Title

Optimal Minimum Wage Policy in Competitive Labor Markets

Author(s)

David Lee David Lee (Princeton University and NBER)

Emmanuel Saez Emmanuel Saez (University of California, Berkeley and NBER)

Abstract

This paper provides a theoretical analysis of optimal minimum wage policy in a perfectly competitive labor market. 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. This result remains true in the presence of optimal nonlinear taxes and transfers. In that context, a minimum wage effectively rations the low skilled labor that is subsidized by the optimal tax/transfer system, and improves upon the second-best tax/transfer optimum. When labor supply responses are along the extensive margin, a minimum wage and low skill work subsidies are complementary policies; therefore, the coexistence of a minimum wage with a positive tax rate for low skill work is always (second best) Pareto inefficient. We derive formulas for the optimal minimum wage (with and without optimal taxes) as a function of labor supply and demand elasticities and the redistributive tastes of the government. We also present some illustrative numerical simulations.

Creation Date

2008-09

Section URL ID

CEPS

Paper Number

178

URL

https://gceps.princeton.edu/wp-content/uploads/2017/01/178lee.pdf

File Function

Jel

E24, J24, J38

Keyword(s)

Suppress

false

Series

3