LCD op-ed: Minimum wage, maximum tax (03.07.1995)

Peter Lorenzi, Dean, University of Central Arkansas

It’s that time of year again. Tax time. W-2 forms. Time to load up the income tax software. But first, before you simply staple that W-2 form to your tax return, you really need to turn the form over and read the explanation on the back about the two taxes that really hurt Arkansans: Social security taxes of 6.2% on the first $61,200 in work income and Medicare taxes of 1.45% on all work income. That’s a 7.65% flat tax on work. And then double that rate, because your employer pays an equal rate to the federal government. That’s a 15.3% flat tax on the first $61,200 of work income. Only a small percentage of Arkansans earn more than that, meaning that they earn enough to have their payroll tax rate drop from 15.3% to 2.9% once they pass $61,200.

These taxes "hidden” on your W-2 play a very large role in the present debate about the minimum wage rate. And federal proponents of an increased minimum wage don’t want you to think about these taxes, because a simple analysis will show that, using their argument of adjusting for inflation, the federal government, has benefitted most from increases in the minimum wage rate. The new proposed increased means more taxes for the same amount of work.

In 1968, the minimum wage was $1.60. Today it is $4.25, and proposed to rise to $5.15 within the next two years. Setting aside for a moment the arguments against a raise or any minimum wage at all, let’s look at the disingenuous position taken by federal officials who support this increase. The primary argument for an increase is that the federal minimum wage has been eroded by inflation. The minimum wage rate has increased about 165% in these past 25 years, the cost of living as increased perhaps 300%. Yet the government does not acknowledge that a big loss in workers’ take-home pay is due to higher payroll taxes. In 1968, social security and Medicaid taxes on the minimum wage were about 4¢ per hour. Today, the same social security and Medicaid taxes on the minimum wage are 65¢ per hour. That’s an increase in the federal payroll tax rate of 1500%. This increase has reduced the take-home value of the minimum wage. To be honest about the lost earning power of the minimum wage, the government needs to acknowledge that taxes are a significant eroding force.

The increase in the minimum wage is a federal tax increase. And the more people helped by a higher minimum wage, the larger the increase. While the proposed 90¢ per hour wage increase sounds pretty impressive, 7¢ will be taken from the worker in payroll taxes and another 7¢ will be taken from the employer. And this is before the government begins collecting federal or state income taxes or the employer pays any fringe benefit costs. A federal minimum wage increase of 90¢ will cost the employer 97¢ to pay that worker less than 83¢. If the federal government continues to move in the direction it has taken these past twenty-five years, minimum wage workers will continue to experience lower take-home pay and pay more of their wages in social security and medicaid taxes, since massive payroll tax increases will likely be required in the future to fund likely deficits in this entitlement fund.

To make work more valuable, important and attractive, government can do two things: Make work more rewarding (i.e., cut payroll taxes) and make not working less rewarding (i.e, cut welfare subsidies for not working). Three quarters of American workers pay more in social security and Medicaid taxes than they pay in income taxes. The best way to increase the minimum wage would be to roll back payroll tax rates. When federal officials say that they want "to make work worth something” to the poorest workers, our government needs to first look to how payroll taxes undermine the value of work. The federal government should do its fair share and eliminate social security and Medicaid taxes for those earning the annual equivalent of the minimum wage. This would reduce business costs, increase incentives to work, and help employers hire new workers. To make work worthwhile, the federal government should tax it less.