How Small Businesses Are Affected by Minimum Wage

State and local minimum wage laws

Small businesses must understand federal and state minimum wage laws to stay compliant and competitive. Minimum wage laws change periodically and can vary widely by state and city.

Currently, 30 states, plus Washington, D.C., have a minimum wage higher than the federally mandated minimum of $7.25 per hour. Thirty states, plus Washington, D.C., have increased their wages since January 2014, so many businesses have had to adjust their wages. 

Washington, D.C., has the highest minimum wage rate at $17 per hour, followed by Washington state and California. In Washington, the minimum wage is $15.74 per hour. California follows closely behind Washington, with a minimum wage of $15.50.

Moreover, 48 cities nationwide have adopted minimum wage rates higher than their state’s required amount. The highest local minimum wage is in West Hollywood, California, where employers are required to pay their workers $19.08 per hour. The minimum wage in Seattle is a close second ― it increased to $18.69 per hour in January 2023.

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. 

How increased minimum wages impact the general economy

The rate at which many states and cities are adopting increased minimum wages suggests that these increases are highly beneficial. Increased minimum wages are correlated with many positive economic impacts, including the following:

• Better employment rates: Workers are increasingly uninterested in jobs that don’t compensate them fairly. Increased minimum wages address this concern and boost employment.
• More consumer spending: When employees earn more, they increase their discretionary spending budgets. Extra spending introduces money into the economy, helping to stimulate it. With more spending, more money is directed to smaller businesses, resulting in growth that bolsters local economies.
• Lower poverty rates: When people experiencing poverty earn more money through their work, they can afford food, housing and other basics more easily. Of course, the lower a country’s poverty rate, the stronger its economy, which can only benefit your small business.
• Potentially lower long-term taxes: Since increased minimum wages can help people escape poverty, they reduce reliance on government programs. In turn, governments can shrink their budgets for these programs. With smaller budgets, less tax money must be funneled into 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 Black and Hispanic households 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. The importance of diversity hiring 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 increases aren’t harmful and might even be beneficial.

In an analysis of reports following the start of the COVID-19 pandemic, the Center for American Progress examined the status of businesses in states that increased the wage floor and states whose minimum wages remained at the federal minimum. The researchers’ findings included the following:

• In 2021, businesses across low-wage industries in states with higher minimum wages grew at a higher rate than similar businesses in states that adhered to a $7.25 minimum wage.
• Businesses with increased wages had an easier time hiring employees. These establishments were also more likely to surpass their pre-COVID-19 employment rates sooner than businesses that didn’t increase their wages.
• Businesses in states with higher minimum wages had an easier time retaining employees. These employers also witnessed increased productivity among their staff. 

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 attract and retain top talent. 

Moreover, additional research published by the hiring employees found that minimum wage hikes did not correlate with an increase in small business failures.

Still, any increase in the minimum wage is bound to impact 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 costs. 

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 essential to prepare for new legislation. The following tactics can help you bring in more money and reduce the money flowing out of your business so you can better handle potential increased labor costs:

• Cut business expenses: If you live in a state or city planning to raise the minimum wage, you have time to increase costs 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? Consider energy consumption, surplus inventory and service contracts. Cutting business expenses will help you absorb new labor costs and streamline business operations.
• Increase prices: If your prices are competitive for your market, consider increasing them. Before raising prices, communicate with your customers so they know what to expect. Also, examine your competitors’ prices to ensure customers don’t flee for more cost-effective alternatives. While increasing prices is a serious move, coupling price increases with modest budget cuts could free up capital if you have the room to do it.
• 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 increased minimum wage costs can be challenging but not impossible. That’s especially true considering that most cities and states with minimum wage increases give businesses several years to gradually step up compensation; they don’t expect them to drastically increase hourly wages overnight. Some businesses build regular, voluntary wage increases into their budget anyway, whether or not they operate in a jurisdiction where minimum wages are increasing.

Why small businesses voluntarily increase pay

Beyond regulatory mandates, small businesses also find themselves in an environment where hiring and retention are challenging and their most significant expense ― labor ― is growing due to market forces. The Great Resignation left many employers in desperate need of workers, especially mid-career employees with in-demand career skills and experience. This means job candidates have significant leverage in negotiating compensation and courting multiple offers. 

To remain attractive to talented candidates, businesses must 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 co-founder of DontPayFull, understand they must remain competitive 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.,” Vasilescu explained. “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, which highly impacts morale. Retention is essential in a business landscape where the average cost of replacing an employee is between half to two times their salary. Losing valuable

How corporate social responsibility affects wages

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. They don’t want their employees working multiple jobs.

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,” shared Joe Mecca, Coastal’s vice president of communication and spokesman. “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 in productivity.

“It’s not just socially responsible; it makes good business sense,” Mecca continued. “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.” [Related article: What Is Corporate Social Responsibility?]

Benefiting from higher minimum wages by planning ahead

No one wants expenses to go up. However, business owners understand the value of investing in critical assets. Your small business has no greater asset than its employees, so their wages should be considered investments. Moreover, increasing compensation is a compliance issue in states and cities where minimum wage increases are legislated. 

While paying higher wages can positively impact your business, you must plan to absorb the costs of minimum wage increases to realize the benefits of increased employee recruitment, retention and morale in your small business. Cutting extraneous costs, raising prices and optimizing your business hours are essential when facing a rising minimum wage.

Small businesses that navigate minimum wage increases successfully 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. If you plan accordingly, minimum wage increases don’t have to be an obstacle. They can benefit your business and employees.   

Shayna Waltower and Max Freedman contributed to this article. Source interviews were conducted for a previous version of this article.