Minimum Wages and Tipped Servers

By Wessels, Walter John | Economic Inquiry, April 1997 | Go to article overview

Minimum Wages and Tipped Servers


Wessels, Walter John, Economic Inquiry


I. INTRODUCTION

Economists have long searched for the presence of monopsony in labor markets. Their consensus has been that the labor market for low-wage workers is competitive.(1) However, some economists have recently asserted that these labor markets are to some degree monopsonistic and that over some range minimum wage laws can increase employment.(2)

This article shows that the labor market for tipped restaurant servers is monopsonistic. There are over two million servers nationwide,(3) most of whom are paid at or near the minimum wage.(4) They represent at least 20% of minimum wage workers. A finding of monopsony in this market is thus of importance.

Even if labor markets for servers are competitive, tipping makes restaurants monopsonistic. Evidence from two data sets presented here shows that this is true. Further, I empirically estimate the full "reverse C" monopsonistic employment pattern with higher minimum wages first increasing and then decreasing employment.

The basic model is as follows. Tips, due to custom, are a certain percentage of a meal's price.(5) As the restaurant hires more servers, factor demand theory tells us that marginal and average revenues per server will fall. The falling average revenue means each server earns less in tips. To retain its work force, the restaurant must then raise its hourly wage. So each restaurant faces a rising supply curve of labor and is a monopsony - even if it is fully competitive in the labor market. Consequently, over some range, a higher minimum wage will increase restaurant employment.

Another way to state the theory is to liken tipping to profit sharing. Most profit sharing plans are tied to average profits or average productivity. As a result, these plans pay out less to each worker when the firm hires more workers. Consequently, the firm has to raise its wages. In a sense, this article could be titled "The Effects of Minimum Wages on Firms with Major Profit-Sharing Plans" as over half of most servers' income is in tips.(6)

The minimum wage applicable to servers will be called the "tipped minimum wage." It differs from the standard minimum wage because federal law allows a 50% tip credit against the minimum wage. However, many states limit this offset and some allow no offset at all. Because of this, the state-to-state variation in tipped minimum wages is very large, with some states having a tipped minimum wage twice that of others. This large variation in tipped minimum wages makes it possible to examine the impact of large changes in the minimum wage. Other articles such as Card [1992] and Neumark and Wascher [1992] analyzed the effects of the much smaller differences in state minimum wages.

Two data sets are analyzed. The first set combines cross-sectional and time-series data from all states for three years (1977, 1982 and 1987). Various fixed-effects models are used to estimate the impact of minimum wages. The second data set consists of information about restaurant employment before and after a minimum-wage hike. The results from these data sets suggest that a monopsony effect exists.

II. METHODOLOGICAL ISSUES

The general methodological procedure is to present a hypothesis and then the evidence that supports it. In this article I present two data sets which support the model's predictions. By using two data sets, each having a different type of data and each from a different time period, the validity of the model is enhanced.

There are other models that predict that a rise in the minimum wage can increase employment (see footnote 2). So even if we find that increases in tipped minimum wages increase employment, how do we know which theory is supported? My central finding, which supports my model, is that tipped minimum wages had a larger and more positive impact on employment than did the standard minimum wage in both data sets. In the first data set, increases in the standard minimum wage usually did not increase employment - only the tipped minimum wage did. …

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