time, that wage may be indexed to some measure in the economy. One of the goals of the Fair Labor Standards Act 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".

Proponents of raising minimum wages argue that changes are needed to help incomes keep pace with increasing costs of living. The argument is that wages should rise in line with inflation to preserve purchasing power and maintain the same standard of living as costs of goods, services, housing, transport and essential living expenses rise.

In practice many places experience a gap:

> The gap between Ontario's minimum wage and living wage continues to grow. The minimum wage ... it bears no relation to the cost of living

And:

> the meagre increase that minimum wage earners will receive on Oct. 1 is nowhere near what is required to keep up with the accelerating cost of living

2. Arguments FOR keeping it indexed to cost of living

•Preserves purchasing power: To "maintain" means to "preserve from failure or decline" or to "keep up" - to maintain employee purchasing power implies a minimum wage that corresponds to the cost of living, rising and falling with increases or decreases in the cost of living. Economists convert current dollars into constant dollars to account for inflation when comparing purchasing power, because inflation erodes the value of money.

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

•More predictable, less volatile: Indexing the minimum wage provides regular adjustments to and reduces the volatility of minimum wage rates, maintains the relative value of the minimum wage to other economic indicators (e.g., prices), and decouples rate changes from other policy considerations. Indexation would provide relatively less volatile, more uniform changes in the minimum wage, given that the values of the possible indices tend not to vary widely from year to year.

That is why many states now do it automatically:

> 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... as the cost of living in Washington increases, the minimum wage will also increase to keep up with inflation and maintain its purchasing power

> In Montana, the minimum wage is adjusted annually by the Cost of Living Adjustment (COLA) based on changes in the Consumer Price Index (CPI) ... as the cost of living increases, the minimum wage will also increase to keep up with inflation

Currently 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), among others. By 2025-2026 several Canadian provinces have adopted annual increases tied to the Consumer Price Index (CPI) to preserve workers' purchasing power over time.

3. Arguments AGAINST or for caution

Opponents argue higher wages could have negative repercussions: leading to inflation, making companies less competitive, and resulting in job losses.

More detailed cons include:

•Higher business costs, unemployment, higher consumer 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 – problems exacerbated in depressed, low wage sectors and regions.

•Prices passed to consumers: Firms respond to an increase in costs by passing some of the costs onto consumers. In San Jose, California nearly all of the cost increase was passed through to consumers, as prices rose 1.45% on average after a 25% minimum wage increase.

•Regional differences: A nationwide minimum wage will have a greater impact on poor areas - regions of high unemployment and low wages... a national minimum wage suitable for London may be unsuitable for a more impoverished area. It's crucial to consider regional cost-of-living differences when setting minimum wage levels.

•Tipping point: Previous increases have been mostly absorbed without significant negative impacts on employment. However, there is a tipping point at which increases will have a negative effect, in particular, if minimum wages are increased over 60% of median wages.

•Reduced legislative oversight: Indexation may also reduce regular oversight of minimum wage changes because it automatically adjusts the rate and changes one part of the act while leaving other parts unchanged subject to congressional action.

•Wage compression and automation: If minimum wages rise faster than median wages, pay differentials narrow, which can reduce incentives for workers to take on extra responsibility, and drive greater automation.

Governments can raise the wage floor. They cannot guarantee that the cost of living stops rising above it. Unless productivity rises, a raise simply helps workers catch up with inflation that has already happened.

4. Minimum Wage vs. Living Wage

This distinction is important:

•The minimum wage is the lowest legal payment that employers can pay their workers.

•A living wage is defined as the minimum income necessary for a worker to cover their basic needs, such as housing, food, healthcare, and transportation. It takes into account the costs of living in a specific area and is typically higher than the minimum wage because it takes into account costs of living in a specific area.

•Minimum wage is the legally mandated lowest hourly pay... Living wage is the income level estimated to cover basic necessities ... Minimum wage often falls below the living wage, failing to meet actual living costs, while living wage varies by location and family size.

A living wage takes into account the actual cost of living in a specific area and reflects the income required for an individual or family to meet their basic needs, while the minimum wage is an arbitrary legal floor.

Bottom line

•If the goal is to preserve purchasing power and prevent in-work poverty, then yes, the minimum wage needs to at least keep pace with inflation. Without indexation, its real value declines steadily.

•If the goal is to avoid harming employment, competitiveness or fueling price increases, then how it keeps up matters: most economists and policymakers who support indexing advocate for small, predictable, annual adjustments tied to CPI-U or CPI-W, rather than large infrequent jumps; others argue for a regionally adjusted rate or combining wage increases with other affordability policies like housing, childcare and benefits, since raising the wage alone cannot control the cost of living.

Whether your jurisdiction should index is ultimately a policy choice about how a federally established standard should be structured and maintained.

Citations (2)

1congress.govGovernment
The Federal Minimum Wage: Indexation
Backs: “If a minimum wage is set at one point in time and not increased through a period of high consumer price inflation, then it loses real value (i.e., purchasing power) despite having the same nominal value. More generally, if a minimum wage rate is established as a fixed nominal amount and not increased, its real value…”
2economicshelp.orgCommercial contentquality 0.84
Pros and Cons of Raising the Minimum Wage
Backs: “Opponents argue higher wages could have negative repercussions: leading to inflation, making companies less competitive, and resulting in job losses. More detailed cons include: Higher business costs, unemployment, higher consumer prices: On the negative side, increasing minimum wages too fast could cause a rise in…”