Government finances

Minimum wages have sometimes been described as an attractive policy tool for poverty reduction and social justice because they do not require significant government spending (Cunningham, 2007). Yet, minimum wage increases can have unintended collateral effects that do affect government finances.

There are three main linkages:

• One is that a higher minimum wage can lead to increases in the public sector wage bill, particularly when public sector pay scales are calculated as a multiple of the minimum. In some instances, this direct link – and the fear of its consequences – has prevented increases in the minimum wage.

• A second complication arises when different aspects of social protection, such as basic pensions, disability payments or maternity benefits, are automatically linked to the level of minimum wages. So, for example, the basic pension may be set at 75 per cent of the level of the minimum wage. In practice, this means that retirement and other benefits will be adjusted upwards when the minimum wage increases.

• A third linkage displays the reverse relationship and occurs where governments supplement low wages with means-tested in-work benefits to address problems of household poverty among low paid workers. Governments then face a strong incentive to raise the minimum wage so as to reduce the size of welfare transfers to the low paid.

While having these links may be attractive for various reasons, it creates the risk of potentially unsustainable increases in social security costs when the minimum wage is adjusted upwards. When the minimum wage increases faster than average wages in order to reduce wage inequality, the consequence is that social security spending grows faster than the revenue base for the social security system, which depends on trends in real earnings.

Marinakis and Velasco (2006, p. 13), for example, point out that in the 1980s the fall in the real value of the minimum wage in Argentina and Brazil was in fact mostly aimed at shrinking the budget deficit by cutting social security spending. Some countries have thus chosen to de-link minimum wage increases from increases in social benefits.

• De-linking Portugal's minimum wage

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1 Cunningham, W. 2007. Minimum Wages and Social Policy: Lessons from Developing Countries, The World Bank
2 Marinakis A; Velasco, J.J. (EDS.) 2006. Para Que Sirve el salario minimo? Officina Internacional del Trabajo, Santiago, Chile