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Ending the Minimum-Wage Subsidy

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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This week, Los Angeles became the third major West Coast city and the biggest in the U.S. to agree to raise the minimum wage to $15 an hour, an increase that will go into effect by 2020. Los Angeles follows Seattle, which will require employers with 500 workers or more to pay $15  by 2017. San Francisco will require the $15 hourly minimum by 2018. 

The Seattle increase in particular has caused all sorts of analytical errors from people who should know better. Seattle Magazine ran one article with the headline “Why Are So Many Restaurants Closing Lately?,” which cited the wage increase as among the reasons. This was quite surprising, given the lack of any notable rise in restaurant closings, which are running at about the same pace as before the minimum wage increase. Even more telling, permits for new restaurants are rising. The data overwhelmingly disproves the assertion that the minimum wage increase is leading to restaurant closings -- or is discouraging people from opening new ones.

That was only the most obvious error, but the rest of the blessedly data-free article was equally innumerate. This is an attribute of the modern news media: Instead of original reporting, there is a regurgitation of prior tweets, posts, anecdotes and second- and third-hand sources. Anyone could have easily looked up the actual numbers on restaurant closing and permits, as one of my colleagues did last month. The details can be found in “A Pizza Place Closes in Seattle,” and “Jobless in Seattle? Not Yet, Anyway” (See Part I and Part II.)

What we know about the minimum wage is that modest increases have a negligible effect on employment, and usually work as a net economic positive to the region that passes them. The groundbreaking research by economists David Card and Alan Krueger has been confirmed by lots of subsequent research. This has become a pet subject for me, discussed many times before (see this, this and this).

So why all the hand-wringing by the business community?

In short, raising the minimum wage is a wealth transfer. That is what has so many fast-food franchise owners up in arms.

Let's unwrap some of the economics behind the McDonald's formula. The average store generates about $2.6 million a year in sales, according to research firm QSR. Stores in prime, high-traffic locations can do much better, with annual sales of as much as $10 million. (There is a trove of information in the McDonald’s annual 10-K.)

To be sure, there are substantial costs to opening and running a McDonald's. Entrepreneur magazine (and others) have estimated the costs to open a McDonald's. As Bloomberg reported in 2013, start with $500,000 to $750,000 in cash, and have $1 million to $2 million available in credit. Then add in the $45,000 franchise fee, plus as much as 12 percent of store sales in rent, or about $300,000 a year. 

And costs generally go in just one direction -- up. Beef prices have risen about 15 percent, with ground beef prices rising even more. In addition, the McDonald's parent company has been trying hard to push more costs onto the individual franchise restaurants.

No matter: a well-run store can net the owner anywhere from $500,000 to $750,000 a year or more. Bigger stores can do much better, and many owners have several stores.

But holding down costs is crucial and one of a restaurant's biggest expenses is labor. By any measure, the fast-food industry doesn’t pay living wages to many workers. 

As research at the University of California's Berkeley Labor Center found, "more than half (52 percent) of the families of front-line fast-food workers are enrolled in one or more public programs," such as Medicaid or food stamps. That compares with about 25 percent of the workforce as a whole.

With the minimum wage at its present levels (the federal rate is $7.25 an hour, though it's higher in some places), Berkeley calculates the cost of public assistance to families of workers in the fast-food industry at about $7 billion a year.

McDonald's has all but acknowledged that its workers can't get by on their paychecks alone. Remember the company's McResource Line phone service and webpage, in which the company advised employees on how to access government safety-net programs? (The service and page have since been closed.)

Right now, the wealth transfer goes in the wrong direction: from taxpayers to the owners of fast-food outlets. In effect, the public helps restaurants and other lower-wage employers save on labor costs. As I see it, the cost of a full-time employee (someone working 30 hours or more a week) should be borne by the employer.

Raising the minimum wage shifts the wealth transfer from the taxpayers to the restaurant owners. Boosting the minimum wage to $12 or even $15 diminishes or even eliminates this subsidy. If it forces hamburger price up by 50 cents, I don’t have a problem with that either. 

I have discussed the issue of how political bias corrupts economic analysis. The reporting on the minimum-wage issue is rife with it. Don’t underestimate how much economic self-interest tilts the debate. 

  1. The breakdown is $3.9 billion for Medicaid and the Children’s Health Insurance Program (CHIP); $1.04 billion in food-stamp benefits; and $1.91 billion in earned income tax credit payments. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net