A MASSIVE TIDAL WAVE OF HIGHER LABOR COSTS IS COMING TO MAINE

 

George Wilson Adams CPA MBA

February 19, 2019

 

Rising Labor Cost 960

 

Storm Warning

One of my duties as an accountant is to warn people and small business owners of major economic changes. In 2016 a public referendum to increase Maine's minimum wage passed by a slim majority. Our minimum wage was increased to $9/hour on January 1, 2017 and by an additional $1/hour effective January 1, 2018, 2019 and 2020. Thus, over a three year period minimum wages in Maine will increase by 33.33%. On January 1, 2020 the minimum wage will be $12/hour and indexed for inflation annually thereafter.

 

An increase in labor costs imposes other additional costs on business owners. Employer social security taxes will increase by 7.65% for each dollar of additional wages, and worker's compensation premiums will also increase. The three-year cumulative rise in Maine's minimum wage will increase net costs to many businesses by 36% to 40%. Further, businesses that pay above minimum wage may feel pressure from some of their workers to increase wages and salaries.

 

Businesses that currently pay 125% or more above minimum wage will probably not be directly effected by this change. This article is focused on businesses that will be impacted.

 

 

How Will Business Respond?

As of early 2019 twenty states raised their minimum wage and the consequences have been widely observed, reported and quantified. See:

 

http://www.ncsl.org/research/labor-and-employment/state-minimum-wage- chart.aspx#Table

 

Here is how Maine businesses will respond to this massive increase in labor costs:

 

 

(1) Cut Hours

Struggling business owners are likely to cut employee hours by reducing business hours. This means take home pay, which is what workers should really care about, would stay the same or even decrease. Many stores and restaurants will open later, close sooner, close on weekends, and even have shut-down periods during quieter times of the day. In February 2019, for example, Brewer Hannaford cut store hours and now closes an hour earlier Monday through Thursday.

 

I can imagine a scene in the not too distant future where long lines of angry customers wait for service from a skeleton crew of employees in a store that is open maybe six hours a day. Many of these unhappy customers might wish that they too were paid the minimum wage for their valuable time standing in long lines waiting for service. Some frustrated customers may turn to shopping on the internet and no longer patronize local Maine businesses.

 

 

(2) Increased Business Bankruptcies

Many small business owners run their affairs by seat-of-the-pants intuition and have difficulty budgeting for new costs. Businesses that fail to re-align their budgets to reflect higher labor costs will ultimately go out of business and layoff their workers. The minimum wage for a job that no longer exists is zero.

 

 

(3) Increased Automation

Zero employee vending machine companies and fully automated Laundromats will weather this storm well. McDonald's and other major franchisors are aggressively implementing automation technologies. A McDonald's in Arlington, Virginia has touch screen kiosks that customers can use to place their orders. By 2020 McDonald's intends to implement this technology in all of its US stores and other big companies will follow suit.

 

McDonalds 960

A McDonald's self-service kiosk. The federal Bureau of Labor Statistics estimates that approximately 80,000 fast food jobs will disappear by 2024 as a result of automation. Increases in the minimum wage and further government regulation of employees accelerate the drive towards automation.

 

 

There are about three million cashiers in the U.S. Higher minimum wages will accelerate the push to delete lower-skilled jobs and replace them with machines. Few businesses will tolerate the absurdity of paying $12 an hour to teenagers.

  

Japan 960

Japan's Advanced Industrial Science and Technology Institute has developed a robot that can install drywall and perform other construction work. The lesson for governments considering imposing even more costs and burdens on employers is quite clear: Back off or else.

 

 

(4) Paying Workers Under The Table

Noted economist Edgar Feige estimated that in 2012 the underground economy in the U.S. was about $2 trillion, or roughly 12% of GDP at that time. There can be no doubt that increasing government regulation of business including higher minimum wages will push more business owners into the underground economy where they pay cash to their workers 'under the table.' Legitimate, law-abiding business owners pay for those who don't.

 

 

(5) Fewer Small Businesses

Higher minimum wages disproportionately hurt small business while big box corporations can afford to absorb additional costs through a variety of means. There is likely to be a wave of consolidation in many industries as bigger companies absorb smaller businesses that can't survive in this new, higher-cost environment. Bigco wins; 'mom and pop' small businesses lose, as does our state as a whole.

 

 

(6) Drastic Cost Cutting

Many business owners in many industries will be forced to look for ways to cut costs in order to survive. This means eliminating slow moving inventory or less profitable services, slimming down capital purchases of equipment, cutting quality, and even turning off hot water heaters, forcing customers to wash their hands in icy cold water.

 

 

(7) Interest Rates for Commercial Loans Will Increase

All banks are required to use risk-based pricing for loans. Higher labor costs will innately increase business risks forcing banks to charge more for commercial loans. This is yet another indirect consequence of imposing higher labor costs on business. Borrowing money will become costlier for businesses.

 

 

(8) Some Businesses Will Evacuate From Maine

Currently (February 2019), most states have NOT changed their minimum wage and represent places of opportunity for business investment. Every business must consider labor costs which include not only the wage rate but also directly related costs that are based on the wage rate such as employer payroll taxes and workers compensation premiums.

 

Capital is mobile and can be relocated anywhere in the world which offers the greatest opportunity. Maine has, in effect, built an economic wall around itself that will deter outsiders from investing in our state.

 

 

(9) Theft Losses At Supermarkets Will Increase

The supermarket industry historically operates with razor thin profit margins. Many supermarkets will be forced to pursue automation to control rising labor costs. This means far more self-checkout lanes and far fewer lanes staffed by an employee. In February, 2019 Brewer Hannaford vastly increased their self-service lanes and cut employee staffed lanes.

 

Hannaford Checkout 2 960

Brewer Hannaford vastly increased their self-checkout lanes.

 

Self-service check out lanes require customers to ring up their own sale. Dishonest customers may refrain from ringing up some items thus cheating the store of sales and profits. For example, assume the profit margin for a $10 razor is fifty cents. If a dishonest 'customer' walks out the store without paying for this item the store will have a theft loss of $10. The store would have to sell twenty razors just to recover from the theft loss and breakeven.

 

Current self-service checkout technology will expose stores to higher theft losses until the day comes when every single product sold by the store, including meat and produce, contains an electronic chip that will alert (remaining) store personnel to unpaid items being carried off.

 

Not everyone who steals is a thief. Some elderly and disabled individuals may struggle with self-service systems and simply not understand how to use them.

 

 

(10) Outsourcing Service Work To Other States

Maine service businesses don't need to relocate to escape the impact of higher labor costs here. Instead of physically relocating, the business could simply outsource service work to states where labor costs are lower. The internet easily facilitates the flow of information and there is no need for many types of service workers to be physically present at their employer's location. Service workers can operate anywhere in the world that has internet service.

 

For example, Eastern Maine Healthcare Systems (now called Northern Light Health) outsourced some patient services performed by telephone to a call center in Tennessee. Tennessee did not change their minimum wage, which is the same as the federal rate of $7.25/hour.

 

For an employer paying the minimum wage, labor costs in Tennessee are at least 34.1% lower than Maine currently, and will be 39.6% lower starting January 1, 2020. This cost differential becomes even greater once employer payroll taxes and workers compensation premiums are factored in.

 

 

(11) Expansion Of The Uber Business Model

The ride sharing company Uber was founded in 2009 and is based on the idea that the company is an information broker that connects customers who want rides with freelance drivers. Uber operates in over 800 metropolitan areas including Greater Bangor, and has a worldwide presence in 70 countries. Over 18 million people have used Uber for transportation. The company is currently valued at approximately $70 billion and earns commissions of 20% to 30% per ride.

 

On April 12, 2018 a federal judge in Philadelphia ruled that Uber drivers are not employees as defined in the federal Fair Labor Standards Act. Instead, Uber drivers are considered independent contractors. Thus, Uber avoids exposure to the massive federal and state regulation and taxation of employees, including minimum wage laws. However, some states including New York and California have made it difficult for Uber to treat drivers as independent contractors. Uber bypasses many of the onerous rules including price controls imposed by governments on traditional taxi companies (which are becoming obsolete.)

 

One of the critical success factors for Uber is that it operates as an information broker not subject to the costly and burdensome rules applicable to businesses with employees. The company earns a commission for providing information to drivers and customers and has leaner, significantly lower labor costs as a result.

 

Obviously the Uber business model could be applied to many other service and information based industries. One example is the service broker Fancy Hands, which offers a wide variety of specialized services provided over the internet by independent contractors. See:

 

https://www.fancyhands.com/

 

 

(12) Higher Prices

Many businesses will be forced to raise their prices to cover higher labor costs. This will increase inflation, which was approximately 1.6% nationally for the twelve months ended January 31, 2019 according to the U.S. Labor Department. Inflation erodes the purchasing power of all consumers and is a silent tax.

 

However, it's difficult for many businesses to simply raise prices because of competition, customer resistance, and fear of unknown consequences. Further, the price of many commodities including Maine lobster and seafood are set by regional and national markets and cannot be changed easily.

 

The painful alternative some business owners will pursue is to increase revenue by working harder and selling more goods and services in order to cover higher labor costs. It may seem that if an expense increases by $1,000 all a business owner must do is increase revenue by the same amount in order to stay even. This is false for the following reason:

 

 

It Costs Money To Increase Revenue: Welcome To Business Economics 101

The cost of revenue refers to all direct costs incurred by a business including labor, job materials, cost of goods sold, inventory, and other production costs directly related to earning the revenue.

 

Assume a business tries to cover a new, additional expense of $1,000 by selling more goods and services (not through a price increase.) The amount of additional revenue needed to cover an additional expense will always be a multiple of the expense as shown in this simplified example:

 

 

PROOF 

Required Additional Revenue from Selling More Goods & Services 

$1,667 

Less: 40% Cost of Revenue  

$(667) 

Equals Gross Profit 

$1,000 

Less: New, Additional Expense 

$(1,000) 

Equals Net Profit 

-0-          

 

Conclusion: This example proves that for a business with a 40% cost of revenue rate, for each dollar of new, additional expense there must be $1.67 in new, additional revenue earned by working harder and selling more goods and services. This new, additional revenue is needed merely to cover the additional expense and results in precisely zero extra profit.

 

The breakeven point for a business is also the breaking point. Many small Maine businesses will not survive this tidal wave of higher labor costs. The death blow for many struggling businesses will come next year on January 1, 2020 when Maine's minimum wage will rise yet again to $12/hour - a 9.1% increase. As stated in the introduction, employer payroll taxes and workers compensation premiums are based on the prevailing wage rate and will rise as the minimum wage goes up. Thus, the actual cost increase will be significantly greater than 9.1% for many businesses.

 

Who Is Responsible?

In my opinion BOTH extremes of the political spectrum are responsible for the economic harm that will engulf our state.

 

 

The Lunatic Left

Voters include the 50% of the population who are on the left side of the Bell Curve of I.Q.'s. (the most dangerous 'leftists' of all.) These individuals of subnormal intelligence are vulnerable to manipulation and exploitation by charismatic demagogues and lunatics who make false promises and who pander to the lowest common denominator. In 1998, for example, Hugo Chavez became the democratically elected President of Venezuela and led his rich country to ruin with disastrous socialist policies and massive corruption.

 

Chavez promised his people free education, free housing and free health care for all. Today, the only thing in Venezuela that is free is death. Millions of productive, talented people have fled the country. See:

 

https://mises.org/library/how-socialism-ruined-venezuela

 

 

The Recalcitrant Right

Special interest groups including business chambers of commerce have historically opposed all attempts to raise the minimum wage over past decades, including modest proposals to index the minimum wage to annual inflation. Many important financial amounts are routinely indexed for inflation including IRS income tax brackets, social security cost of living increases, and pensions. Indexing the minimum wage for inflation should never have been a political issue.

 

If the minimum wage had been indexed for inflation from the beginning there would never be the catastrophic labor cost increases now impacting our state. Instead, annual increases would have been a moderate 1% to 3% - an amount that could be easily absorbed by businesses.

 

 

The laws of economics cannot be overruled by referendums, government regulations, or wishful thinking.

 

 

LEGAL DISCLAIMER

George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339

©2015 Copyright George Adams CPA MBA. All Rights Reserved.

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