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The minimum wage is one of the most researched areas in labor economics with a vast body of literature that dates back nearly seventy years (Brown 1999). Research proliferated as variation in state minimum wage policies gained steam over the last several decades. However, research, debate and policy has largely ignored the lesser known subminimum wage received by tipped workers (also referred to as the tipped or cash wage). That there are two federal wage floors is unknown to many and the existence of the federal subminimum wage—at $2.13 since 1991—often comes as a bit of a surprise.

The rationale for the lower subminimum wage for tipped workers is the ‘tip credit’ provision. The 1966 Fair Labor Standards Act amendments expanded wage protections to restaurant, hotel and other service workers but also allowed for a tip credit whereby employers may use tips, provided by customers, as credit towards a workers regular minimum wage. Today, at the federal level, the maximum tip credit is $5.12—which is the difference between the regular $7.25 minimum wage and the $2.13 subminimum wage. At the federal level, the tip credit allows an employer to pay workers an hourly wage of $2.13 as long as this base wage combined with additional tipped income equates to at least the regular minimum wage. Thus, the subminimum wage and the tip credit allowance is a zero sum game—an increase in one translates into a decrease in the other.

There has been little research inquiry into the subminimum wage and the tip credit provision thus the effects of each are not well understood. Given the fast growth in the restaurant industry it is important to know the dynamics of the wages floors. Since 1990 private sector employment grew by approximately 22% while full-service restaurant employment grew by 72%. The main focus of the paper, as with much of the literature on minimum wages, is to estimate earnings and employment effects of the subminimum wage. Though there has not been any movement at the federal level on the subminimum in over two decades there is more than ample variation due to state enacted policies. Just as many states enact regular minimum wages above the federal level, so too have states adopted subminimum wages above the federal level. The state variation in the regular and the subminimum is the identification strategy used to estimate earnings and employment effects for limited- and full-service restaurants of which both are intense users of low wage workers.

After more than two decades of the $2.13 for the federal sub-wage floor the most basic policy question is whether it can be raised without contributing to employment losses and would the workers benefit in the form of higher earnings. Otherwise, if the tipped credit allowance were decreased or abandoned all together what would the effect be on employment and earnings of tipped workers in affected industries? Even as there is very little literature regarding the subminimum wage this research parallels the literature on the regular minimum wage. Most recently minimum wage researchers are building on past research to better understand the problem of unobservable heterogeneity. Central to the debate is how to best account for minimum wages that are correlated, but not causal, to employment growth patterns. The researcher takes the stance that the traditional two-way fixed effects model applied to panel data are inadequate due to the fact that minimum and subminimum wages are not randomly distributed. The non-random nature of state wage floor policies poses a nontrivial threat to estimating spurious effects of such policies. In Allegretto et al. (2013) it is shown that observable confounds vary considerably across high and low minimum wage states suggesting that unobserved factors do as well. Thus, central to this research and any research on minimum wages is to adequately address the issue of spatial heterogeneity.

In sum, findings indicate that the earnings effect of both wage floors are positive and statistically significant for full-service restaurants; but as expected due to the lack of tipped workers the earnings effect is restricted to the minimum wage for limited-service restaurants. Employment estimates that include geographic controls that better account for unobserved heterogeneity are small and not distinguished from zero for the tipped wage -0.012 (-0.005) and the minimum wage -0.026 (-0.045) in the full (limited) service sector.

Citation

Institute for Research on Labor and Employment. (2014). A Paper Series Commemorating the 75th Anniversary of the Fair Labor Standards Act. Chief Evaluation Office, U.S. Department of Labor.

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The Department of Labor’s (DOL) Chief Evaluation Office (CEO) sponsors independent evaluations and research, primarily conducted by external, third-party contractors in accordance with the Department of Labor Evaluation Policy and CEO’s research development process.