May 17, 1996
(Archived document, may contain errors)
No. 102 May 17,1996
HOW TO RAISE TAKE-HOME PAY WITHOUT DESTROYING JOBS
MarkWilson Rebecca Lukens Fellow In Labor Policy and Angela Antonell! Deputy Director for Economic Policy Average American workers have become fru strated that their take-home pay seems to buy less and less. Some policyrnakers say this is because corporations are not passing on to workers the real value of their labor. Focusing on the low-paid, some lawmakers say take-home pay needs to be in- creased by raising the minimum wage, even though this would destroy thousands of job opportunities.I The problem with this view is that it overlooks the huge gap between what employers pay out to hire and maintain a worker and the amount of money that actually reaches the worker in the form of a paycheck that can be cashed. Most American workers have little understanding of just how much disappears from their earnings before the money reaches their pockets. They usually are aware only of the taxes taken directly from their paychecks. What they do not see is the additional cost of gov- ernment taxes, mandates, and rejulations that employers also must bear and that, in practice, comes out of a worker's compensation. Over the past 20 years, these additional costs have taken an ever- increasing bite out of personal income, creating a larger and larger "wedge' between the cost of hir- ing a worker and what that worker receives as take-home pay. How do government taxes, mandates, and regulations increase the cost of hiring employees and reduce the take-home pay of workers?
X In 1995, it cost all employers in private industry an average of $17. 10 per hour to hire and keep workers on their payrolls.3 After the cost of government-mandated benefits, taxes, and optional benefits is deducted, workers took home an average of $9.84 per hour, 42 percent less than the total direct expense of employing them. The total tax wedge (government-man- dated benefit costs plus taxes) cost workers an average of $4.00 per hour, or 23 percent of 4 their total compensation. X In 1995, it cost a typical employer at least $4.76 per hour to hire a minimum wage worker. 5 After the cost of government-mandated benefits and taxes ($1.03) is deducted and the Earned Income Tax Credit is added, however, an average minimum wage worker took home only $3.73 per hour, or 22 percent less than the total expense of employing that worker and 12 per- cent less than the cash wage of $4.25. X These figures do not include the hidden cost of federal regulations. One study estimates the regulatory burden per employee, on average, to be in the range of $3,000 to $4,000. This equals somewhere from $1.40 to $2.00 per hour for a fun-time worker. 6 Government must share the blame for reductions in the take-home pay of American workers. Over the years, it has forced employers to shift more of their employees' "pay" to mandated em- ployee benefits, thereby making the hiring of workers more and more expensive. Employers, as well as employees, operate within a competitive labor market in which wage rates broadly reflect the productivity of workers-less the costs of taxes, mandated benefits, and regulations associated with employing a worker. The more productive a worker is, the more that worker will be paid. The smaller the government tax and mandate wedge is, the more cash workers will be able to take home. The solution to this problem is not more government mandates, such as job-killing increases in the minimum wage. Instead, government should pursue policies that directly reduce the wedge be- tween compensation and take-home pay. Such policies also would promote economic growth and thereby increase productivity, job opportunities, and real earnings. Specifically, Congress should cut payroll and income taxes, reduce the regulatory burden on business, cut the capital gains tax, and improve basic education through school choice.
THE DIRECT COST OF GOVERNMENT TAXES AND MANDATED BENEFITS The hourly wage that employers pay is not what workers take home; nor is it the total cost of la- bor borne by businesses. When calculating the hourly cash wage rate that a business will pay work- ers, the employer also must take into account the legal obligation to pay Social Security/Medicare taxes, federal 2 =1 M @1 Z and state unem- .!Chart I ployment insur- ance taxes, and The Government Mandate and "Tax Wedgen workers' com- Between the Cost of Labor and Take-Home Pay pensation taxes. 7 These costs reduce Take-Home Pay Fed Unemployment Tax $0.03 the amount the $9.84 State Unemployment Tax $0.12 Measures employer other- Worker's Compensation -That Increase wise would be $0.39 Cost to prepared to Employer Sham of Social Employers pay, based on Sqcurity/Medicare $1.02 the productivity Employee Share of Social of the worker. Security/Medicare $0.94 Measures But from the That Reduce Income of wages and sala- Federal Income Tax $1.11 Employees nes employees receive initially State Income Tax $0.36 in their pay- checks, work- Cost of Labor. $13.81 per hour ers must pay Now Figures represent hourly averages for all private industries, March 199S. Total does not include optional their sham of rovided benefits. employer-p Social Secu- Source: Heritap calcuMons and Bureau of Labor Stftcs. rity/Medicare taxes, as well as federal and state income taxes. The difference between this cost of labor to employ- ers (cash wages plus mandated taxes and benefits) and the take-home pay of workers (cash wages minus payroll and income taxes), is the tax wedge (see Chart 1). In 1995, the tax wedge averafed $4.00 per hour, or 23 percent of an average worker's total hourly compensation (see Table 1). Legally mandated benefits, such as unemployment insurance and workers' compensation, are not "free" to the worker, as many employees assume. A range of studies indicates that, on average, some 88 percent of the cost of all employer-paid government-mandated benefit taxes is shifted to workers in the form of reduced cash compensation.
Taxes and Government Mandates Drive A Wedge Between The Total Cost Of Labor To Employers And Workers' Take-Home Pay
Notes. These figures represent averages for all workers. Optional employer benerrts for minimum wage workers are not available Estimated federal income taxes include the Earned Income Tax Credit State income taxes are estimated to average 2.9% (0.9% for minimum wage workers). The tax wedge has not been adjusted. See footnotes 11. 13, and 15. Sources: Heritage Foundation calculations and Bureau of Labor Statistics. X In 1995, it cost all private industry employers an average of $17.10 per employee per hour to hire and keep workers on their payrolls.10 After the cost of government-man- dated benefits, taxes, and optional benefits is deducted, workers took home an average of $9.84 per hour, or 42 percent less than the total expense of employing them. The total tax wedge cost workers an average of $4.00 per hour, or 23 percent of their total compensation. X In 1995,, it cost manufacturing industry employers an avera e of $20.47 per em- ployee per hour to hire and keep workers on their payrolls.11 After the cost of government-mandated benefits, taxes, and optional benefits is deducted, workers took home an average of $10.93 per hour, or 47 percent less than the total expense of employing them.
10 Bureau of Labor Statistics, Internet siteftp.-Ilstatsblsgovlpublnewsreleaselecectxt. I I Taking into account that 88 percent of the cost of all legally required benefits is shifted to workers in the form of reduced cash pay and that some workers receive Social Security benefits, the net cost of the tax wedge for workers is between $3.8 land $3.69 per hour, or at least 21.6 percent of a worker's total compensation. 12 Bureau of Labor Statistics, Internet siteftp.Ilstatsblsgovlpublnewsreleaselecectxt.
The total tax wedge cost workers an average of $4.65 per hour, or 23 percent of their total compensation. 13 X In 1995, it cost service industry employers an average of $15.88 per employee per hour to hire and keep workers on their payrolls. 14 After the cost of government-man- dated benefits, taxes, and optional benefits is deducted, workers took home an average of $9.46 per hour, or 40 percent less than the total expense of employing them. The to- tal tax wedge cost workers an average of $3.64 per hour, or 23 percent of their total compensation. 15 X In 1995,, it cost a typical employer at least $4.76 per hour to hire a minimum wage worker. 16 After the cost of government-mandated benefits and taxes ($1.03) is deducted, however, an average minimum wage worker took home only $3.73 per hour, or 22 percent less than the ............ . total expense ............- of employing that worker Increasing Taxes And Fees Are Taking An Ever-Larger Bite and 12 per- Out Of Personal Income Per Person cent less than the cash wage $3.000 nstant 1992 Dollars of $4.25. Over the years, $Z500 - proliferating man- dates and rising taxes have increased $ZOOO - the cost of hiring workers. By 1994, Taxes and Fees per Person the cost of govern- $1,5W - ment-mandated benefits accounted $ 1.0W - for 8.9 percent of to- tal employer pay- rolls, up from 6.3 percent in 1971 and 1960 1965 1970 197S 1980 1985 1990 1995 just 3.5 percent in 1951. 17 Note. Taxes and fees per person=real personal inc-ome per person rninus real disposable income per person. Sourow Heritage calculations, based on Economic Report of the ftskient February 1996.
Government taxes and fees have been taking an ever-increasing bite out of personal income (Chart 2). Although real personal income per person increased 121 percent from 1959 to 1995, gov- ernment taxes and fees paid per person increased 155 percent in real terms over the same period. 18 In 1994, federal, state, and local governments took an average of $2,800 (in 1992 dollars) from every person. In addition, in recent years there has been a significant increase in mandated benefits (Table 2), and these costs are likely to become larger in the future. For example: sw If Congress proceeds with a proposed 90 cent increase in the minimum wage, it will cost con- sumers and workers about $2.2 billion per year as the cost of entry-level jobs is passed on through higher prices and lower real wages. It also will cause employers to create over 200,000 fewer entry-level jobs each year until 1999. 19 The Medicare prograin is on the brink of insolvency. To put it on a sound financial basis with- out reforming and improving the way the program operates could mean as much as a 3.52 per- centage point increase on top of the current 2.9 percent Medicare payroll tax. This means workers earning $45,000 per year would have to pay an additional payroll tax of $1,584 per year. If Americans had to write a monthly check for each tax and government-mandated benefit, they would quickly understand how government excess, rather than corporate greed, consumes their take- home pay.
THE HIDDEN COSTS OF GOVERNMENT REGULATION
Taxes and mandated benefits are not the only government policies that drive a wedge between the cost of hiring an employee and that employee's take-home pay. Regulations also increase the cost of employing workers. For example, environmental and workplace safety regulations impose costs that take the form of such things as compliance expenditures (e.g., equipment purchases, worker training); time lost due to paperwork requirements; delays in the processing and issuance of permits required by the government; and attorneys fees incurred in regulation-related litigation. For the smallest businesses, the costs of tax compliance (paying professionals to decipher the tax code, fill- ing out forms, maintaining theypropriate records) and payroll recordkeeping are the largest compo- nents of the regulatory burden. Regulation imposes the heaviest burden on small and medium-sized businesses because they find it harder to spread the high overhead costs of paperwork, attorney and accountant fees, and staff time needed to negotiate the federal regulatory maze. According to recent studies by Professor Thomas Hopkins of the Rochester Institute of Technology: Bw For the average firm with fewer than 20 employees, the regulatory cost per employee is esti- mated to be about $5,500. For the largest firms (those with more than 500 employees), the cost is about $3,000 per employee. 21 Unfortunately, Congress has responded to the disproportionate burden on small business by exempting different sizes of companies from different regulatory statutes. The effect of this approach has been to discourage companies near an es- tablished threshold from hiring new employees.22 The business regulatory burden also varies considerably by industry. For example, the aver- age cost of regulation per employee in the manufacturing industry, where regulatory costs are the highest, is in the range of $5,000 to $7,000. For the service industry, where regulatory costs are the lowest, it is in the range of $2,000 to $3,000. As Table 3 shows, these average costs are equal to a range of approximately $1.00 to $3.00 per hour per worker. 23 As Professor Hopkins notes, estimating the precise cost of federal regulations to business and workers is extremely difficult. These cost estimates are intended to offer only an illustrative profile of the cost of the regulatory system. T" 2 While these estimates do not factor in the benefits of particular regula- Some Federally Required Burdens on Employers tions, understanding the cost impact Payroll Taxes is important for policyrnakers, par- Social Security ticularly in light of the already sig- Medicare nificant costs to employers of taxes Federal Unemployment Insurance and mandated benefits. State Unemployment Insurance Although regulation imposes Mandated Benefits costs on businesses, ultimately they Davis-Bacon Act of 1931 (prevailing wage requirements) Fair Labor Standards Act of 1938 (minimum wage & overtime) are passed on to individual Ameri- Workers'Compensadon cans, often through lower wages Equal Pay Act of 1963 (see Chart 3). 24 Moreover, man- Service Contract Act of I %S (prevailing wage requirements) Americans with Disabilities Act of 1990 dated requirements, such as family Family and Medical Leave Act of 1993 and medical leave, directly affect an Various Regulations employer's decisions about whether and when to hire a worker, which Tide Vil of Civil Rights of 1964 Age Discrimination In Employment Act of 1967 worker to hire, how much cash to Executive Order 11246 (non-discrimination in employment by f6derall contractors) pay the worker, and how long to Occupational Health and Safety Awt of 1970 keep that worker. The rise in man- Rehabilitation Act of 1973 dated labor costs paid by employers Federal Mine Safety and Health Act of 1977 Worker Adjustment and Retraining Notification Act of 1988 is one of the most important forces Migrant and Seasonal Agricultural Worker Protection Act of 1983 leading companies to lay off work- Immigration Control Act of 1 N16 ers, as well as to utilize part-time, Employee PolylMh protection Awt of 1988 temporary, and contract labor. 25 DrLTFree Workplace Act of 1988 Various environmental regulations (eg. Clean Air Act) A recent study by Richard Ved- Source: F6*ml Labor Law% West Publishing Company. 1993. der for the Center for the Study of American Business shows that in addition to the costs of complying with regulation, there are longer-run costs in the form of reduced productivity. Vedder explains that when a business must devote resources to implementing regulatory mandates, those resources are used in a less efficient 26 manner because firms are forced to use more costly and less productive methods of production.
Direct and Indirect Costs Can Consume Half the Cost of Employing a Worker Service Minimum All Private Manufacturing Producing Wage Houriy Wage/ Houriy Costs Industry Industries Industries Workers 5,
Notes: AM figures are in 1995 dollam Soumes: Thomas D. Hopkins, Pmffies afRegulatory Costs, A Report to the US. Small Business Administration; HeftV calculations.
This significant "drag" on productivity denies workers higher wages and a higher standard of living. Other studies support similar conclusions. One 1987 study by economist Wayne Gray examined the effects of Environmental Protection Agency (EPA) and Occupational Safety and Health Admini- stration (OSHA) regulations on 450 manufacturing industries and concluded that these regulations explained more than 30 percent of the slowdown in productivity from the 1960s to the 1973-1978 period. 27 A 1995 study by the Employment Policy Foundation found that 19 percent of the produc- tivity slowdown during the 1970s is directly attributable to regulations published by OSHA7' 8 and that nearly half of the slowdown in long-run productivity growth can be explained by rising govern- . . 29 ment regulatory activity. Further, since productivity and workers' pay and benefits rise together, government regulations are directly responsible for some part of the slowdown in wage growth and take-home pay (Chart 3).
RAISING TAKE-HOME PAY
Congress and the Administration should focus on policies that will increase wages and job oppor- tunities for Americans by improving labor productivity and reducing the cost of employing workers. Specifically, Congress and the Administration should: Cut payroll taxes. Taxes and govemment-mandated benefits cost the average worker over 21 per- cent of total compensation- 13.8 percent for minimum wage workers. The solution is not more mandates-for example, a higher minimum wage. Cutting payroll taxes, however, would directly in- crease take-home pay.
Cut the capital gains tax. The U.S. tax code punishes capital investment by taxing investment income more than once.30 It taxes corporate and individual income from investment, and then taxes capital a third time by taxing capital gains. Lowering the captial gains tax would increase invest- ment in the U.S. and provide an incentive for both American and foreign firms to put their capital to work here with American workers. A capital gains tax cut also would make more venture capital available for emerging technologies and for research and development that would improve future productivity. Enact significant regulatory reform. The explosion of new regulations since 1988 has raised the cost of labor and capital, created barriers to the formation of new companies and jobs, and raised the cost of employing . ........ . 6@3 . ... .. Z, Americans. This higher cost of employment in Real Wages Have Fallen While Regulatory Spending Has Risen turn means that in a competitive economy, $14,000 Millions of 1987 dollars 1987 Dollars the return to labor in the form of wages is re- $12.000 $8.50 duced. The regulatory burden needs to be $10,000 rolled back, not only to allow wages to rise, but $8.00 Plow also to decrease the cost of hiring workers. To do $6,OW this, Congress should $7.50 strengthen White House $4.000 Regulatory Spending oversight of executive (Left Scale) Aver-age Hourly Earnings- branch agencies; estab- (Right Scale) $2.000 lish in statute a set of - $7.00 principles, including 11111111111111 cost-benefit analysis, to 1970 1975 1980 198S 1990 1995 -i- guide regulatory dec Sources: Bureau of Labor Standards; Center for the Study of American Busine% sionmaking; establi! .1 . -A@_ regulatory budget; and require federal agencies to review existing regulations to ensure that they meet sound regulatory princip es.31 Increase the skills of the workforce. What is needed is fundamental change aimed at improving basic education through school choice, strengthening core curricula, and enabling local educators to improve discipline and set high expectations. Congress also should consider tax-deferred or tax-free education savings accounts similar to individual retirement accounts, or enabling states and indi- viduals to use lump-sum unemployment insurance benefits for education and training.
Briefing Book (Washington, D.C. The Heritage Foundation, 1996).
Politicians who blame "corporate greed" for what is happening to the take-home pay of American workers are diverting attention from the real problem: an overly intrusive and expensive federal gov- ernment. Over the years, more and more mandates, higher and higher taxes, and excessive regula- tion have slowed the growth of the economy and created a larger and larger wedge between the cost of hiring employees and workers' take-home pay. If Americans had to write a monthly check for each tax and government-mandated benefit, they would quickly realize the significant costs govern- ment imposes and the effects on their take-home pay. The solution to these problems is not more government mandates and programs, such as job-kill- ing increases in the minimum wage. Instead, what is needed are policies that focus on the primary problems-high payroll and income taxes, and excessive regulation. Removing these obstacles will increase productivity, job opportunities, and real wage growth for all Americans.
1 Increasing the minimum wage will destroy 200,000 job opportunities. See Mark Wilson, "Ibe Folly of Increasing the Minimum Wage," Heritage Foundation Backgrounder Update No. 275, April 22,1996.
2 Mackinac Center for Public Policy, "Ibe Right to Know Payroll Form," April 1996. Workers can determine the amount of Social Security and Medicare taxes they pay, as well as their federal and state income taxes, simply by looking at their pay stubs. Employers, however, usually do not report to workers the cost of government-mandated benefits and taxes paid on behalf of their workers.
3 Bureau of Labor Statistics, Internet siteftp.Ilstatsbisgovlpubhtewsreleaselecectxt, or "Employer Costs for Employee Compensation, March 1995," June 22, 1995. The sum of cash wages plus the cost of all employer-paid benefits (government-mandated and optional) and payroll taxes equals total compensation, or the total direct expense to the employer. Employer costs associated with recruitment, screening, and initial training of employees are not included. Also not included are the indirect costs of complying with federal regulations.
4 Ile cost of the tax wedge to workers excludes the cost of optional employer-provided benefits (see Chart I for a complete description). Further, taking into account that 88 percent of the cost of all legally required benefits typically is shifted to workers in the form of reduced cash pay (see footnote 9), as well as the fact that some workers receive Social Security benefits, the net cost of the tax wedge for workers is between $3.81 and $3.69 per hour, or at least 21.6 percent of a worker's total compensation.
5 Heritage Foundation calculation of hourly cash wages plus the cost of government-mandated benefits. Although some employers provide optional benefits to minimum wage workers, accurate cost estimates for minimum wage workers are not available.
6 This calculation assumes a full-time employee works 2,080 hours per year. See Thomas D. Hopkins, "Profiles of Regulatory Costs," report to the U.S. Small Business Administration, November 1995, Tables A-6 and B-6.
7 Total compensation is the sum of an employee's cash pay plus the cost of all employer-paid benefits (government-mandated and optional) and payroll taxes. Total compensation is the same as the total direct cost of labor for the employer.
8 Heritage Foundation calculation based in part on Bureau of Labor Statistics, "Employer Costs for Employee Compensation" data. Optional employer-provided benefits that account for another $3.26 per hour, or 19 percent of total compensation, are not included in the tax wedge but also increase the cost of labor.
9 The 88 percent figure is based on such analyses as Jonathan Gruber and Alan B. Krueger, "The Incidence of Mandated Employer-Provided Insurance: Lessons from Workers Compensation Insurance," Tax Policy and Economy (1991); Jonathan Gruber, "Me Incidence of Mandated Maternity Benefits:'American Economic Review, Vol. 84 (June 1994), pp. 622-641; and Lawrence H. Summers, "Some Simple Economics of Mandated Benefits," American Economic Review, Vol. 79, No. 2 (May 1989).
13 Taking into account that 88 percent of the cost of all legally required benefits is shifted to workers in the form of reduced cash pay and that some workers receive Social Security benefits, the net cost of the tax wedge for manufacturing workers is between $4.43 and $4.32 per hour, or at least 21.1 percent of a worker's total compensation.
14 Bureau of Labor Statistics, Internet siteftp.Ilstatsblsgovlpublnewsreleaselecectxt.
15 Taking into account that 88 percent of the cost of all legally required benefits is shifted to workers in the form of reduced cash pay and that some workers receive Social Security benefits, the net cost of the tax wedge for service-producing workers is between $3.47 and $3.36 per hour, or at least 21.2 percent of a worker's total compensation.
16 Heritage Foundation estimate of hourly cash wages plus employer-paid taxes for legally mandated benefits. Although some employers provide optional benefits to minimum wage workers, accurate estimates of the cost are not available.
17 U.S. Chamber of Commerce, "Employee Benefits Historical Data," 1982, and "Employee Benefits Survey," 1994.
18 Mark Wilson, "Wages, Profits, and Income: Politics vs. Reality," Heritage Foundation F. Y.L No. 97, April 19, 1996.
19 Mark Wilson, "Me Folly of increasing the Minimum Wage:'Heritage Foundation Backgrounder Update No. 275, April 22, 1996.
20 I'homas D. Hopkins, "Me Changing Burden of Regulatory Paperwork and Tax Compliance on Small Business: A Report to Congress," October 1995, p. 20.
21 Hopkins, "Profiles of Regulatory Costs," p. 1. Cost estimates include process, social, and economic regulation.Estimates are for 1992 (in 1995 dollars).
22 Murray Weidenbaum, "Government Regulation and Medium-Sized Businesses;' Center for the Study of American Business Issue Series No. 77, March 1996, p. 8.
23 Hopkins, "Profiles of Regulatory Costs:'Tables A-6, B-6.
24 For a more detailed discussion, see William G. Laffer lH, "How ReguWon Is Destroying American Jobs," Heritage Foundation Backgrounder No. 926, February 16, 1993.
25 Jack A. Meyer, "Tbe Impact of Employee Benefit Costs on Future Job Growth," Manufacturers Alliance Policy Review No. PR-133, March 1995.
26 Richard K. Vedder, "Regulation's Trillion-Dollar Drag on Productivity:'Center for the Study of American Business Policy Brief No. 165, March 1996. Although this study suggests that nearly half of the slowdown in long-run productivity growth, and therefore wage growth, from 1963 to 1993 can be explained by rising govament regulatory activity, this should be considered a somewhat high estimate because the study did not account explicitly for regulatory benefits.
27 See Wayne Gray, "Me Cost of Regulation: OSHA, EPA, and the Productivity Slowdown," American Economic Review, December 1987.
28 Max Lyons, '@OSHA: The Case for Reform," Employment Policy Foundation, October 9, 1995.
29 See note 26, supra.