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How Small Businesses Are Affected by Minimum Wage

Adam Uzialko
Adam Uzialko
Editor
Business News Daily Staff
Updated Nov 02, 2022

As minimum wages rise and big businesses offer employees more money, how can small businesses compete?

  • Twenty-nine states plus Washington, D.C., have a higher minimum wage than the federal minimum.
  • Forty-six cities and counties have minimum wage rates that exceed their states’ minimums.
  • Researchers say raising the minimum wage doesn’t kill small businesses or reduce job opportunities.
  • This article is for small business owners who want to understand how minimum wage increases may impact their business, and how to absorb the associated costs.

If you compared the paychecks of workers in 1969 with paychecks in 2019, you could be forgiven for thinking that the average employee makes much more money today. However, for decades, the purchasing power of the average American worker has been largely stagnant.

That could well be changing, with scattershot increases in the minimum wage throughout cities and states across the U.S. Many states have moderately increased their minimum wages, and some of the biggest cities have hiked their minimum wages beyond $15 per hour.

Even in cities where legislators are not raising the minimum wage, the realities of a tight labor market and the necessities of competition often place upward pressure on compensation as well. Small businesses are forced to consider raising wages to recruit much-needed talent for their open positions. [Related content: How Long Should You Maintain Paycheck Records?]

How might rising wages impact small businesses, and what can they do to ensure they remain compliant with the law and competitive with larger companies?

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State and local minimum wage laws changing

Currently, 29 states plus Washington, D.C., have a minimum wage higher than the federally mandated minimum of $7.25 per hour. Twenty-seven states plus D.C. have increased their wages since January 2014, meaning many businesses have had to adjust in recent history. 

D.C. has the highest minimum wage rate at $15.20 per hour, followed closely by California and Massachusetts. In California, the minimum wage is $14 per hour for businesses with 26 or more employees. The equivalent for smaller companies is $13 per hour. Washington state and Massachusetts follow closely behind California, with respective minimum wages of $13.69 and $13.50. 

Moreover, 46 cities nationwide have adopted their own minimum wage rates that are higher than their state’s. The highest local minimum wage is in Emeryville, California, where employers are required to pay their workers $17.30 per hour. Seattle, Washington, is a close second with a minimum wage of $16.69 per hour.

In these cities, where legislation has been enacted to mandate a minimum wage increase, small businesses have no choice but to comply with the law or face enforcement actions and lawsuits. [Is your small business looking for a better way to manage payroll? Check out our reviews of the best payroll software.]

How increased minimum wages impact the general economy

The prevalence of increased minimum wages suggests they have an impact toward which striving is worthwhile. In fact, increased minimum wages are correlated with many positive economic impacts. 

  • Greater employment rates: Paying attention to the news in 2021 meant seeing an abundance of stories about a “labor shortage.” Listening more closely to workers can paint a different picture. Reporters who have done so have found that people are indeed available for work. However, they’re increasingly uninterested in jobs that don’t pay them fairly. Increased minimum wages address this concern and boost employment.
  • More consumer spending: When employees earn more, they can increase their discretionary spending budgets. This extra spending introduces money into the economy, which helps stimulate it. With more spending, more money is directed to smaller businesses, resulting in growth that especially bolsters local economies.
  • Lower poverty rates: Employees who earn more can also expand their budgets for basic needs. This notion can have a profound impact on those in poverty. When people currently in poverty earn more money through their work, they can more easily afford food, housing and other basics. Of course, the lower a country’s poverty rate, the stronger its economy, which can only be good for your small business.
  • Potentially lower long-term taxes: Since increased minimum wages can help those in poverty escape it, they can also reduce reliance on government programs. In turn, governments can shrink their budgets for these programs. With smaller budgets, less tax money must be funneled to these programs. The result can be an overall lower tax burden for the average taxpayer, including your small business.
  • More diverse workforces: The median income of most marginalized groups is less than that of the national median income. This discrepancy often stems from conscious and unconscious employer biases. When employers must pay a higher minimum wage, these pay gaps shrink. As they do so, marginalized groups may feel more incentivized to join the workforce. The result is more diverse workforces in most, if not all, sectors. And the importance of diversity hiring simply can’t be overstated.

What minimum wage hikes mean for small businesses

It’s not uncommon to hear that minimum wage increases have disastrous consequences, particularly for small businesses. However, economic research into the impact of minimum wage hikes on small businesses suggests that not only are increases not harmful, but they might even be beneficial.

Research from the Fiscal Policy Institute examined three years of small business activity in states that increased the minimum wage above federal standards as well as in states that did not. These were some of the researchers’ findings:

  • From 1998 to 2001, the number of small business establishments grew at a rate of 3.1% in states with higher minimum wages, compared with a rate of 1.6% in states with lower minimum wages.
  • Employment grew 1.5% more quickly in states with higher minimum wages.
  • Annual payroll and average payroll per worker increased more quickly in states with higher minimum wages.

Based on this data, the notion that minimum wage hikes kill small businesses and reduce job opportunities appears to be false. Instead, raising the minimum wage seems to improve entrepreneurs’ abilities to start new businesses and hire new workers. Moreover, additional research published in the Journal of Economic Issues found that minimum wage hikes did not correlate with an increase in small business failures. The research even suggested the opposite is true.

Still, any increase in the minimum wage is bound to have an impact on a small business’s balance sheet. While there might be some benefits associated with increasing workers’ pay, small businesses must first be capable of absorbing the cost. There are several steps an entrepreneur can take to either reduce costs or boost revenue in order to offset wage increases.

How small businesses can absorb the increased costs of minimum wage hikes

Many small businesses aren’t prepared to pay increased labor costs out of pocket, so it’s important to prepare for when new legislation is enacted. How can small businesses prepare for a minimum wage hike? With one or more of the following tactics, you can start bringing more money in and/or reducing the amount of money flowing out of your business.

  • Cut expenses. If you live in a state or city that is planning to raise the minimum wage, you likely have some time to phase in cost increases in modest increments. While preparing to absorb these costs, reexamine every facet of your business. Is there waste or inefficiency you can address that would save you money elsewhere? Consider aspects like energy consumption, surplus inventory and service contracts. Cutting extraneous expenses will help you not only absorb the new labor costs, but also streamline business operations.
  • Increase prices. If you find yourself in a market where you are competitive on prices, consider increasing what you charge. Before raising prices, be sure to communicate with your customers so they know what to expect. Also examine what your competitors charge to ensure your customers don’t flee for more cost-effective alternatives. Be very careful when increasing prices, but if you have the room to do it, coupling price increases with modest budget cuts could free up some capital. [Read related article: Can Low Prices Scare Away Customers?]

  • Reduce hours. If you find it difficult to offset a minimum wage increase, consider reducing your operating hours. Are you open beyond peak times? Identify when most of your revenue comes through the door, and adjust your operating hours accordingly to save money.

Planning for the costs of a minimum wage increase can be challenging, but it’s not impossible. That’s especially true considering that most cities and states that raise the minimum wage give businesses several years to gradually step up compensation, rather than expecting them to drastically increase hourly wages overnight. In fact, some businesses build regular, voluntary wage increases into their budget anyway, whether or not they operate in a jurisdiction where minimum wages are increasing.

TipTip: To ensure your employees are being paid accurately and on time, choose online payroll software that is easy to use and fits all of your needs. These services can also ensure all of your payroll taxes are being paid on time.

Why small businesses voluntarily increase pay

Beyond regulatory mandates, small businesses also find themselves in an environment where their largest expense – labor – is growing due to market forces. The Great Resignation has left many employers in desperate need of workers, especially mid-career employees with developed skills and experience. That gives job candidates significant leverage in negotiating compensation and courting other offers. 

To remain attractive to talented candidates, businesses have to offer more attractive working conditions to job seekers (which often means better pay, first and foremost) than their competitors.

Many business owners, including Andrei Vasilescu, CEO and digital marketing expert at DontPayFull, understand they have to remain competitive if they want to keep their best workers and continue bringing in the candidates with the most potential. That’s why Vasilescu offers automatic annual wage increases as well as a midyear bump.

“I own a small online business, which needs a team of tech-savvy smart minds as programmer, designer, digital marketer, sales analysts, etc.,” he said. “None of those professionals work at basic wages, and these expert professionals are always wanted by other companies. Hence, to retain them in my business … I have to give them something extra.”

Well-paid employees are less likely to leave, reducing turnover. In a business landscape where the average cost of replacing an employee is $2,000 to $7,000, not to mention the impact of high turnover on morale, retention is important. In a tight labor market, losing valuable employees is an expense most businesses cannot afford.

Key TakeawayFYI: Understanding how a minimum wage increase will impact your cash flow is important to determine the best pay schedule for your small business and your employees. Business owners should take all of this into account when preparing for any type of employee pay increase. Learn more about how to run on-demand payroll for your business, and when a payroll advance makes sense for your employees.

The corporate social responsibility perspective

It’s not always a pure bottom-line motivation that leads to wage hikes. Some businesses voluntarily raise wages because they believe in giving their employees a living wage, which accounts more for the cost of living in each region than the going rate for labor.

One such company is Coastal Credit Union, which is organized as a cooperative and headquartered in Raleigh, North Carolina.

“As a cooperative and a responsible corporate citizen, we felt like it was necessary to take the initiative to ensure that our own employees are able to earn enough to take care of themselves,” said Joe Mecca, Coastal’s vice president of communication. “Coastal puts employee engagement at the core of what we do, and we believe it is every bit as important as member satisfaction and overall business performance.”

Coastal initially increased its minimum wage to $12.50 per hour in 2016 and raised it again to $15 per hour in March 2018. Although Coastal’s rationale focused on employees, the company has recognized the hallmark rewards of paying employees a living wage: reduced turnover, higher employee engagement and a boost to productivity.

“It’s not just socially responsible; it makes good business sense,” Mecca said. “In our experience, increasing the minimum wage has been well worth it. We’re enjoying high levels of engagement, which helps with member satisfaction, productivity and our overall financial results.” [Read related article: What Is Corporate Social Responsibility?]

Benefiting from higher minimum wages by planning ahead

No one wants expenses to go up, but business owners understand the value of making investments in important assets. A small business has no greater asset than the people in its employ, so their wages should be viewed as an investment. Moreover, in states and cities where minimum wage increases are legislated, increasing compensation is a compliance issue. Luckily, paying higher wages doesn’t have to be a negative; in fact, it can be a positive.

However, small businesses must plan to absorb the costs of minimum wage increases if they are to realize the benefits of increased employee recruitment, retention and morale. Cutting extraneous costs, raising prices and optimizing your business hours are essential when facing a rising minimum wage.

Small businesses that successfully navigate minimum wage increases often find themselves in an economically healthy environment where consumers have more disposable income to spend on goods and services. They also have happier, more productive and more loyal workers in their employ. If you plan accordingly, minimum wage increases don’t have to be an obstacle; they can instead be a benefit for both your business and your employees.  

Max Freedman contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.

Image Credit: AndreyPopov / Getty Images
Adam Uzialko
Adam Uzialko
Business News Daily Staff
Adam Uzialko is a writer and editor at business.com and Business News Daily. He has 7 years of professional experience with a focus on small businesses and startups. He has covered topics including digital marketing, SEO, business communications, and public policy. He has also written about emerging technologies and their intersection with business, including artificial intelligence, the Internet of Things, and blockchain.