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Turkey’s Increase in The Minimum Wage for 20161

The minimum wage increased by 30 percent in January 2016, affecting around 8 million workers directly. Despite the government subsidies, the overall wage bill is estimated to increase by 0.7 percent of GDP. Yet, the impact on employment could be mitigated by the large informal labor market; the increase will be also partially eroded by inflation over the coming years. The fiscal cost of the subsidy will be around 0.56 percent of GDP, but the net fiscal cost is estimated to be smaller once the increase in revenues from indirect taxes and pension contributions are taken into account.

1. The minimum wage fixing board increased the minimum wage by about 30 percent starting on January 1, 2016.2 The board fixed the gross minimum wage at TL1647 per month, an increase of 29.3 percent from the minimum wage set in July 2015 (and 33.1 percent higher than the average minimum wage for 2015). This implies the net minimum wage, for single worker with no dependents, has increased by 30 percent to TL1300 in January 2016 from TL1000 in mid-2015.

2. To ameliorate the impact on the labor market the government will provide a temporary subsidy for labor. For 2016, the government will support formal employment—for those earning up to TL2550 per month—by providing a subsidy amounting TL100 per month. Under the government’s current plan, this support will be discontinued in 2017.

3. About 8 million workers will be directly affected by the increase, but many more will be affected indirectly. Data from the social security institution suggest that about 8 million formal workers earned wages below the new minimum wage threshold. The increase will also put pressure to raise the wage of workers above the threshold, albeit significant more bunching of wages along the minimum wage is expected. In relative terms, the minimum wage increase will affect more women than men in the formal sector, as 65 percent of the female workers have a salary below the new minimum wage, while the share for male workers is at 61 percent. While the proportion of minimum wage earners is similar, for women the distribution of wages is bunched closer to the minimum wage. However, almost half of women are employed in the informal sector, compared to only about 30 percent of men. This implies female workers will be less affected if the minimum wage increase affects the informal labor market less.

A. Implication on Wages and Labor Costs

4. Social security contribution, unemployment insurance, personal income taxes, and stamp taxes affect net wages and labor costs. For minimum wage earners, the minimum wage increase will result in a higher net salary, but also in higher contributions to the social security and higher personal income taxes. The government subsidy largely returns those extra earnings to limit the impact on labor costs. To calculate this impact it is necessary to understand the impact of taxes and contributions:

  • From gross to net wages. The gross salary is subject to employee social security contribution (14 percent) and the unemployment insurance fund contribution (1 percent), which are excluded from the tax base. The tax base is subject to personal income tax (the lowest personal income tax bracket is subject to a 15 percent tax) but is reduced by the minimum living allowance—which is linked to the minimum wage. There is also a stamp tax on gross wages at a 0.759 percent rate.

  • From gross wages to labor cost. Labor costs include the gross wages, the social security premium paid by the employer (15.5 percent), and the unemployment insurance fund contribution (2 percent).

A02ufig01

Change in the Minimum Wage

(TL; July2015 to January 2016)

Citation: IMF Staff Country Reports 2016, 105; 10.5089/9781484338209.002.A002

5. In order to analyze the impact on the labor market, we use data from the Turkey Social Security Institution (SGK). The data contains information on the distribution of the number of insured person by insurable earning levels. However, this dataset has three important limitations: (i) the last available data is for 2014; (ii) the data has a truncated distribution at the right tail due to the cap on social security contributions (at 6.5 times the minimum wage), and (iii) it covers only formal workers. Therefore, to construct the distribution for 2015, we assumed that wages increased by the inflation rate, and that the relative wage distribution remained unchanged.

6. We estimate that the share of workers with minimum wage will increase to about 58 percent of the total formal workers. For this, we constructed a cumulative distribution function (CDF) for the wage bill in 2016. First, we inflated the 2015 wage bill by 11 percent; this gave us a baseline for the wage distribution for 2016. The 11 percent was chosen, because this is the agreed wage increase for public sector employees for 2016. Then workers with gross wages at or below the minimum wage were set at TL1647. Figure 1 illustrates the cumulative distribution of workers and wage bill over different real insurable earning levels that are normalized with the 2015 minimum wage. The left panel shows the CDF assuming no policy change, and the right panel shows the CDF with the minimum wage policy—and our implicit assumption that the increase in minimum wage does not trickle to wages above the minimum wage, which implies that the number of workers on the brackets above the new minimum wage remain unchanged.

Figure 1:
Figure 1:

The Cumulative Distribution of Employees and Wage Bill over Wage Brackets

Citation: IMF Staff Country Reports 2016, 105; 10.5089/9781484338209.002.A002

7. The minimum wage increase is estimated to raise net wages and labor costs by 0.9 and 1.3 percent of GDP, respectively. Table 1 shows our estimates for the increase in net wages and labor costs. Approximately 8 million workers are affected by the minimum wage increase representing about 60 percent of the formal worker. The minimum wage policy would lift their gross wages to TL1647, implying a net wage increase by about 0.9 percent of GDP. This also translates to an additional burden to firms as the labor cost increasing by 1.3 percent of GDP.

Table 1.

Turkey: Impact of the Minimum Wage Increase and Government Subsidy

(change from the baseline in percent of GDP unless otherwise stated)

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Note: Changes are estimated with respect to a baseline that assumes an 11 percent increase in nominal wages.

8. The increase in the labor costs will be ameliorated by the government subsidy. The authorities calculate that 40 percent of the increase in labor costs is absorbed by the government through the subsidy. This calculation is based on a baseline that assumes an increase in the minimum wage in line with the increases granted to government employees. We use slightly different assumptions and estimated that the increase in labor costs would be about 1¼ percent of GDP, with the government covering slightly more than 40 percent of that increase.

A02ufig02

Impact of Minimum Wage

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 105; 10.5089/9781484338209.002.A002

9. The subsidy will also lower the costs of employing mid-skill workers. The labor costs for those not directly affected will actually decline due to the subsidy. While there might be some trickling up in wages, under reasonable assumptions the subsidy will reach workers that will likely face little impact from the minimum wage increase.

B. Implication on the Labor Market

10. The literature seems to have concluded that the impact of minimum wages on employment is small in advance economies. Freeman (1996) stated that “—debate over the employment effects of the minimum wage is a debate of values around zero.” Yet, the debate remains lively on whether the impact is negative or insignificant, particularly for the small group of people for which the minimum wage is binding—typically the youth and low skill workers. Card and Krueger (2001) found no evidence of the rise in minimum wage reduced employment of low skill workers in the fast-food industry in New Jersey. Yet, Neumark and others (2014) have challenged this view suggesting minimum wages would cause job losses for the lower-skilled workers. Several explanations have emerged to reconcile these empirical observations with theory. One possibility is that the effects of minimum wage could be felt through other channels including non-wage benefits or training, as firms tend to be reluctant to layoff existing labor.

11. Yet, much less is known about the impact of minimum wage in emerging economies, and the existing results are inconclusive. Few EM-specific factors complicate the assessment, and point in different directions. On one hand, the high share of minimum wage earners suggests larger impacts from an increase in minimum wage. Moreover, the increase in the minimum wage is sometimes a benchmark to adjust the whole wage distribution, thus the whole wage curve could move with the increase in the minimum wage (see Maloney and Mendez, 2004 and Gürcihan-Yüncüler and Yüncüler, 2016). On the other hand, low compliance levels (Bhorat and Stanwix, 2013) and large informal labor markets dampen the impact from the minimum wage.

12. Studies on the impact of the minimum wage on the Turkish labor market have shown mixed results. Using the Household Labor Force Survey for 2002–2005, Papps (2012) found that a 1 percent increase in labor costs resulting from an increase in the minimum wage leads to a 0.13 percent fall in the probability of remaining employed in the following quarter, and that the impact is stronger for young and rural workers. These results are qualitatively similar to those obtain from simulations using the IMF GIMF model, a calibrated DSGE model, which suggests that a 1 percent increase in the real wage markup—over labor productivity—would lead to an increase in unemployment of about 0.3 percent two years after the shock. On the contrary, using data from 1996 to 2006, Korkmaz and Coban (2006) found that the long run relationship between minimum wage and unemployment is statistically insignificant. Moreover, Pelek (2011) found no effects on low-skilled youth employment.

13. In Turkey, several factors mitigate the possible impact on employment. The high share of employees whom are hired at or around the minimum wage (around 30 percent in 2014) suggests the impact should be large. However, the informal sector—which accounts for about 35 percent of total employment—is large and able to absorb a significant share of workers, such that the increase in minimum wage may have little effect on the overall employment—but result in a significant increase in informality.

14. Moreover, a high inflation environment may help to mitigate the impact of the minimum wage hike over time, by setting modest increases in following years. The sharp increase—about 38 percent—in the minimum wage in 2004 was followed by modest increases breaking the upward trend in the ratio of minimum wages to average wages. If the previous trend had continued, the minimum wage might have been at the same level by 2007. The increase in the gross minimum wage in the four years following the 2004 increase averaged 9½ percent, but with inflation averaging 8.8 percent the impact in real terms was minimal. Thus, a high inflation environment facilitated containing real wage increases.

A02ufig03

Ratio Between Minimum and Average Wage

(Ratio)

Citation: IMF Staff Country Reports 2016, 105; 10.5089/9781484338209.002.A002

Sources: OECD ;and IMF staff calculations.

15. In light of all these factors, we see the impact on labor market from the recent raise in minimum wage may be small. In part, because the higher minimum wage would boost the spending power of the low-income workers leading to higher private consumption. However, there could be a significant surge in informality, at least temporarily, which could have adverse effects on productivity and increase fiscal costs. This would allow firm to reduce the impact from the policy change, while retain its employees. In addition, the structural of the subsidy “distorts” the labor skill premium by making the middle skilled workers (ones who are earning between TL1670–2550) cheaper compared to the low-wage and high wage earners.

Turkey: Impact of the Minimum Wage Increase and Consumption

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Assuming a coefficient of 0.9 on the propensity to consume.

16. The raise in minimum wage would raise aggregate demand over the short run, while having negative impacts on the supply side. Given the high marginal propensity to consume for the low-wage earners, they are very likely to spend a high share of the increased wages at 0.9 percent of GDP. Yet, the cost of the higher minimum wage, at 1.3 percent of GDP amounts to about 1/3 of firms’ profit.3 Assuming no major lay off the existing workers, firms essentially have three options to absorb the raising costs.

  • First, they could simply reduce their profit margin, which would likely to translate to lower capital investments.

  • Second, firms can pass on the higher costs to the price of consumption goods which would in turn add to the already high inflation.

  • Last but not least, firms would force some of the workers into informal sector, making the new minimum wage not binding. Although this option has the least adverse impact on inflation and investment, it has negative consequences for the budget, as social security contribution and personal income tax receipts would decline. It could also impact productivity, as firms in the informal sector are characterized by lower productivity levels.

C. Fiscal Implications

17. The increase in indirect taxes, social security contributions, and the limited increase in personal income tax thresholds will partly offset the direct fiscal costs due to the employment subsidy. The minimum wage increase will have a negative effect on the personal income tax due to the minimum living allowance, albeit it will be largely compensated by a modest increase in the PIT thresholds. It will boost contributions to the social security and the unemployment insurance fund, as well as indirect taxes—partially compensating the fiscal cost of the subsidy. Below are some rough estimates of the fiscal costs.

Impact of the Minimum Wage on Indirect Taxes

(percent of GDP)

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  • The subsidy will cost about 0.56 percent of GDP. Based on social security data, there are about 10.3 million workers with earning below TL2550. The government subsidy of TL100 per month per work implies that the total cost is about TL12 billion. This is likely a lower bound, as there will be incentives to move higher wage earners into the range by creating new firms and underreporting their wages.

  • A positive impact on indirect taxes is expected. The Turkish tax system relies significantly on consumption taxes. The positive effect on aggregate consumption will result in higher VAT and SCT revenues. Assuming the impact is similar to the average VAT and SCT on disposable income—and taking into account that the shares are higher for the households in the lower income quintile—we expect an increase in indirect taxes of about 0.16 percent of GDP.

  • The minimum wage increase raises also the minimum living allowance. This allowance is equivalent to 50 percent of the minimum wage for a single worker taxed at the rate of the lowest bracket. The allowance is increase by 10 percent of minimum wage for a non-employed spouse, 7.5 percent for each of the first two dependent children, 10 percent for the third dependent child, and 5 percent for each additional dependent child. The assessment is then multiplied by the first tax bracket, at 15 percent, to get the size of the allowance. Therefore, the increase in the minimum wage entailed a decline in the effective personal income tax rate

  • Clawing back the increase in the minimum living allowance. The higher wages will increase taxable income by about 0.9 percent of GDP, which would result in an increase in tax revenues. The higher tax revenues from low wage earners will be partly offset by lower tax revenues on high wage earners that also benefit from the minimum living allowance. To claw back part of the unintended tax break, the government pursued a modest—well below inflation—increases in the income tax bracket thresholds. The net effect will be a small increase in personal income taxes of about 0.04 percent of GDP.

  • The loss of corporate income taxes is hard to estimate. Companies can absorb the increase labor costs by reducing profits, raising prices or some could pursue informality. Assuming that 40 percent of the increase is absorbed through profits the decline in corporate income tax revenue would be about 0.055 percent of GDP.

18. Fiscal costs would be larger to the extent that the minimum wage leads to an increase in informality. The previous estimates assume that employment and formality remain unchanged. To the extent that informality increases, the fiscal cost would increase by about 0.02 percent of GDP for every percent increase in informality. This is likely a lower bound as it assumes that workers will just be relocated to the informal sector earning their previous salary and therefore limiting the impact on indirect taxes. It also assumes that the move to informality results in a proportional loss of CIT with respect to the 2015 level.

Sensitivity of Fiscal Costs to Increase Informality

(percent of GDP, unless otherwise stated)

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References

  • Bhorat, Haroon and Benjamin Stanwix, 2013, “Minimum Wage Enforcement in the Developing World,” DPRU Policy Brief, No. 13/29.

  • Card, David and Alan B. Krueger, 2000. “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply,” American Economic Review, American Economic Association, Vol. 90(5), pp. 13971420, December.

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  • Gürcihan-Yüncüler and Yüncüler (2016), “Minimum wage effects on labor market outcomes in Turkey”. Unpublished manuscript.

  • Korkmaz Adem, and Orhan Çoban, 2006, “Emek Piyasasinda Asgari Ücret, İşsizlik ve Enflasyon Arasindaki İlişkilerin Ekonometrik Bir Analizi: Türkiye Örneği (19692006)” Maliye Dergisi, No. 151, pp. 1622.

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  • Maloney William F., and Jario Nunez Sr., 2004, “Measuaring the Impact of Minimum Wages: Eviences from Latin American” in J.J. Heckman and C. Pages (eds.), Law and Employment: Lessons from Latin American and the Caribbean, University of Chicago Press.

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  • Neumark, David, John Michael Ian Salas, and William Wascher, 2015. “Policy Levers to Increase Jobs and Increase Income from Work after the Great Recession,” IZA Discussion Papers 9529, Institute for the Study of Labor (IZA).

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  • Papps Kerry, 2012, “The Effects of Social Security Taxes and Minimum Wages on Employment: Evidence from Turkey”, Industrial and Labor Relation Review, Vol. 65/3, pp. 686707.

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  • Pelek Selin, 2013, “The Employment Effect of the Minimum Wage on the Wage Distribution: Evidence from TurkeyGiam Working Paper, No. 1308.

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1

Prepared by Jiaqian Chen and Enrique Flores.

2

The fixing board consists of representatives from employees, employers and the government, and the size of the increase is aligned with the AK Party campaign promises for Turkey’s general election of November 2015.

3

To derive the total non-financial corporate profits as share of GDP, we assume the ratio between net profit and total asset to be 2.8 percent, which is consistent with what the CBRT’s firm level data suggests.

Turkey: Selected Issue
Author: International Monetary Fund. European Dept.