The Complexities of the $15 Minimum Wage

If a person works hard and adds value to the organization for which they work, would anyone argue the person is not entitled to a livable wage in the United States today?

Who would argue that this person should not have at least a baseline economic life in which they can readily pay their bills, have access to decent health care, and go on a vacation once or twice a year? It is easy to agree that this person should not live in scarcity.

In the debate about increasing the minimum wage, there is the perception that if you are not in favor of a $15 per hour minimum wage, you are against working folks. The truth is that the minimum wage argument is much more complex than it appears on the surface. It is an issue that requires thought and analysis, which is not necessarily the highest skill set of politicians, whose currency is popularity, not necessarily accuracy, or even justice.

The average net profit margin of most companies in America is between 3 and 6 percent. This means that, for every dollar of product or service sold, companies earn around 3 to 6 cents. Additionally, the highest cost to running any company is always labor; this is even true in businesses that are highly automated. It is typical for a company to spend at least 50 or 60 percent of its revenues on labor.

Consider a couple of examples.

The first is a situation where all or most employees at a small business are earning only a minimum wage. Note that the US Small Business Administration defines small businesses as those with fewer than 500 employees, but 90 percent of those businesses have fewer than 20 employees. In this example, the company has annual sales of $2 million and a net profit margin of 5 percent (i.e., the owner takes home $100,000). This means the company’s total costs are $1.9 million, and about $1 million is spent on people (assuming that labor costs are 50 percent of sales). An increase in the minimum wage from $7.25 to $15 is about a 100 percent increase in labor costs. If people costs increase by 100 percent at this business, then costs for just people rise to $2 million, and total costs would be about $2.9 million. The company is now losing $900,000 a year. For this small business, the owner was making $100,000 before wages increased. Is the owner of that business willing to take on the risk of owning and running that business where it is unclear if they can make any profit at all? Most reasonable people will see that the risk is too high.

Let’s take another example. All of a business’s employees are already being paid above $15 per hour. An increase in the minimum wage does not affect this business or its profits. Some of these businesses may include software or pharmaceutical companies, or other businesses with higher net profit margins. I ran one of these as recently as last year. Unfortunately, there are more small businesses than there are high-tech, highly profitable businesses. As such, a higher minimum wage hurts small businesses in lower-margin industries.

Finally, at root, how does a minimum wage increase manifest itself in reality? Some businesses may be able to increase the prices of their products or services and apply them to the customer. However, even this is not a given, and it may take time. In very low-margin small businesses that are barely hanging on, owners cannot always simply increase prices. If someone is running a self-service car wash (which still requires labor), they may be able to increase their prices, but 15 percent of customers may decide to wash their cars at home. As is always the case in business, a 15 percent reduction in sales can lead to a 50 percent or more decrease in profit.

For these reasons, the minimum wage argument is convenient political fodder for some, but it is not an uncomplex one. We know that capitalism in the free enterprise system, if left unchecked, leads to social ills such as poverty, which nobody wants. However, increased regulation applied the wrong way, like a national increase in the minimum wage, has serious social consequences that could end up hurting everyone. For example, people who are poor and who do not have college educations may not always be able to get a job with Microsoft, which probably pays most of their workers above $15 per hour. They are often forced to work for smaller companies with much smaller margins, which do not have excess profits to distribute.

My concern with the minimum wage increase is that it will adversely affect small businesses and small-business formation and continue a dangerous long-run trend of fewer people owning companies. This trend in turn hurts job creation, since small companies create the most jobs, by far.