Maximum Wage: What It Is, How It Works, and Examples

What Is a Maximum Wage?

A maximum wage is a price ceiling imposed on how much compensation 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), then it will tend to result in the usual problems associated with price ceilings and similar price controls, though other policy considerations may outweigh these known social costs.

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

Understanding the Maximum Wage

As a price ceiling, a maximum wage may be binding (below the market wage) or not (above the market wage). In the latter case, the maximum wage will have no actual effect on wages paid or other market outcomes. In the case of a binding maximum wage, the predictable result will be a shortage of high-skilled, high-earning workers, who cannot be compensated for the full value they create for their employers and naturally reduce the amount of labor time and effort they will be willing to offer on the market in response.

These workers may individually reduce the amount of marginal effort they put into their jobs and some may exit the market for labor entirely to pursue self-employment, retirement, leisure, or to enter other labor markets where the maximum wage does not apply. The maximum wage can be incorporated country-, industry-, or company-wide, and the wider the scope, the greater these basic effects will be.

This shortage of high-skilled labor, like any shortage, reduces both consumer and producer surplus in labor markets and imposes a deadweight loss on society. At the maximum wage, the quantity of labor demanded by employers is greater than the quantity of labor high-skilled workers are willing to supply. Employment of high-skilled workers will fall as they withdraw from the market, and employers will not be able to fill job vacancies for high-skilled work. Firms impacted by the maximum wage will be less productive and less profitable to the extent that they depend on the availability of high-skilled labor, and the more of the economy the maximum wage applies to, 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 the affected firms and high-skilled workers will flow out of the economy unless employers can find ways to circumvent the maximum wage through other incentives or forms of compensation. These may take the form of non-wage benefits, hiring bonuses, or illicit under-the-table payments. High-skilled workers who are unable to find suitable employment may flow into self-employment and start businesses, which they would otherwise not prefer and may be unsuited for, reducing the overall quality of entrepreneurial judgment and decision-making in society.

Given the welfare costs imposed on workers, employers, and society in general by a maximum wage, substantial offsetting gains would be needed to justify such a policy. Typical policy justifications involve moral arguments against wealth and income inequality. Because the shortage of high-skilled workers that results may constitute a major barrier to entry to some industries, rent-seeking activity can play a large role. Rent-seeking on the part of employers who have a relative advantage in attracting high-skilled workers (due to legal exemptions or the ability to pay non-wage benefits such as access to elite social networking opportunities) may provide the primary practical motivation for policymakers to impose and maintain a maximum wage.

Examples of Maximum Wages

U.S. President Franklin D. Roosevelt, in 1942, proposed a marginal tax rate of 100% for annual incomes over $25,000 to discourage war profiteering and encourage the rich to make sacrifices in monetary earnings.

Today, the maximum wage is increasingly becoming a subject of debate in the 21st century as more CEOs and top executives take home millions of dollars in earnings compared to the minimum wage earned by some of the employees in the same companies.

The communist country of Cuba long had a maximum wage capped at $20 per month for almost every job across the nation, 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 salary of $87 per month and maximum salary of $396 per month bookend a range of 32 wage levels that vary depending on the job.

Egypt’s banking industry was hit hard when over two hundred executives resigned after the country’s central bank applied a maximum wage law of approximately $5,800 monthly. Switzerland initiated a referendum in 2013, which failed to pass, that would have limited a company’s executive pay to twelve times the lowest-paid employee’s wage.

In 2017, British politician Jeremy Corbyn, following Britain’s decision to exit the European Union (EU), called for a CEO-to-worker pay ratio of 20:1. If passed into law, this would have meant that top executives of companies vying for government contracts would not be able to earn more than 20 times the annual income of the companies’ lowest-paid workers.

Pros and Cons of a Maximum Wage

Proponents claim that a maximum wage is sure to bolster the economy. In their view if high wage earners earn less, then the additional funds left over can be used to raise wages for others and hire more employees. Note that this view assumes that firm revenues are simply given and do not depend largely on the efforts and decisions of top-earning employees.

With more people working, they claim, more taxes will be paid, which in turn would mean that the government and society benefit from a reduction in the wages of top executives. It is unclear what the basis is for their belief that shifting more wages from high earners in top income tax brackets toward workers in lower tax brackets will result in greater tax revenue.

Also, if the wages of top earners of a company are tied directly to those of minimum wage employees in the same company in the form of a ratio, it is believed that the top managers will be incentivized to increase the minimum wage in order to get an increase in pay themselves. Proponents hope that this will increase the rate at which revenues and profits trickle down to the lower wage workers in a company, government, and economy.

Critics and capitalists argue that when a government gets involved in the price controls of an economy, the economic state of a free market is compromised. By setting maximum wages, companies would have fewer talented leaders and employees, as the more valuable talents would be unwilling to work for a capped fee.

Maximum wage legislation could set the stage for a human capital flight where the most talented individuals emigrate to freer nations that could pay them their worth. In effect, setting such a policy would not lead to a more productive and profitable economy as the advocates believe.

The Bottom Line

A maximum wage is a hypothetical policy that would cap individual incomes. While proponents believe that a maximum wage could rein in exorbitant salaries, some economists argue that such a policy would have market-distorting effects.