The Redistributive Effects of a Minimum Wage Increase in New Zealand: A Microsimulation Analysis

• Published date: 01 December 2020
• Author: Nazila Alinaghi,John Creedy,Norman Gemmell
• Date: 01 December 2020
• DOI: http://doi.org/10.1111/1467-8462.12381

The Australian Economic Review, vol. 53, no. 4, pp. 517–538 DOI: 10.1111/1467-8462.12381

The Redistributive Effects of a Minimum Wage Increase in New

Zealand: A Microsimulation Analysis

Nazila Alinaghi , John Creedy and Norman Gemmell*

Abstract

This paper examines the potential effects on

inequality and poverty of a minimum wage

increase, based on a microsimulation model

that captures the details of household compo-

sition and the income tax and welfare benefit

system and allows for labour supply re-

sponses. Results suggest that, largely due to

the composition of household incomes, a

policy of increasing the minimum wage has

a relatively small effect on the inequality of

income per adult equivalent person, and a

money metric utility measure, using several

inequality indices. Hence, the minimum wage

policy does not appear to be particularly well

targeted, largely due to many low wage

earners being secondary earners in higher

income households, while many low income

households have no wage earners at all.

These results are reinforced when allowing

for wage spillovers further up the wage

distribution. Nevertheless, a minimum wage

increase can have a more substantial effect on

some poverty measures for sole parents in

employment.

1. Introduction

A legal minimum wage, commonly used

across OECD countries, is explicitly aimed

at redistributing earnings towards low paid

workers or assisting workers with low bar-

gaining power to receive a ‘fair’wage. The

aim of this paper is to assess the potential

distributional effects of an increase in the

legal minimum wage in New Zealand. Results

are obtained using a behavioural tax micro-

simulation model. This also allows the ceteris

paribus labour supply effects on distributional

measures of minimum wage reforms to be

examined.

While it may be tempting to assume that an

increase in the minimum wage must be

inequality‐reducing, many low wage indivi-

duals are in households that have relatively

high total incomes. Hence, if concern is with

the distribution of income per adult equivalent

person, a widely used welfare metric, it is not

clear that a minimum wage policy is the most

effective. Indeed, many low income house-

holds consist of people who are not in the

labour market, and who therefore cannot

benefit from a minimum wage increase.

Creedy et al. (2010) demonstrate the impor-

tance of the heterogeneity of low income

households in New Zealand for the design of

fiscal policies aimed at redistribution. The

limitations of minimum wage settings to

* Victoria Business School, Victoria University of

Wellington, 23 Lambton Quay, Pipitea Campus,

Rutherford House, Wellington, 6011, New Zealand.

Corresponding author: Alinaghi, email <nazila.

alinaghi@vuw.ac.nz>. This paper is part of a larger

project on ‘Improving New Zealand's Tax Policy via

International Tax Transfer Model Benchmarking’, funded

by an Endeavour Research Grant from the Ministry of

Business, Innovation and Employment (MBIE) and

awarded to the Chair in Public Finance. Access to the

data used in this paper was provided by Statistics New

Zealand in accordance with security and confidentiality

provisions of the Statistics Act 1975. The results

presented in this study are the work of the authors, not

Statistics New Zealand. We have benefited from discus-

sion with Christopher Ball, Nicolas Hérault and Guyonne

Kalb. We also thank two anonymous referees for their

comments.

© 2020 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd

influence wage inequality or household in-

come inequality or poverty have been stressed

by Burkhauser and Finegan (1989) and

Burkhauser and Sabia (2007) in the United

States context, by Gosling (1996) for the

United Kingdom, and by Pacheco (2009) and

Maloney and Pacheco (2012) for New

Zealand.

Additional distributional effects may be

expected to the extent that there are

behavioural responses to minimum wage

settings. Employment responses, discussed

extensively in the labour economics litera-

ture (and reviewed brieflyinSection2),

have often been treated as demand‐side

responses whereby employment offers de-

cline and some existing jobs are terminated,

following an increase in minimum wage

rates. However, as Gosling (1996) and

Pacheco (2011) suggest, labour supply

responses are both conceptually and empiri-

cally relevant, so that observed employment

effects of minimum wages are likely to be

the result of both demand‐and supply‐side

responses.

Using a tax microsimulation model that

captures a high degree of population hetero-

geneity, this paper examines the distributional

impact of a minimum wage policy across

families. The model also enables the ceteris

paribus distributional effects of labour supply

responses to a higher minimum wage to be

identified. These have largely remained un-

explored, despite the potential labour supply

effects highlighted by Gosling (1996) and

Pacheco (2011), among others.

In microsimulation modelling a distinction

can be drawn between first‐, second‐and

third‐round effects. First‐round effects, pro-

duced by ‘arithmetic models’, refer to the

measured consequences of exogenous policy

changes, with all wage rates and hours

worked held constant at their pre‐reform

levels. Microsimulation studies of minimum

wage effects in this tradition include Müller

and Steiner (2009) for Germany, and

Atkinson et al. (2017) for the United

Kingdom. Second‐round effects, produced

by ‘behavioural models’allow for the con-

sequent labour supply effects, at both

extensive and intensive margins, while

holding all wage rates constant. Finally,

third‐round effects would allow for the

interaction of both the supply and demand

sides of the labour market, whereby all wage

rates as well as labour hours are endogenous

and markets are in equilibrium.

1

The present

results are limited to first‐and second‐round

effects and therefore abstract from general

equilibrium effects, though possible wage

spillovers to higher earners in the wage

distribution are examined.

While it is always important to recognise

this limitation of the existing generation of

behavioural microsimulation models, it is

nevertheless of interest to consider how large

these second‐round effects are empirically,

and their ability to align with the policy

objectives of reducing inequality and poverty.

Furthermore, the explicit modelling of the

choice between net income (income after

direct taxes and transfers) and hours worked

makes it possible to examine welfare metrics

other than net income, and thus to allow for

welfare changes arising from changes in non‐

work time (which allows implicitly for the

value of home production).

2

The paper there-

fore extends the small number of distribu-

tional studies that use a microsimulation

model of this kind to examine minimum

wage effects.

Section2briefly reviews evidence from

previous studies with a focus on minimum

wages. Section 3 describes the simulation

model approach used. Section 4 describes the

policy examined, and presents simulation

results for the distributional and social

welfare outcomes. To explore the possibility

that minimum wage increases may spill over

to wages rates further up the wage distribu-

tion, Section 5 investigates comparable

simulations which allow for substantial

wage spillovers. Conclusions are drawn in

Section 6.

2. Previous Literature

Previous literature on the economic impact of

a legislated minimum wage has concentrated

on employment effects (regarded as arising

518 The Australian Economic Review December 2020

© 2020 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research, Faculty of Business

and Economics