Response to Service Employees International Union’s (3/1/04) “Putting Baltimore’s People First: Keys to Responsible Economic Development of Our City”
Joseph Pomykala, Ph.D.
Department of Economics
Towson University
False Claims of Local Economic Stimulus
From an economic perspective, SEIU claims are grossly exaggerated or outrightly incorrect. SEIU claims that raising hospital worker wages would produce a large stimulative effect on the Baltimore economy. Economics however leads to the conclusion that there would likely be no simulative effect.
In “IV. Higher Wages as the Key To Responsible Economic Development in Baltimore, The Economic Impact of Raising Service Workers’ Wages” (pp. 17-18) SEIU remarks, “There is probably no better means to stimulate overall economic activity in a region than to raise the incomes of its low-wage workers.” The argument which follows is that by raising worker wages, there will be what is termed in the economic literature as “multiplier effect” where higher incomes lead to higher consumer spending, and such spending in turn raises incomes leading to additional spending. Using such theory, SEIU claims that a $1 per hour raise among 3,500 hospital workers will lead to “$10.4 million in additional income for everyone in Baltimore within a year. In three years, it would produce a total of $62.4 million.”
This claim is of local economic stimulus is incorrect. Raising wages would have little or no stimulative effect on the Baltimore economy. Hospitals do not have the ability to print money to pay higher wages. An increase in wage costs will lead to higher priced hospital services paid for by consumers directly or by higher priced insurance premiums. Any stimulative effect on the local economy by higher income hospital worker spending more is completely offset by local consumers of hospital services paying more for such and thus spending equivalently less in the local economy on non-hospital goods and services. The positive multiplier effect of hospital workers spending more is nullified by consumers of hospital services spending less in the local economy. SEIU ignores the negative economic consequences of higher priced health care among consumers leading to reduced income left over after heath care costs and thus reduced non-heath care spending in the local economy by consumers.
The SEIU figures are calculated based on a RIMS II multiplier effect of 1.433 (footnote 32) for hospital workers in Baltimore City. A theoretical $1 per hour rise in income for 3,500 persons working 40 hours per week for 52 weeks per year amounts to an initial gross annual rise in hospital worker income of $7.3 million. With a multiplier of 1.433, local stimulus resulting from higher hospital worker spending would be 1.433 x $7.3 million or $10.4 million additional local income per year, and thus total annual income rises by $17.7 million ($7.3 +$10.4 mil.). Over three years this amounts to $53.1. SEIU makes an error by claiming a $62.4 million rise in income over three years, an overestimation of $9.3 million. However, the corrected figure still ignores the offsetting negative impact of a $21.9 million rise in health care costs over three years which has a similar, but negative, multiplier effect. This reduces consumer income left over after higher heath care expenditures, and thus consumers of higher priced heath reduce local spending. Assuming a similar multiplier of 1.433 for local heath are consumers, the net impact on the local economy is zero.
SEIU figures do not account for higher taxes paid by hospital workers. Some of the $1 per hour raise would be reduced by higher federal, state, and local income taxes, in addition to FICA taxes. If such amount to 25%, a $1 per hour wage rise only increases disposable income by 75¢ per hour reducing the claimed positive multiplier effect by higher paid heath care workers by 25%. In comparison, higher resulting local heath care expenditures in Baltimore only receive mild tax reductions if such spent is in excess of 7.5% of adjusted gross income and thus deductible if itemizing. Thus, any increased hospital worker wages paid would be reduced by increased taxes draining money spent in the local economy. The negative consequences upon the local economy of higher heath care costs would not be reduced by equivalent tax savings. The total impact of an increase in wages of heath care workers for the Baltimore economy would thus be NEGATIVE as local spending would be reduced by higher net federal, state, and local income taxes, and FICA taxes paid, thus reducing net spending in the local economy. If assuming 25% of additional hospital worker income leaves the local economy via higher taxes and a multiplier effect of 1.433, then within three years the $1 per hour raise would reduce total income and spending by $5.5 million, not an increase $62.4 million as claimed by SEIU. Simply, hospital worker income rises and more is equivalently spent by consumers of heath care services, but increased tax payments by the former lead to reduced local spending.
However, SEIU figures do not account for higher taxes paid by hospital workers. Some of the $1 per hour raise would be reduced by higher federal, state, and local income taxes, in addition to FICA taxes. If such amount to 25%, a $1 rise in gross hourly wage rise only increases disposable income by 75¢ per hour reducing the claimed positive multiplier effect by higher paid heath care workers by 25%. In comparison, higher resulting local heath care expenditures in Baltimore only receive mild tax reductions, e.g. when such spent is in excess of 7.5% of adjusted gross income making such deductible if itemizing. Thus, increased hospital worker wages paid would be reduced by increased taxes draining money from in the local economy. The negative consequences upon the local economy of higher heath care costs would not be reduced by equivalent tax savings.The total impact of an increase in wages of heath care workers for the Baltimore economy would thus be NEGATIVE as local spending would be reduced by higher net federal, state, and local income taxes, and FICA taxes paid, thus reducing net spending in the local economy. If assuming 25% of additional hospital worker income leaves the local economy via higher taxes and a multiplier effect of 1.433, then over three years the $1 per hour raise would theoretically reduce total income by $13.3 million, not an increase $62.4 million as claimed by SEIU. Simply, hospital worker income rises and more is equivalently spent by consumers of heath care services on such and less on other things, but because of higher tax payments by the former, the resulting decrease in consumer spending could be more than the increase in heath care worker spending leading to reduced net local spending.
Similar false arguments are often used for propaganda purposes to justify government subsidies to “create jobs and stimulate the economy.” If government spends $10 million more for a stadium or subsidizing a university financed by raising property taxes by $10 million, the reduction in disposable income leads to reduced private sector consumer spending which can completely offset any positive economic stimulus.
Joseph S. Pomykala, Ph.D. Economics, University of Pennsylvania
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