Minimum wage policy with optimal taxes and unemployment

• Published in: Journal of public economics 2020-10, Vol.190, p.104228, Article 104228
• Main Author: Lavecchia, Adam M.
• Format: Article
• Language: English
• Subjects: Labor force participation; Minimum wage; Optimal policy; Sufficient statistics
• ISSN: 0047-2727; 1879-2316
• DOI: 10.1016/j.jpubeco.2020.104228

Using a search model, I derive a formula that links the welfare gains from the minimum wage to its effect on low-skilled labor force participation and employment. This formula shows that the minimum wage is welfare improving if pushing the low-skilled labor market tightness downwards brings it closer to its efficient level. I estimate the causal effect of the minimum wage on low-skilled labor force participation and employment using federal and state minimum wage variation. I discuss the policy implications of my estimates when viewed through the lens of the marginal welfare gain formula. •I derive a formula linking the total welfare change from introducing a minimum wage to its effects of labor market participation and employment•I show that the minimum wage affects welfare through two distinct channels: a labor market efficiency channel and a redistribution channel•My formula indicates that both the macroeconomic labor force participation and employment responses to the minimum wage are relevant for welfare•I estimate both responses using an event study design using U.S. state and federal minimum wage variation from 1983-2014•I provide new evidence on the effects of the minimum wage on the labor market participation of young, low-skilled adults, a margin often overlooked