Minimum Wages and Optimal Redistribution in the Presence of Taxes and Transfers∗

This paper characterizes optimal redistribution for a social planner with three instruments: labor income taxes and transfers, corporate income taxes, and a minimum wage. The modeled economy features searchand-matching frictions, generates positive firm profits in equilibrium, and can accommodate limited employment effects and spillovers to non-minimum wage jobs after minimum wage increases. The analysis formalizes the effects of the minimum wage on the relative welfare of low-skill workers, high-skill workers, and capitalists as a function of sufficient statistics for welfare, social preferences for redistribution, and fiscal externalities. Minimum wages are more likely to be desirable when corporate taxes are low because minimum wages can generate corporate revenue losses. Minimum wages can improve welfare even under optimal income taxes by shifting the incidence of the tax system when there is bunching in the wage distribution at the minimum wage. I estimate the sufficient statistics that guide the welfare analysis using US state-level variation in minimum wages. Minimum wages have increased low-skill workers’ welfare –especially for teens– with null effects on high-skill workers. Aggregate welfare effects on capitalists are negligible but they are negative and sizable in certain industries, especially in non-professional services. Income maintenance benefits have also decreased after minimum wage hikes, suggesting that the effects of minimum wage increases on labor market outcomes generate fiscal externalities. A simple calibration based on the empirical estimates suggests that small minimum wage increases today would increase welfare, especially when incorporating distributional concerns between workers and capitalists. Email: damianvergara@berkeley.edu. I am especially grateful to Pat Kline, Emmanuel Saez, and Danny Yagan, for continuous guidance and encouragement. I also thank Alan Auerbach, Sydnee Caldwell, David Card, Patricio Domı́nguez, Cecile Gaubert, Andrés González, Attila Lindner, Cristóbal Otero, Pablo Muñoz, Marco Rojas, Harry Wheeler, Gabriel Zucman, my discussants Benjamin Glass and Thomas Winberry, and seminar participants at the Online Public Finance Workshop for Graduate Students, the NTA 114th Annual Conference on Taxation, the XIII RIDGE Forum Workshop on Public Economics, UC Berkeley, and Universidad Adolfo Ibáñez for very helpful discussions and suggestions. Early versions of this project benefited from discussions with Jakob Brounstein, Sree Kancherla, Maximiliano Lauletta, Michael Love, Billy Morrison, and Mónica Saucedo. I acknowledge financial support from the Center of Equitable Growth at UC Berkeley. This paper previously circulated under the title “When do Minimum Wages Increase Social Welfare? A Sufficient Statistics Analysis with Taxes and Transfers”. Usual disclaimers apply. ar X iv :2 20 2. 00 83 9v 2 [ ec on . G N ] 6 M ay 2 02 2 “The simplest expedient which can be imagined for keeping the wages of labor up to the desirable point would be to fix them by law; the ground of decision being, not the state of the labor market, but natural equity; to provide that the workmen shall have reasonable wages, and the capitalist reasonable profits. ” John Stuart Mill, Principles of Political Economy, 1884.