A minimum wage can be welfare-improving and employment-enhancing

We examine whether minimum wages can fulfill a useful role as part of an optimal tax-transfer scheme. The government cannot observe household abilities, only their incomes, and is constrained to ensure that those working are at least as well-off as those not working. A minimum wage combined with the institutional features of typical welfare systems allows the incentive constraint to be severed at the ability level associated with the minimum wage. If such a scheme can be enforced, the government can increase the amount of redistribution from those working to those not working, and possibly lower the number of unemployed. (C) 2001 Elsevier Science B.V. All rights reserved. JEL classification: H21; H23; J38.