The Minimum Wage Poverty Trap: A Theoretical Analysis

Abstract

This paper develops a theoretical framework for understanding how minimum wage policies may create a “poverty trap” that reduces low-wage workers’ incentives to invest in human capital. While minimum wage increases provide immediate income benefits, beyond a certain threshold they diminish expected returns to education and training, thereby reducing occupational mobility. I formalize this relationship through a utility maximization model incorporating time discounting, opportunity costs, and uncertainty. The framework derives explicit conditions under which an inverted-U relationship emerges between minimum wage levels and human capital investment, including bounded skill premia, education affordability constraints, and wage-dependent present bias. Recent empirical work by Alessandrini and Milla (2024) provides partial support, finding minimum wage increases lead to higher community college enrollment but lower university enrollment, consistent with the model’s predictions. The analysis contributes to minimum wage policy debates by highlighting potential trade-offs between short-term income support and long-term economic mobility, suggesting complementary policies are needed.