President Obama’s State of the Union Call for a Higher Minimum Wage Is Built on These 3 Myths

Last night, President Obama gave his annual State of the Union address. One promise in particular regarding the minimum wage sparked a sharp response from Republicans -- a vow to issue an executive order to raise the minimum wage for some government contract workers from $7.25 to $10.10 per hour.

Although that action would affect less than half a million workers, President Obama then urged Congress to apply the rule to all low-wage workers across America, in a bid to reduce income inequality.

(Source: Whitehouse.gov)

In the official Republican response, Rep. Cathy McMorris Rodgers of Washington stated that Obama's proposed policies would make "people's lives harder." That raises an interesting question -- whose lives, exactly, would be made harder?

Let's take a closer look at the numbers behind the current demands for a higher minimum wage and dispel three common myths.

Myth 1: McDonald's can afford to pay its workers more.

It's easy to say, "McDonald's (NYSE: MCD  ) can afford to pay its employees more because it makes lots of money." Yet that's a broad, uninformed statement without any fundamental weight.

Is McDonald's unfairly vilified in minimum wage debates?

This following chart illustrates how much it could cost McDonald's to raise its minimum wage from $7.25 to $10.10 or $15.00 per hour (which was previously demanded by fast food workers last September), based on a 40-hour work week and 52 weeks worked per year.

Total U.S. employees

Yearly cost at $7.25 per hour

Yearly cost at $10.10 per hour

Yearly cost at $15.00 per hour

760,000

$11.46 billion

$15.97 billion

$23.71 billion

Source: Industry websites, author's calculations (approximation, does not account for the difference between part-time, full-time, or franchise employees)

Now, that's not to say that every McDonald's employee works a 40-hour work week, 52 weeks a year -- the above model is just to illustrate the highest possible costs of raising the minimum wage across the board for all McDonald's employees. 

(Editor's note: The following paragraph has been added for clarity and context.) In 2012, McDonald's actually reported $4.7 billion in payroll and benefit costs, indicating that not that all of its employees were actually working full-time. On that note, let's take a look at McDonald's sales and profits in fiscal 2012:

2012 revenue

YOY growth

2012 operating income

YOY growth

$27.57 billion

2%

$8.60 billion

1%

Source: McDonald's 2012 annual report, author's calculations.

Notice two facts: the expense of hiring McDonald's employees in the U.S. is substantially higher than its operating income from the entire world, and McDonald's bottom line only inched up by 1% from 2011 to 2012.

Even with $4.7 billion in payroll and benefit costs, hiking the minimum wage to $10.10 would immediately drop McDonald's operating income to less than 1%, and $15.00 would likely result in flat growth or an operating loss.

While the case isn't same for every company, many companies that pay the minimum wage -- such as McDonald's, Yum! Brands' (NYSE: YUM  ) restaurants, and Wal-Mart (NYSE: WMT  ) -- operate on similar high volume, low-margin business models.

That means that any additional expenses to its top line will result in lower margins and possible unprofitability. To keep their heads above water, these companies will have to reduce their workforces or raise prices to pass the costs onto the consumer.

Myth 2: The majority of minimum wage employees are employed by large corporations.

That leads us to the second point -- recent protests have made it seem as if large corporations are the only businesses that support keeping the minimum wage in place.

(Source: Freedomoutpost.com)

Yet a recent analysis by the Employment Policies Institute found that approximately half of the minimum wage workforce was employed by businesses with fewer than 100 employees, and 40% work at very small businesses with fewer than 50 employees.

If a larger corporation like McDonald's is already struggling with balancing its bottom line, imagine the trouble smaller businesses would have if the minimum wage were abruptly raised across the board.

McDonald's can just adjust its menu prices, close down company-owned restaurants, and boost the number of its franchised locations. I doubt that smaller businesses with less than 50 employees have the same luxury.

Another 2012 study from Sabia, Burkhauser, and Hansen showed that New York state's minimum increase from $5.15 to $6.75 in 2006 actually reduced the employment rate by 20% among the least educated and skilled people in the workforce. This was assumed to be caused by employers tightening up their hiring standards and hiring fewer workers in response to the forced pay hike.

Myth 3: The majority of minimum wage workers are living below the poverty line.

Lastly, the argument that the minimum wage keeps workers in poverty is based on deceptively simple math: an employee being paid $7.25 per hour, working 40 hours per week for 52 weeks a year would only earn $15,080 per year.

The problem with that statement is that the poverty line (as defined by the U.S. Department of Health and Human Services) was set at $11,490 per individual for 2013. While $15,080 per year is definitely not a lot of money, the government does not define it as the "poverty level."

In fact, data from the U.S. Census Bureau and the U.S. Bureau of Labor Statistics has shown that 80% of minimum wage earners do not live below the poverty line.

Teens and young adults actually comprise nearly half (46%) of all minimum wage employees in the country. To top that off, over a third of minimum wage earners still live with their parents, whose average household incomes exceed $100,000.

The bottom line

After all is said and done, raising the minimum wage accomplishes these things:

  • It forces large companies to readjust their prices, resulting in higher costs for consumers.

  • It could hurt smaller companies more than larger ones.

While raising the minimum wage might help boost the public's opinion for President Obama, it does very little to reduce income inequality.

In fact, natural economic forces, such as market demand and inflation, will eventually force companies to readjust their wages in the future. When companies have trouble filling positions, they naturally raise their pay to remain competitive.

Unfortunately, this non-issue will likely remain just another partisan flashpoint in the coming year.

What do you think, dear readers? Do you agree or disagree with President Obama's stance on raising the minimum wage? Please sound off in the comments section below!

Now on to Obamacare...

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 29, 2014, at 2:30 PM, TMFHousel wrote:

    <<based on a 40-hour work week and 52 weeks worked per year.>>

    What percent of MCD employees work 40 hours a week?

  • Report this Comment On January 29, 2014, at 2:32 PM, TMFHousel wrote:

    Leo, it looks like you assume MCD's annual labor cost is $11.46 billion, but if you look at their income statement you'll see that the actual number is $4.7 billion.

    If we're calling out myths, I think that's only fair to point out ...

  • Report this Comment On January 29, 2014, at 2:35 PM, TMFHousel wrote:

    From the article:

    "(approximation, does not account for the difference between part-time, full-time, or franchise employees)"

    I think that's the key. If you don't approximate and you use the actual figures, it looks completely different.

  • Report this Comment On January 29, 2014, at 2:43 PM, TMFSunLion wrote:

    Thanks for noticing that, Morgan, let me try to change that chart to be more accurate.

  • Report this Comment On January 29, 2014, at 2:45 PM, TMFSunLion wrote:

    Yes, I see how it can come across as deceiving without mentioning the $4.7 billion payroll and benefits expense from fiscal 2012. I'll add that in.

  • Report this Comment On January 29, 2014, at 2:47 PM, TMFHousel wrote:

    Also, from McDonald's most recent annual report:

    "The Company’s number of employees worldwide, including Company-operated restaurant employees, was approximately 440,000 as of year-end 2012."

  • Report this Comment On January 29, 2014, at 2:50 PM, SkepikI wrote:

    ^ No, if you read it, presumes 40 hr weeks, which as you point out first is not correct or reasonable. But its one of those nice round numbers analysis myths that illustrates the point, even if its practical application is limited. Which I presume Housel is your point.

    Mine would be no matter what your math might be and no matter what you think will happen to corporate profits, the raising of minimum wages is a cruel hoax. It never plays out with any real benefit for those who the proponents are claiming loudly to help. My state has a minimum wage of $9.10 and is indexed to "inflation" (which I do not believe accurate). We in Oregon have one of the most persistently bad employment pictures in the US. Its covered up and fuzzed by several urban populations that dominate the numbers. In Rural Oregon, several counties are double digit and climbing. The pressure of minimum wage increases and mismanagement of state functions in some of these rural spots have caused individual businesses to "Fire the State of Oregon" and simply quit.

    Loss of one or two businesses in Portland does not mean much. A closure in Cave Junction (pop about 1000) is much more "statistically significant"

    The change in economic activity will be much more visited on this end of the spectrum rather than McDonalds. What this kind of analysis leaves out is the elimination of HIGHER than minimum wage jobs occurring at this end of the spectrum.

    Doubly cruel.

  • Report this Comment On January 29, 2014, at 3:16 PM, dieselfreek wrote:

    All of the focus is on those who are currently earning the minimum wage. What are the effects on those who have gained skills and worked hard to earn a higher wage that is now below or equivalent to the higher minimum wage? Are their skills and accomplishments considered the “minimum,” or will their wages be raised as well and by how much? When you raise the floor everyone standing on it will get taller, not just the shortest person; how does this improve equality?

  • Report this Comment On January 29, 2014, at 9:49 PM, TMFSunLion wrote:
  • Report this Comment On January 30, 2014, at 10:40 AM, Mathman6577 wrote:

    I think it will be a moot point anyway. The GOP House will never vote to raise the federal min. wage.

    The thing to do to help the low wage earners (not only min. wage workers) instead of mandating an increase is education and economic growth. Help the people get out of the rut with job training programs and certifications (instead of expensive degrees that may not get them a job). Lower taxes and reduce regulations for small business (most min. wage workers work for small businesses).

  • Report this Comment On January 30, 2014, at 11:29 AM, TMFSunLion wrote:

    I agree it may be a moot point as well. Right now, it seems like a lot of showmanship on Obama's part in asking for $10.10 and not $9.00.

    According to a recent poll, 59% of Republicans favor raising the minimum wage to $9.00, which would be a reasonable compromise:

    http://www.gallup.com/poll/165794/americans-raising-minimum-...

    Since that's a 24% increase which should, in theory, somewhat keep up with inflation.

  • Report this Comment On January 30, 2014, at 12:35 PM, SkepikI wrote:

    ^ Futile. Cruel Hoax

  • Report this Comment On February 01, 2014, at 7:00 PM, TMFJCar wrote:

    "Yet a recent analysis by the Employment Policies Institute"

    Not sure you should quote that source Leo. It seems like a think tank rather than a credible source. I perused their website and it seems slightly slanted as opposed to providing fact-based research. Can you provide a link to their research study?

    Thanks man!

    Jamal Carnette

  • Report this Comment On February 02, 2014, at 12:34 PM, TMFSunLion wrote:

    Hi Jamal, thanks. Let me ask the editors to add a link to the study in the article.

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