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

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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 (MCD 0.25%) 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.

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:

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' (YUM 0.25%) restaurants, and Wal-Mart (WMT 0.15%) -- 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!