Tuesday, December 17, 2013

The Government Subsidy Fallacy - McDonald's Edition

Can you believe the government subsidizes McDonaldsWal-Mart and the Big Bad Banks?

The Bloomberg opinion pages are filled with this nonsense and we’d like to cut through the click-beckoning populist outrage to present the issue fully and logically.

The Bloomberg thesis is that government policies are providing scandalous subsidies to unpopular businesses.  Bloomberg kicked off this movement by noting that subsidies for the Big Bad Banks are vaguely estimated, yet reported as fact, at $83 billion a year.  The takedown of this fallacy has already been provided, and the fact that Bloomberg wrote no fewer than three editorials and two blog posts to defend their stance speaks volumes about its credibility. 

Bloomberg newcomer Barry Ritholtz is the most recent columnist to get drunk on the Bloomberg subsidy Kool-Aid, extending it to McDonalds’s and Wal-Mart, calling them “America’s biggest welfare queens.”  His logic is as follows:  Wages at McD’s are low, and a large percentage of their employees qualify for public welfare programs so it's McD's fault these individuals require public assistance.  When the government steps in with welfare assistance - voila - a “government subsidy” for McD's is created.  The solution?  Raise the minimum wage by 56%.


Let’s unpack this faulty logic, starting with the definition of a subsidy.

Merriam-Webster defines subsidy as “money that is paid usually by a government to keep the price of a product or service low or to help a business or organization to continue to function.”  The government does not pay McD’s, and in fact, the cash flow is reversed as McD’s pays the government 35% of it's taxable income.  Claiming McD’s is the beneficiary of a government subsidy is just fraudulent.

Secondly, McD’s does not force people to work for the minimum wage.  Last we checked we still live in a capitalist society where the market forces of supply and demand determine wages (floored at the minimum wage set by Congress).  Low skill, low experience workers are provided employment at a wage set by the market for low skill, low experience labor.  In fact, if you want to play the subsidy game, you could make a strong argument that anyone paying minimum wage for skills worth less than $7.25 an hour is subsidizing the taxpayer. 

The unspoken assertion is that it’s corporate America’s responsibility to provide all its workers with a living standard equal to the living standards provided for by public welfare programs, regardless of the real market value of that workers labor.  If that is your argument, make it.  Don’t hide behind the populist curtain of “government subsidies” for easy targets like McD's, Wal-Mart and Big Bad Banks.  

Let’s assume for a minute that we agreed with that unspoken assumption (we don’t), and the minimum wage should be set high enough that an employee earning it had no need for public welfare programs.  Yea, happy days, right?  Wrong. 

Let’s peel back the populist rhetoric one layer and think logically about the consequences of a significant rise in the minimum wage.

McD’s is not an employment program, it’s a business.  As distasteful as this might be to some people, a corporation exists to make money for its shareholders.  A rational entity will respond to a mandated increase in the minimum wage, and the impact on its cost base, by either reducing the number of employees or increasing prices to offset the rise in costs.  To suggest otherwise - a popular, if misguided, trend in today’s opinion pages - flies in the face of logic.  

“But corporate profits are at an all-time high!!!”  Perhaps, but margins remain tight, particularly in highly competitive industries like fast food and discount retail.  For example, Wal-Mart's margins are a paltry 5.93%, compared to Apple's margins of 37%.  When the costs of inputs rise, to continue to remain profitable, prices must rise in tandem.

To Ritholtz credit, he accepts this reality in his final sentence – “Raising the minimum wage … effectively shifts the cost of eating greasy French fries and overcooked burgers from taxpayers to fast food consumers -- where they belong.”  

Now we’re getting somewhere…but we're afraid it’s a cul-de-sac.

Ritholtz's solution is to shift the costs of welfare programs from the taxpayer to McD’s through a higher minimum wage.  However, Ritholtz concedes that McD’s will act rationally and just shift the costs back to its customers, who by the way, are also taxpayers.  In fact, it’s circular in the worst possible way.  It transfers this phantom subsidy from the backs of the wealthiest 53% of the population (i.e. those that pay income taxes) to the backs of the population who frequent McD’s (or Wal-Mart, or any other target du jour).  So, the same taxpayers who are supposedly benefiting from the higher minimum wage will give that benefit right back by paying higher prices for goods and services.  Add in the devastating side effects of lower employment, particularly among younger workers, and it's clear that any benefits from a significant increase in the minimum wage do not outweight the costs.  

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