On first reading, the DC City-Council voted 8-5 to institute a two-tiered minimum wage system in the District. The current minimum wage for all workers is $8.25 per hour, a dollar more than the federal minimum wage and a dollar more than the minimum wage in Maryland and Virginia. If the new law is implemented, it will force retailers that operate stores with more than 75,000 square feet and whose parent company has in excess of $1 billion in sales to pay their workers no less than $12.50 per hour. This represents a 51% increase over the current minimum wage. This is a bad idea for a number of reasons.

Note: Let me make clear at the outset that I am strongly in favor of workers earning more per hour than they do now. Improvements to the education and job training systems in the District are the best ways to achieve this goal. Getting residents more effective post-secondary training, including the acquisition of technical skills, is the best the way to allow them to move up the skills ladder to the point where they are earning what is truly a living wage. On to my arguments in no particular order:

The trade off: Raising the minimum wage has always involved a trade off, and it is a zero sum game because the total pot of money stays the same size. The trade off is a smaller group of workers will earn the higher wages. Take the example of the small retailer that employs ten minimum wage workers. This example looks at raising the minimum wage in general. It does not address the labor market distortions caused by a two-tiered minimum wage. That is addressed further below. Keep in mind that all retailers, not just small ones, operate on very thin margins — sometimes as little as 1-2%. Unless there is a sudden uptick in business or competitive pressures ease and allow for significant price increases, the business owner either finds some other expenses to cut, or takes home less money for herself. Many would say, why can’t the owner just make less money? That seems reasonable but it is not how the free enterprise system works, nor should it be. Profit maximization is at the heart of free enterprise. All things being equal, the business owner will and should do everything in her power to maximize profits. Another thing to keep in mind is many times, there’s not much profit to begin with. Many small retailers are barely profitable. In a retail environment, people costs are one of the few variable expenses a business owner faces. She can’t change the wholesale cost of her goods, she can’t constantly renegotiate her rent, and so when expenses have to be cut, they will be cut out of people costs. In this case, the small retailer will make due with more like 7 employees at the new minimum wage, eliminating three jobs. Economists debate the extent of this phenomenon, but the fact that it occurs is not in dispute. On balance, we come down on the side of having more people employed at the lower wage, but that’s the trade off you make when you raise the minimum wage.

The Wal-Mart can afford it argument: Depending on the year, Wal-Mart is either the first or second largest publicly held company in America, and therefore the world. Last year it had gross revenues of $405 billion and was the largest private sector employer in the U.S. On the surface, it would seem Wal-Mart can afford $12.50 an hour. But  looks are deceiving. Wal-Mart, like smaller retailers, works on extremely thin margins. Of that $405 billion a large portion goes towards paying for the goods that end up in Wal-Mart stores. Wal-Mart runs up such big numbers because they have thousands of stores around the world that sell a lot of product at low margins. What’s important as far as the District is concerned is each Wal-Mart store carries it’s own profit and loss statement. In essence, they treat each individual store like a separate small business. And they close the stores that aren’t profitable. So, if the District stores get up and running, and they’re not able to price products where they need to because of competitive pressures, those individual stores may run at a loss, but they won’t run at a loss for long.

The wage competition issue: District leaders crafted this bill specifically to exclude small, local retailers from its provisions because they know that small retailers operate on thin margins and that kind of wage increase would be devastating. But a competitive labor market is going to force those wage increases on smaller employers. Think about it, if you are just coming into the workforce and are looking for an entry level retail job, would want to work for Target at $12.50 an hour, or a local restaurant at $8.25 an hour. Smaller employers are going to lose their best employees to the big box employers and this bill will make it even harder to retain workers in what is already a high-turnover industry. As smaller employers are forced to pay higher and higher wages, it will mean the difference between being profitable and not profitable.

The inflated price conundrum: As mentioned, people costs are far and away the largest variable expense in a retail operation. A retailer’s first response when hit with higher wage costs will be to raise prices. A number of factors will interact and determine whether those price increases will stick. If they are able to maintain the higher prices, then Wal-Marts own employees and thousands of low income consumers will have to pay the higher costs. Many entry level retail workers come from low income backgrounds. They are the group of people most likely to shop at Wal-Mart and they will be penalized the most by higher prices.

The retail is a career hypothesis: Wal-Mart is not unique in retail. Low wages are endemic in the retail industry. Most entry level retail jobs are exactly that. They’re supposed to be stepping stones, not the end point of one’s career ,unless you go into retail management. One group that will be hurt most by a $12.50 minimum wage is young people. They are often looking for their first job and an opportunity to learn what working for someone is like. These jobs will be fewer in number at the higher wage rate, preventing many young people from getting that first work experience.

The this will help DC workers argument: $12.50 is a 72% increase over the minimum wage in both Maryland and Virginia. That rate is going to be irresistible to entry level workers in both those states. They are going to come rushing across the border for those higher wage jobs. If they are better qualified for those positions, there is nothing to prevent the large retailers from giving those jobs to residents of MD & VA. Unless you’re prepared to legislate that those jobs go to DC residents only, the idea that this bill will help DC workers is marginal at best.

The other effects on the retail industry issue: There is already anecdotal evidence that the proposed bill is having a negative effect on the retail market. We believe we’ve heard that Trader Joe’s has made it clear that they will not come to the Walter Reed site in the District if the higher minimum wage is in effect. How many other retailers might choose not to come to the District because of the new wage is impossible to know because you can’t prove a negative, but more evidence will probably arise.

We’re sure there are additional reasons to avoid a two-tiered minimum wage, but these are all we can think of right now. Reasonable people will disagree about whether our reasoning is compelling. There are 7 of us associated with Economic Growth DC and we are not even all in agreement on this issue just among our small group, but we hope this will be viewed as an attempt to make a positive contribution to the debate. Some may feel that the trade off is worth the costs. We respect that outlook, but we think the two-tiered minimum wage will end up hurting the people it’s trying to help — namely low income, lower skilled workers and young people. We know the Council will operate in good faith and do what it thinks is best for District residents. We think we have the best interests of the District’s residents in mind as well and we urge the council to resist the higher minimum wage.