The Minimum Wage & Housing Prices

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:

laincomedist

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.

wagestorents

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.

Advertisements

7 thoughts on “The Minimum Wage & Housing Prices

  1. johnthacker

    “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.”

    San Francisco has a city-level EITC, called the Working Families Credit. Do you think that it “doesn’t work?”

    Reply
    1. letsgola Post author

      $250/year is equivalent to $0.13/hr wage increase, apparently only available in 2015 to those who’ve never received it before. LA’s minimum wage hike is from $10/hr to $15/hr by 2020. Maybe it works but could the city really afford it at the same scale as the minimum wage hike? (Ignoring that such a huge city-provided credit would induce people to try to claim residence in the city.)

      Reply
    2. devin

      From the WFC site: Due to limited funding, the WFC is only available to qualified applicants who have NEVER received this credit before. So I personally wouldn’t say a one-time $125 check for families with at least one kid “works” to ameliorate the challenges faced by low-income families.

      Could we, in practice, see a much larger GBI or EITC-type benefit within cities? Maybe! The issue people usually point to for why a city can’t (or even a state, really) is that you might see a selection effect of many many low-income families moving in to capture the benefit, which would limit the city’s ability to keep providing the benefit (and the flip side: if you raise taxes to pay for it, you might see high-earners leave the city). Certainly many wealthy employees of Manhattan firms find NJ/CT taxes attractive enough to move out of the city, but it’s an empirical question whether it would work.

      Reply
  2. Alon Levy

    It boils down to what percentage of income growth is spent on rent, and I think there’s a strong argument that it’s higher than 50%. This is because, in the LA area, travel times are well beyond Marchetti’s constant, and many people are priced out of the areas within commute range. Give one of them more money and they’ll move closer to work, paying higher rent. Give all of them more money and they’ll all try to move closer to work, raising overall rents.

    Anecdotally, a similar dynamic exists in Morningside Heights: grad students want to live right next to campus, so every time Columbia hikes the stipends, the rents rise to match them. If I remember correctly, the two annual rent hikes I saw in Columbia housing were $500-600 a year on an annual stipend increase of $1,000 before taxes and around $680 after taxes (15% federal income tax, 7.65% FICA, 6.45% state tax, 2.9% city tax).

    Now, this does not mean the real wage increase will be zero. There’s enough substitution between middle- and lower-middle-income housing that some of the rent increase will fall on middle-income households. This is unlike the case of Columbia grad student housing, which is only for grad students. But I do think rent growth will eat a substantial portion of the extra check.

    I think you’re also overestimating the effect of the minimum wage hike on household finances. It doesn’t affect the question of what proportion of the hike will be eaten by rent, but it’s an important aspect of American poverty: poor people do not usually have full-time jobs. That’s why there are so many households with lower income than that of a single minimum wage earner. Either they are underemployed or only seasonally employed, or employers give them just less than the minimum number of hours that would classify them as full-time workers.

    Reply
    1. letsgola Post author

      FWIW, the breakdown here is based on ACS data for full time workers. In the case of Columbia, that’s a very specific population getting the wage increase, with very specific housing demand. If NYC raised all low income job wages by $1,000, maybe Columbia grad students would end up paying almost all to rent, but what about at the city level?

      Reply
      1. Alon Levy

        Well, yes, this is an extreme case involving a housing niche, and not many places for the group in question to be priced out to. The Upper West Side is expensive, Central Harlem is down a steep hill from Columbia (and the apartments that a grad student could get aren’t that cheap), and West Harlem and Washington Heights are gentrifying fast. But it does show that the income elasticity of housing demand is very close to 1 in this limiting case.

    2. Andy

      Not a bad point, but grad students really don’t have much ELSE to spend their money on besides housing. For the most part. When I was a grad student, I paid about as much as I could for housing. If my stipend were higher, I’d have paid more, since I really didn’t have that many other costs. But now, an income shock would probably go to a lot of other expenses I didn’t have back then.

      Reply

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s