Don’t Expect a Pay Increase to Fix Financial Woes

Many people find themselves spending more than they make each month.  According to the Financial Industry Regulatory Authority (FINRA), 60% of Americans spend all or more than they earn.  In the past few years, there was a discussion about raising the minimum from $10 to $15 an hour, a 50% increase.  The argued justification for a minimum wage increase significantly higher than the rate of inflation is that companies make huge profits and can absorb the costs.  The reality is quite different, however.

McDonald's is one company mentioned a lot through the minimum wage increase debate.  The flaw with assuming McDonald's can absorb the cost is most of their stores are franchises.  Franchises are individual businesses that pay McDonald's franchise fees to use their branding and sell their product.  Typically, franchise fees are split between a fixed royalty fee and a percentage of sales.  The royalty fee must be paid regardless of sales.  These individual franchises do not have billions, or even millions, in profits.  A secondary issue is that a significant minimum wage increase affects all companies, big and small, in the state.  Some companies may be able to absorb the increased labor costs with a few adjustments, while others may go out of business due to the increase being too much to overcome. 

In most situations, when a pay increase occurs, there is a period of time where there is a noticeable difference in discretionary income.  When financial behaviors are not altered upon receiving an increase in wages, people soon find themselves in the same financial situation they were in before the pay increase.  In the case of a significant minimum wage increase, there is a period of time where individuals may have more income to buy more things.  However, once companies increase prices to account for the rise in labor costs, people will not have the same buying power they initially experienced when minimum wages increased.  Basically, after a few months, people are back to where they were before their pay increased.          

The focus of this article isn’t whether a state should or should not implement a 50% minimum wage increase.  It’s about understanding why such a significant pay increase won’t, in most cases, fix an individual’s financial woes.  A pay increase can come from a job promotion, moving from one company to another, minimum wage increase, taking on another job, etc.  When a person or couple is experiencing financial stress due to spending more than they make, they often think a wage increase will fix the problem.  Most of the time, though, people do not change their financial behavior when they receive an increase in wages.

Spending habits must change to take full advantage of a pay increase.  Revamping the budget when a wage increase happens is a strategic way to change financial behavior, assuming the budget is realistic, accurate, and followed.  Additionally, if spending is adjusted, it can feel like a big increase in income occurred.  For example, if a wage increase adds $200 to monthly net income and $100 is decreased in discretionary spending, a net increase of $300 can be allocated to paying down debt, savings, etc.  Alternatively, if the additionally $200 is used as a monthly payment for new auto or RV loan and spending remains the same, then nothing has been gained.

The best way to fix financial problems is to change financial behaviors!