Does Uncle Sam Subsidize Ronald McDonald?

Includes: DG, FDO, MCD, WMT
by: John Slater

Recently, food industry workers in Manhattan and other cities staged highly publicized strikes and manned picket lines to demand a "living wage" of $15 per hour. This echoes recent discussion by the Washington, DC, City Council concerning the enactment of a "living wage" law that would guarantee employees at big box retailers (such as Wal-Mart (NYSE:WMT)) with global sales in excess of $1 billion be paid a minimum wage of at least $12.50 per hour.

In part this recently increased focus on the minimum wage has been precipitated by a change in the nature of the low wage work force. Thirty years ago burger flippers at McDonald's (NYSE:MCD) were high school students earning money for a Saturday night date. Today, they are increasingly breadwinners with a family to support. Some states and 125 municipalities have enacted local minimum wages above federal levels or passed "living wage" laws.

Whenever something is happening in the economy that makes no sense on its face, one should be tempted to ask why. In the present case, it makes little sense that families are being supported at income levels inadequate for food, shelter and other basic necessities. How could such an impossible situation continue without a far greater outcry than has been witnessed to date? As it turns out the U. S. federal government provides major props that support this otherwise unsustainable level of very low-income employment.

In 1975 Congress enacted the Earned Income Tax Credit (EITC), which not only provides a tax reduction to low income wage earners, but can also provide an additional tax refund of up to $5891 in 2012 for a single wage earner supporting three or more children. The EITC has been a favorite of both political parties and, since its humble beginnings in 1975, has been increased steadily. Ronald Reagan was a fan and the Republican Party has been particularly fond of this credit on the assumption that it encourages work, while traditional welfare programs encourage indolence.

In the 1980s and 1990s the U. S. Congress dramatically strengthened the EITC and increased the availability of Food Stamps (now SNAP) and Medicaid while at the same time taking other actions to dismantle the old welfare system that was created during the post-war era and reached its peak with Lyndon Johnson's Great Society. In the same timeframe it also acted to dramatically reduce the minimum wage in real dollars.

Source: U. S. Census Bureau, U. S. Department of Labor

During the 20-year period from 1961 to 1980, which includes the "Great Society" era, the U. S. minimum wage averaged approximately 78% of the federally defined poverty level for a family of four, assuming a 2,000 hour work year. From 1981 through 2010, the federal minimum wage averaged only 59% of the poverty level for a family of four. Bottom line - if you were at the very bottom of the income scale, you took a 24% pay cut in real terms.

Taken together it appears that, over the past thirty years, decisions made by the U. S. Congress have had the impact of legalizing jobs with wages far below the levels mandated during the Great Society years and increasingly insufficient to sustain a breadwinner and a typical family of four in the modern U. S. economy. At the same time Congress has created a massive safety net (including SNAP, housing subsidies, Medicaid and other support programs in addition to the EITC) that costs the federal budget hundreds of billions of dollars annually and makes employment at such wages economically sustainable.

By providing smaller employers and those with part-time workers with an alternative to providing healthcare for their employees, Obamacare appears to add significantly to these subsidies. Taking all of these programs together, the taxpayer is unwittingly subsidizing low wage employers, including retailers such as McDonald's and Wal-Mart, but also many small business owners who would become uncompetitive if forced to pay the "living wage" being demanded by retail unions.

As with housing finance, farm subsidies and thousands of other federal programs, the EITC was designed with an eye to seemingly sound public policy: i.e. to encourage people to work rather than relying only on welfare - surely a worthy goal. As always seems to be the case when Washington sets out to fix a problem, it is the unintended consequences that come back to haunt.

And just as with other federal programs that may have outlived or exceeded their original purpose, there are now many vested interests that stand to be harmed by any potential attempts to correct the imbalances this situation has created. These interests could include industries vital to the ongoing success of the U. S. economy such as manufacturing. Thousands of U. S. manufacturing businesses have survived despite being subjected to extremely low wage foreign competition. These survivors benefit from logistical advantages, perceptions of higher quality and their customers' concerns about unreliability with overseas suppliers. They also depend to some extent on their ability to access labor at acceptable wages, wages which have conveniently decreased in real terms over recent decades. Current demands for "living wage" legislation, should it be enacted, could significantly impact these firms, pushing their customers (and jobs) to foreign competitors..

It would most likely be possible, with an increase of the minimum wage to the 1961-1980 level, to materially reduce the support burden being carried by the taxpayers through the EITC and other safety net programs. Much of this burden can be shifted to employers and their customers, though that would result in higher retail prices. With such wide-reaching implications across the entire economy, it is important that we better understand the overall impact of proposed "living wage" legislation before Congress (or more likely, states and cities) acts to address the issue.

Would such a shift be positive, negative or neutral for the economy as a whole? Who would be the winners and losers? What real impact would the higher minimum wage have on employment levels? Could savings from the reductions in the safety net be used to fund job training or alternative forms of employment? On the other hand what are the societal costs of a continued drift to a world where a large percentage of the American workforce is dependent on federal subsidies for survival?

With or without these answers, what is clear now is that low wage employers such as McDonald's and the rest of the restaurant industry, low-cost retailers such as Wal-Mart, Dollar General (NYSE:DG), and Family Dollar (FDO) and many others are increasingly facing risks from political actions designed to assure their employees a "living wage." Should legislative action result, the profit impact for these employers could be significant.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.