Thanks to @devin_mb for helpful input on this post.
The Los Angeles City Council recently voted to increase the city’s minimum wage to $15/hour, a major victory for labor advocacy groups. This is a significant increase over the state minimum wage, which will be $10/hour as of January 1, 2016, and in real buying power peaked at $11.22/hour (in 2015 dollars) in 1968. Overall this is a very good thing for LA’s low income workers. Some have kvetched that other options, such as an expanded Earned Income Tax Credit (EITC) or a Guaranteed Basic Income (GBI), would be better. This is a distraction, because those options only work at the state or even national level, and were not realistically on the table for the city. Like global warming and infrastructure, cities cannot afford to wait while Congress twiddles its thumbs.
In the Twitterverse, or at least the little corner of it focused on housing, there was talk that raising the nominal minimum wage would have no effect on real wages, because California’s ongoing housing crisis will allow landlords to capture all the wage increase through higher rents. In such a case, raising the minimum wage without taking action on housing is futile.
This is wrong. Landlords cannot arbitrarily raise rents to take away whatever wage increase you receive. Despite all the many distortions, rents are set by the market. If landlords could charge you more for your apartment, they would already be doing it. When the minimum wage increases, landlords will only be able to raise rents if households decide they want to spend their additional income on housing. So, if you get a raise, you might decide to spend some of your money on a more expensive apartment closer to your job, or on a larger apartment. Your desire to increase housing consumption is what allows landlords to raise rents.
However, not everyone is going to receive a wage increase from the minimum wage, and not everyone receiving a wage increase is going to want to spend all of it on housing. Some people who are not receiving a wage increase will respond to rising rents by moving to cheaper areas. It is therefore likely that landlords will be able to raise rents a little, because of low-income households’ increased buying power and supply limitations.
We can make a rough estimate of how much rents will increase based on the proportion of workers receiving a wage increase, the size of the wage increase, and the portion of wages those households are willing to put towards housing costs. Considering current conditions in LA, we will take the last parameter to be 50%. For the current distribution of income among full-time workers in LA, we have the following:
We can see why this minimum wage increase is such a big deal: assuming a uniform distribution of workers in the $25,000-$34,999 bracket, about 37% of workers in LA will get a raise.
Since $15/hr equates to roughly $30,000/year, we’ll assume everyone making less than that gets a bump to $30,000/year. For the $25,000-$34,999 bracket, we’ll assume half of those workers are getting a raise. We’ll also collapse the brackets to single assumed values for ease of analysis: $7,500 for the $1-$9,999 bracket, $12,500 for the $10,000-$14,999 bracket, $20,000 for the $15,000-$24,999 bracket, and $27,500 for the half of the workers in the $25,000-$34,999 bracket that we assume are getting a raise. We can then determine the wage increase for each bracket, as the difference between current wages and $30,000. Next we calculate the resulting rent increase due to each bracket’s wage gains, as (percent of city residents in the bracket) x (wage increase) x (portion of wage increase spent on housing), divided by twelve to convert from years to months.
Summing up each bracket’s rent increase, we see that we expect rents to rise $173/month as a result of the hike in the minimum wage. We can then calculate how much of each bracket’s wage increase is captured by higher rents. Note that if your current wages are already close to the new minimum wage, most of your increase will indeed go to rents. However, the portion falls off quickly for people getting a larger raise; if you make the current minimum wage of $10/hour ($20,000/year), only about 20% of your raise will end up going to higher rents. By calculating the weighted average wage increase, we can find the total amount of increased wages going to rents, estimated to be 19.1%.
Now, a $173/month increase in rent is still a big increase! That’s over $2,000/year, which is a lot of money for people only earning $30,000/year. This emphasizes the importance of solving California’s high housing costs, which we will only do if we address the enormous shortage of supply. However, even if we don’t, increasing the minimum wage will still result in an improvement to the lives of low-income households. It’s just that their lives would be improved even more if we do.