Definition of maximum salary

What is a maximum salary?

A maximum wage is a maximum price that is imposed on the amount of compensation that a worker can receive in a given period of time. It can be imposed as an absolute level or as a ratio between high and low wage earners. If it is a binding constraint (below the market wage), it will tend to give rise to the usual problems associated with cap prices and similar price controls, although other policy considerations may outweigh these known social costs.

A maximum wage can be contrasted with a minimum wage or the minimum price imposed on what employers can pay their workers.

Key takeaways

  • The maximum salary is the maximum compensation that a company can pay a worker during a given period of time.
  • Economists believe that such an artificially imposed ceiling on wages causes inefficiencies in the market and is undesirable in a capitalist free market.
  • Maximum wages can be imposed as a mark of social virtue to oppose income inequality or to favor the interests of certain politically influential companies and industries over others.

Understand the maximum salary

As a maximum price, a maximum salary can be mandatory (below the market salary) or not (above the market salary). In the latter case, the maximum wage will have no real effect on wages paid or other market outcomes. In the case of a binding maximum wage, the predictable result will be a shortage of highly skilled and high-earning workers, who cannot be compensated for the full value they create for their employers and naturally reduce the amount of time spent working. work and effort they will do. be willing to offer in the market as an answer.

These workers can individually reduce the amount of marginal effort they put into their jobs and some may exit the labor market entirely to pursue self-employment, retirement, leisure, or to enter other labor markets where pay does not apply. maximum. The maximum salary can be incorporated at the national, industrial or business level, and the broader the scope, the greater these basic effects will be.

This highly skilled labor shortage, like any shortage, reduces both consumer and producer surplus in labor markets and imposes a deadweight loss on society. With the maximum wage, the amount of work demanded by employers is greater than the amount of work that highly-skilled workers are willing to offer. Employment of highly-skilled workers will decline as they withdraw from the market and employers will not be able to fill job openings for highly-skilled jobs. Businesses affected by the maximum wage will be less productive and less profitable to the extent that they depend on the availability of highly skilled labor, and the more in the economy the maximum wage is applied, the more society as a whole will suffer from this. . reduced productivity.

In a dynamic sense, investment and capital will tend to flow out of affected firms and highly skilled workers will exit the economy unless employers can find ways to circumvent the maximum wage through other incentives or forms of compensation. These can take the form of non-salary benefits, hiring bonuses, or illicit under-the-table payments. Highly skilled workers who cannot find suitable employment may choose to become self-employed and start businesses, which they would not otherwise prefer and for which they might not be suitable, reducing the overall quality of business judgment and decision making. decision-making in society.

Given the welfare costs imposed on workers, employers, and society at large by a maximum wage, substantial compensatory earnings would be needed to justify such a policy. Typical political justifications involve moral arguments against income and wealth inequality. Because the resulting shortage of highly-skilled workers can be a significant barrier to entry into some industries, rent-seeking activity can play an important role. Rent seeking by employers who have a relative advantage in attracting highly skilled workers (due to legal exemptions or the ability to pay non-salary benefits, such as access to elite social media opportunities) may provide the main practical motivation for policy formulation. manufacturers to impose and maintain a maximum wage.

Examples of maximum wages

United States President Franklin D. Roosevelt in 1942 proposed a 100% marginal tax rate for income above $ 25,000 in order to discourage war speculation and encourage the wealthy to make sacrifices in profit. monetary.

Today, the maximum salary is increasingly becoming a topic of debate in the 21st century as more CEOs and senior executives take home millions of dollars in earnings compared to the minimum wage that some of them earn. employees of the same companies.

The communist country of Cuba long had a maximum salary of $ 20 per month for almost all jobs across the country, along with a dual currency system. However, that changed in 2021, with wages rising to reflect a jump in overall prices as a result of the unification of the two currencies. The new minimum wage of $ 87 per month and the maximum wage of $ 396 per month close a range of 32 salary levels that vary by job.

Egypt’s banking industry was hit hard when more than two hundred executives resigned after the country’s central bank enforced a maximum salary law of roughly $ 5,800 per month. Switzerland launched a referendum in 2013, which did not pass, that would have capped the salary of company executives to twelve times the salary of the lowest paid employee.

In 2017, British politician Jeremy Corbyn, following Britain’s decision to leave the European Union (EU), called for a 20: 1 CEO-to-worker salary ratio. Had it been signed into law, this would have meant that top company executives competing for government contracts could not earn more than 20 times the annual income of the companies’ lowest paid workers.

Supporters of a maximum salary argue that paying less to senior officials allows the company to generate more economic benefits for everyone. However, critics say that companies would lose top talent to other companies and economies that do not put a cap on potential earnings.

Pros and cons of a maximum salary

Proponents claim that a maximum wage is sure to boost the economy. In his view, if high earners earn less, then the extra funds that are left over can be used to increase the wages of others and hire more employees. Note that this viewpoint assumes that the company’s income is simply given and is not heavily dependent on the efforts and decisions of higher-earning employees.

With more people working, they claim, more taxes will be paid, which in turn would mean that the government and society would benefit from a reduction in the salaries of top executives. It is unclear what is the basis for his belief that shifting more wages from those who earn more in the upper income tax brackets to workers in the lower tax brackets will result in higher tax revenues.

Furthermore, if the salaries of the main employees of a company are directly linked to those of the employees with minimum salary in the same company in proportion, it is believed that the top managers will be incentivized to increase the minimum salary to obtain an increase of pay themselves. Advocates hope this will increase the rate at which income and profits leak to the lowest paid workers in a business, government and economy.

Critics and capitalists argue that when a government engages in the price controls of an economy, the economic status of a free market is compromised. By setting maximum salaries, companies would have fewer talented leaders and employees, as the most valuable talents would not be willing to work for a limited fee.

Maximum wage legislation could set the stage for a human capital flight in which the most talented people migrate to freer nations that could pay their worth. Indeed, establishing such a policy would not lead to a more productive and profitable economy as advocates believe.

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Mark Holland

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