Optimal Minimum Wage Policy in Competitive Labor Markets

David Lee and Emmanuel Saez
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David Lee: Princeton University and NBER

No 1105, Working Papers from Princeton University, Department of Economics, Industrial Relations Section.

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 co-existence 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.

Keywords: minimum wages; tax policy; labor supply; demand elasticity (search for similar items in EconPapers)
JEL-codes: C23 C24 I29 J22 (search for similar items in EconPapers)
Date: 2008-10
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Citations: View citations in EconPapers (23)

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Related works:
Journal Article: Optimal minimum wage policy in competitive labor markets (2012)
Working Paper: Optimal Minimum Wage Policy in Competitive Labor Markets (2010)
Working Paper: Optimal Minimum Wage Policy in Competitive Labor Markets (2010)
Working Paper: Optimal Minimum Wage Policy in Competitive Labor Markets (2008)
Working Paper: Optimal Minimum Wage Policy in Competitive Labor Markets (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:pri:indrel:535

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