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Immigration Nation

How Wages and Public Finances Respond to Immigration

July 6, 2021

Author

Lisa Camner McKay Writer/Analyst
Constructions workers
Photo by Joe Raedle/Getty Images

Article Highlights

  • When immigrants compete for low-wage jobs, wage inequality increases
  • Immigration’s effects on wages dissipate as people react by moving to new cities or sectors
  • With progressive taxation, these labor market responses increase government revenue

Every year, some 1 million immigrants arrive in the United States. The foreign-born population is now at 44.8 million, higher in per capita terms than it’s been in 90 years. The United States is a nation of immigrants, in fact and in mythology.

As a result, immigration’s social and economic impacts are far-reaching. Immigrants come, many of them, for opportunity: higher wages, safer neighborhoods, world-class educational programs. When they arrive, they affect the local and national economy in many and varied ways. They become consumers. They compete for jobs. They use health care, enlist in the military, collect veteran’s benefits, and invent new technologies. Their children go to school, grow up, and pay taxes.

Measuring immigration’s impact requires understanding what happens after immigrants arrive—where they go, what they do—and how the economy responds.

The breadth of these effects makes measuring immigration’s impact a nuanced task, one that requires understanding what happens after immigrants arrive—where they go, what they do—and how the economy responds. While many of these dynamics have been studied, former Institute visiting scholar Mark Colas extends the analysis in two important ways to form a more complete picture about the economic impacts of immigration. Doing so allows the country to address any negative impacts while reaping immigration’s many benefits—not the least of which is that the U.S. population, and likely the entire economy, would shrink without it.

How wages respond to immigration

In “Dynamic Responses to Immigration,” Colas seeks to understand how changes to the wages of existing U.S. residents (“natives”) play out over time. The economy is dynamic, not static, after all, and people may choose to change jobs or move to a different city in response to changes in their local labor market that occur when immigrants (authorized or unauthorized) arrive.

Economists continue to debate how much wages change in response to immigration, but there is reason to think that, at least some of the time, there is an impact. In the simplest formulation, immigrants arrive and compete for jobs in certain occupations. This increases the supply of workers and pushes down wages for both native and immigrant workers in those jobs. Other people do jobs that are complementary to those of immigrants. These people are now more productive, sending their wages up.

People may choose to change jobs or move to a different city in response to changes in their local labor market that occur when immigrants arrive.

Which jobs would see a decline in wages and which an increase? According to Pew, 49 percent of the foreign-born population has a high school degree or less, compared with 36 percent of the U.S.-born population. Thus, when a group of immigrants arrives, the supply of workers competing for jobs that don’t require much formal education, usually low-wage jobs such as warehousing, agriculture, and food services, increases more than the supply of high-education workers, who typically work higher-wage jobs. This suggests that lower-wage jobs will see wages fall, while higher-wage jobs see wages rise.

Consider the case of a construction worker and an architect, who work in complementary jobs: Architects make designs, and construction workers bring them to life. Construction worker jobs typically require no formal education, and their median annual income is $37,890, less than the median across all occupations in the United States. Architects, meanwhile, typically require a bachelor’s degree, an internship, and passing the Architect Registration Examination. Their median annual income is $82,320—more than twice as much as construction workers earn. When construction wages are high, fewer people can afford to build a house, remodel their kitchen, and so on.

If a large group of immigrants arrive and take jobs in construction (and data suggest around 30 percent of construction laborers are foreign-born, compared with 17 percent of all workers), construction worker wages fall. More people can now afford to build or remodel, which means architects will be more in demand. Since their supply hasn’t increased much, their wages go up.

Why wages continue to change over time

To study immigration’s effect on wages, Colas estimates what would happen if there is a large influx of approximately 5 million low-education immigrants (about 10 percent of the low-education workforce in the United States today). He calculates that immediately after immigrants arrive, low-education wages decrease by 2 percent on average, while wages for highly educated workers go up about 0.8 percent.

How much time it takes for workers to adjust depends on how costly it is for people to switch sectors or cities and how much individuals value income compared with how much they value working a particular job or living in a particular place.

But these effects on wages don’t necessarily persist indefinitely because workers can adjust by switching the city they live in or sector they work in. Importantly, the average wage changes hide considerable regional variation. Cities that receive the most immigrants as a fraction of their low-education workforce (Miami, San Francisco, Washington, New York, and Houston) see low-education wages decrease more and high-education wages increase more than in places with less immigration. So a low-education worker in Miami might choose to move to a city that has less immigration—Savannah or Charleston, say—to take advantage of higher wages.

A large influx of low-education workers also affects what sectors people work in. Colas considers three broad sectors: service, manufacturing, and professional. Figure 1 shows what percent of each sector’s workforce is low-education and high-education. Because the service sector employs the largest fraction of low-education workers, it experiences the largest decrease in low-education wages and largest increase in high-education wages. This increase provides skilled workers with incentive to switch to the service sector, ultimately allowing the sector to expand.

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These adjustments to where workers work don’t happen overnight—rather, they play out over time. Just how much time it takes depends on two key factors, Colas explains.

First, it depends on how costly it is for people to switch sectors or cities. Some of these costs are strictly monetary (the cost of hiring a moving truck, say) while others take the form of time and effort (the “cost” in forgone leisure of searching for a new job or home). Some costs vary across individuals: Some people enjoy change; others dread it. And some costs depend on the structure of the economy—for instance, how much human capital will a worker lose by switching sectors?

Second, adjustments depend on how much individuals value their consumption and, therefore, their income, compared with how much they value working in a particular sector or living in a particular city. If many workers value consumption greatly but don’t have strong feelings about where they live, the economy will adjust more quickly.

To study how the labor market responds over time, Colas creates a model of the economy that incorporates wages, individuals’ preferences for what sector they work in and where they live, the costs of switching, and human capital accumulation (such as the expertise in a specific job that grows over time). Using data from the 20 largest U.S. cities, he finds that after 10 years, the effect on wages is half of what it was immediately after the immigrants’ arrival. See Figure 2 for how these changes play out in eight cities over time.

The sectoral shifts after 10 years are fairly modest due to the relatively high costs to switching sectors: About 0.5 percent of the low-education workforce and 0.3 percent of the high-education workforce have left the professional sector, while 0.25 percent and 0.18 percent, respectively, have joined the service sector.

2

How wages change in different cities over time
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Note: How much wages change depends on the number of immigrants who arrive in a city. Of the 20 largest U.S. metro areas, Miami has the highest proportion of low-education immigrants. In the first year of an immigration influx, low-education wages fall by 3.5 percent. The median weekly earnings for a worker with a high school diploma are about $750. A 3.5 percent decline means earning $26 less a week, about $1,365 a year. After five years, the loss is 2.8 percent ($1,092/year); after 10 years, the loss is 1.6 percent ($624/year). For high-education wages in Miami, the gains are 2.1 percent, 1.6 percent, and 1 percent, respectively.
Source: “Dynamic Responses to Immigration,” Institute Working Paper 6,Federal Reserve Bank of Minneapolis

Immigration’s impact on government revenue

The economic impact of immigration goes beyond the labor market. Immigration also affects public finances. Previous research suggests that the amount the U.S. government spends on services for low-education immigrants is larger than the amount those immigrants pay in taxes. But this calculation misses an important element of the equation, Colas contends, because immigration also affects tax revenue by impacting who works, how much they work, and what their wages are, which in turn affects how much the government collects in taxes from native workers. In “The Indirect Fiscal Benefits of Low-Skilled Immigration,” Colas and his co-author, Dominik Sachs, seek to measure immigrants’ indirect effect on public finances.

Because the U.S. tax system is progressive, the amount of tax the government collects changes when already-low wages go down and already-high wages go up. Estimating just how much tax revenue changes, however, is a difficult task. First, the U.S. tax system is complex, involving federal, state, and local taxes, many of which vary by family status, income, investments, state of residence, and more. Second, workers differ from each other in many ways. They can have more or less education, be more or less productive (even if they have the same level of education), or work more or fewer hours. If my wage goes up by $1 per hour, how much more will I work? How much more would you work?

Immigration affects tax revenue by impacting who works, how much they work, and what their wages are, which in turn affects how much the government collects in taxes from native workers.

Colas and Sachs therefore estimate in their model how tax revenue responds to one low-education immigrant under a host of assumptions about how people respond to changes in their wages, including whether they keep working, how much they work, and how those decisions might depend on income, gender, and marital status. In every estimation, they find that tax revenue goes up between $700 and $1,700 a year.

Importantly, this amount is similar in size to previous estimates of how much an immigrant “costs” based on the services they use and the taxes they pay. When it comes to the government’s coffers, then, immigrants are probably close to neutral.

Implications for worker welfare and policy

An important outcome suggested by this research is that immigration of low-education workers causes already-low wages to fall and already-high wages to rise. Even if the total amount of money employers pay to workers stays the same, the income distribution does not—income inequality increases.

However, the research also shows that the economic impact of immigration is complex and dynamic. The immigrants themselves are often earning two to three times a year what they earned previously. Immigrants contribute their ideas and their labor, without which the U.S. workforce would shrink, limiting economic opportunity for everyone. Immigrants’ children often experience considerable upward socioeconomic mobility. The immediate wage changes that native workers experience don’t last forever, Colas shows. And additional tax revenue can be used in a way that supports those who have lost, perhaps via programs similar to trade-adjustment assistance. Funds could assist with relocating costs and job retraining, helping people take advantage of where economic opportunity exists.

Even if the total amount of money employers pay to workers stays the same, the income distribution does not—income inequality increases. However, the research also shows that the economic impact of immigration is complex and dynamic.

Another way to fund such programs is via immigration fees, Colas suggests. One possibility is to calculate the total lifetime cost of a low-education immigrant on all low-education workers in the United States and require immigrants to pay a one-time fee on entry equal to that cost. The model Colas uses suggests that amount is in the vicinity of $16,000.

The effects of immigration extend far beyond the query “do they take jobs?” that often animates political debate. For immigrants who stay in the United States, the effects also last for generations, which adds further elements to the analysis. While questions remain, Colas’ research on the long-term labor market dynamics and their impact on government revenue presents a richer understanding of the economic impacts of immigration.

Lisa Camner McKay
Writer/Analyst

Lisa Camner McKay is a writer/analyst with the Opportunity & Inclusive Growth Institute at the Minneapolis Fed. In this role, she creates content for diverse audiences in support of the Institute’s policy and research work.