Optimal minimum wage policy in competitive labor markets

David Lee, Emmanuel Saez

Research output: Contribution to journalArticlepeer-review

36 Scopus citations

Abstract

This paper provides a theoretical analysis of optimal minimum wage policy in a perfectly competitive labor market and obtains two key results. First, we show that a binding minimum wage - while leading to unemployment - is nevertheless desirable if the government values redistribution toward low wage workers and if unemployment induced by the minimum wage hits the lowest surplus workers first. Importantly, this result remains true in the presence of optimal nonlinear taxes and transfers. In that context, a binding minimum wage enhances the effectiveness of transfers to low-skilled workers as it prevents low-skilled wages from falling through incidence effects. Second, when labor supply responses are along the extensive margin only, which is the empirically relevant case, the co-existence of a minimum wage with a positive tax rate on low-skilled work is always (second-best) Pareto inefficient. A Pareto improving policy consists of reducing the pre-tax minimum wage while keeping constant the post-tax minimum wage by increasing transfers to low-skilled workers, and financing this reform by increasing taxes on higher paid workers. Those results imply that the minimum wage and subsidies for low-skilled workers are complementary policies.

Original languageEnglish (US)
Pages (from-to)739-749
Number of pages11
JournalJournal of Public Economics
Volume96
Issue number9-10
DOIs
StatePublished - Oct 2012

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Keywords

  • Minimum wage
  • Optimal taxation

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