At the start of 2013, ten states raised their minimum wage rates: Arizona, Colorado, Florida, Missouri, Montana, Ohio, Oregon, Rhode Island, Vermont, and Washington. These ten states did so because each has a law requiring that it maintain the purchasing power of the state wage floor with an annual inflation adjustment, also called a “cost-of-living adjustment (COLA)” or “inflation-indexing.”
This flurry of activity sparked, yet again, a political fight over the merits of this century-old labor standard. One issue that comes up is whether minimum wage hikes will trigger inflation, i.e., cause an overall rise in prices.
Take, for example, John Fleming, spokesman of the Florida Retail Federation. Reflecting on the 12-cent (1.6%) Florida minimum wage hike from $7.67 to $7.79 about to take effect on the New Year, he worried that in order to adjust to the higher minimum wage, businesses would be forced to mark up prices, “And then you get to this inflationary spiral where higher prices lead to higher cost of living.”
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This fear of inflation from the minimum wage is not based on any reasonable description of how these minimum wage hikes will likely impact businesses, or the economy more generally. The potential impact of minimum wage hikes on the overall price level is simply too small to have any appreciable impact on inflation.
One way to assess the threat of inflation posed by a minimum wage hike is to estimate directly how much it could raise businesses’ costs. This would give us a sense of what the potential impact of a minimum wage hike would be on prices, assuming businesses would pass these costs onto their consumers. Of course, there are other ways firms can adjust, aside from raising prices. For example, employers may experience some labor-cost savings as their higher wages lower turnover rates and motivate greater worker productivity. But for the sake of simplicity, let’s assume that firms pass the entire cost increase from a minimum wage hike to consumers.
Past research on how business costs rise with minimum wage hikes indicates that a 10-percent minimum wage hike can be expected to produce a cost increase for the average business of less than one-tenth of one percent of their sales revenue. This cost figure includes three components. First, mandated raises: the raises employers must give their workers to meet the new wage floor. Second, “ripple-effect” raises: the raises employers give some workers to put their pay rates a bit above the new minimum in order to preserve the same wage hierarchy before and after minimum wage hike. And third, the higher payroll taxes employers must pay on their now-larger wage bill. If the average businesses wanted to completely cover the cost increase from a 10-percent minimum wage hike through higher prices, they would need to raise their prices by less than 0.1 percent.A price increase of this size amounts to marking up a $100 price tag to $100.10.
COLA increases are much, much smaller than 10 percent. The average rate of annual inflation, as measured by the Bureau of Labor Statistics’ Consumer Price Index for Urban Consumers, averaged 2.6 percent over the last two decades (1991-2011). The average business therefore could easily cover the cost increase from a typical COLA by raising prices less than 0.03 percent. This amounts a price tag of $100 going up by less than three pennies. Price increases this small would have a negligible impact on a 2.6 percent average inflation rate.
This basic conclusion is supported by a 2008 study that reviewed the economic studies on the impact of minimum wage hikes on prices and inflation. The estimates from these studies cover a relatively wide range, suggesting that a 10-percent increase in the minimum causes overall prices to rise somewhere between 0.2 percent and 2.16 percent, with most estimates falling below 0.4 percent. These estimates are larger, but in the range of how much businesses’ costs increase as discussed above. Even the higher estimate of a 0.4 percent rise in price level with a 10 percent minimum wage hike suggests that a typical COLA adjustment to the minimum wage rate would only push up the price level by 0.1 percent. Recall that this amounts to adding just one dime to a $100 price tag.
The bottom line: these minimum wage hikes pose no inflationary threat. The potential contribution of the minimum wage COLAs to inflation would be to raise the rate of inflation by less than 0.1 percent. This would raise, for example, the average annual inflation rate of 2.6 percent to 2.7 percent—a change so small that the rate is effectively unchanged in any meaningful way. In fact, this potential impact on inflation is smaller than the margin of error for the Department of Labor’s estimate of inflation.
 (0.1%/10%) x 2.6% = 0.026%
 “A Survey of the Effects of Minimum Wages on Prices,” by Sara Lemos, Journal of Economic Surveys 22(1): 187–212, 2008.
 (0.4%/10%) x 2.6% = 0.1%