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COLAs, CPIs, and the $14 Minimum Wage

Research & Commentary
January 02, 2012


Inflation has been steadily eroding the value of the U.S. minimum wage over recent decades. But inflation only explains part of the story why the minimum wage has become such an inadequate guarantor of low-wage decency.

By Salvatore Babones

In 2012 the 63 million Americans who depend on Social Security will have their first cost of living adjustment (COLA) in three years: a 3.6 percent increase in benefits.  In other words, one-fifth of the U.S. population are getting a raise.  For the average beneficiary the 2012 COLA amounts to an extra $38.95 a month.  Not much, but it’s something.[pullquote]After adjusting for inflation, minimum wage workers today are paid about 26 percent less than they were in 1974.[/pullquote]

For workers earning minimum wage, the COLA for 2012 is . . . zero.  The minimum wage was raised to $7.25 on July 24, 2009, and there it stands.  There is no regular COLA for minimum wages.

COLAs are necessary because inflation constantly changes the value of the dollar.  A dollar today is not worth the same as a dollar yesterday.  The year-to-year changes are small, but over time the add up.  The Bureau of Labor Statistics estimates that it costs $4.58 today to buy what $1.00 bought in 1974.

Because of inflation, payments for government benefits can’t be set once for all.  Most federal programs have some kind of built-in mechanism to update dollar amounts for inflation.  For Social Security, benefits have been indexed to changes in the Consumer Price Index (CPI) since 1974.

While federal benefit programs like Social Security are indexed for inflation, the federal minimum wage isn’t.  The federal minimum wage has been increased over the years whenever Congress and the President got around to it.  As a result, there have been only seven minimum wage increases over the past 30 years.

Back in 1974, when COLAs for Social Security were first indexed for inflation, the federal minimum wage was $2.00 an hour.  If the minimum wage had also been indexed to the CPI, the inflation-adjusted minimum wage today would be $9.16 an hour.[pullquote]If the federal minimum wage had been updated since 1974 using the Social Security yardstick, it would now stand at $10.74 an hour.[/pullquote]

In other words, after adjusting for inflation minimum wage workers today are paid less — about  26 percent less — than they were in 1974.

But that’s not the end of the story.  The Social Security COLA is an adjustment made for people who are already receiving benefits.  People’s benefit levels are determined at the point of retirement by the average wages they earned over the course of their working lives.

Because of inflation, it’s not fair to lump wages earned in the 1970s with wages earned in the 2000s.  The earlier wages have to be adjusted to make them comparable with recent wages.  But the Social Security Administration doesn’t use the CPI for this purpose.  It uses something called the Average Wage Index (AWI).

The AWI is exactly what it sounds like.  It’s an index of the average wages paid in any given year.  Because wages tend to go up faster than inflation, the AWI goes up faster than the CPI.

The Social Security Administration uses the AWI instead of the CPI because the CPI doesn’t capture changes in living standards over time.  The CPI adjusts for changes in the cost of living, but it doesn’t adjust for changes in the quality of life.  Simply put, we expect people to live better in 2012 than they did in 1974.[pullquote]The massive rise in non-wage income has made workers’ wages a smaller and smaller slice of the overall pie.[/pullquote]

If the federal minimum wage had been updated since 1974 using the Social Security AWI, it would now stand at $10.74 an hour.  That’s quite a bit more than the $9.16 an hour it would be if it had been updated for inflation using the CPI.  It’s a whole lot more than today’s actual minimum wage of $7.25 an hour.

A very strong case can be made for a $10.74 minimum wage.

But that’s not the end of the story.  The Social Security AWI is based on the changes in people’s average annual wages over time.  Wages, however, have not kept pace with rising economic prosperity.

Since the 1970s ordinary workers’ wages have failed to rise along with the economy as a whole.  The massive rise in non-wage income (dividends, interest, and capital gains) has made workers’ wages a smaller and smaller slice of the overall pie.  America’s total personal income per capita — including income from all sources — has risen much faster than the Social Security AWI.

Between 1974 and 2011 the AWI rose a cumulative 17% (adjusted for inflation).  Per capita personal income, on the other hand, rose 57% (adjusted for inflation).  Had the minimum wage been indexed to  per capita personal income growth starting in 1974, the minimum wage today would be $14.41 an hour.

That’s a far cry from $7.25.[pullquote]Once upon a time, America was always on the high end of international comparisons.[/pullquote]

By today’s standards $14.41 an hour might sound like a lot for a minimum wage, but it doesn’t have to stop there.  At the top 1 percent of the American income distribution, average incomes rose 194 percent between 1974 and 2011.  Had U.S. minimum wages risen at the same pace as U.S. maximum wages, the minimum wage would now be $26.96 an hour.

The difference between $7.25 and hour and $26.96 an hour shows just how much inequality has increased in America over the past four decades.

Inequality has risen across the developed world in recent years, but nowhere as much as in the United States.  Top 1 percent incomes are higher in America than anywhere else in the world.  And the rest of the world’s developed countries in turn have much higher minimum wages.

Our closest neighbor, Canada, has minimum wages of C$9.00 – C$11.00, depending on the province or territory.  In US Dollars these figures translate to $8.59 – $10.50.  These figures and the figures below are based on average exchange rates for the three year period 2009-2011.

In the United Kingdom, the minimum wage is £6.08, or about $9.56.  In France, it’s €9.19, or about $12.44.  In Australia, the statutory minimum is A$15.51, or about $14.20, but very few workers earn so little.  The standard wage for fast food and other service jobs is A$17.03, or about $15.59.

In all these countries, minimum wage work also includes benefits like paid sick days and government-sponsored universal health insurance.

So how high should the U.S. minimum wage be?  It’s currently $7.25.  Adjusted for inflation using the CPI it would be $9.16.  Adjusted for wage growth using the AWI it would be $10.74, similar to the minimum wages found in other countries.

On the other hand, if the minimum wage had grown along with personal income overall, it would now be $14.41.  That would put us on the high end of international comparisons.  Once upon a time, America was always on the high end of international comparisons.  Maybe someday we’ll get there again.

Salvatore Babones is a senior lecturer in sociology and social policy at the University of Sydney and an associate fellow at the Institute for Policy Studies

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