Opinion: Taking minimum wage work out of tax would deliver the Living Wage

With greater ambition, the Liberal Democrats’ policy of increasing the personal allowance would equalise the Living Wage and the minimum wage, without risking jobs.

It was announced yesterday that the national ‘Living Wage’ for 2013/14 will be £7.45. This compares to the National Minimum Wage of £6.19. Boris Johnson has urged more companies to adopt the Living Wage, and Labour are even considering giving tax incentives for firms to pay the Living Wage.

Few would argue with the benefits of higher pay for employees, or with other Living Wage benefits such as lower staff turnover. But evidently most employers are not convinced that this is a good deal, while the Low Pay Commission gives careful thought to how high it can set the minimum wage without an unacceptable impact on unemployment. This leaves us with only 2% of workers paid the minimum wage, but 20% on less than the Living Wage.

However, the real consideration for employees is post-tax income, while for employers it is the total cost of paying a given wage. So the Living Wage debate must also look at the difference between what employers pay and employees get: what the government takes from minimum wage workers in income tax and National Insurance.

In April, the post-tax income of someone working full-time on the Living Wage will be £12,700, while the pre-tax income of someone on the minimum wage is… £12,700. It is only a £1,700 tax wedge that divides the minimum wage and the Living Wage. The graph below shows a comparison of the minimum wage and Living Wage, with the all-important take-home pay in blue (full-time here meaning 37.5 hours a week).

What this shows is that we could deliver the living standard that comes with the Living Wage by taking minimum wage work out of tax. This is represented by the third bar in the graph. Raising the personal allowance to £10,000 will close some of the gap, but it would need to rise beyond £12,000, as must the National Insurance (NICs) thresholds (this includes employers’ NICs, as “in the long run, wages absorb changes in payroll taxes”). The graph shows that NICs are even more important than income tax.

Raising the income tax and NICs thresholds so significantly would be a huge change, and unaffordable at present. It should also be said that part-time minimum wage workers wouldn’t benefit directly, unlike with the Living Wage, but these tax cuts would reduce marginal rates, making extra hours more attractive and encouraging second earners into full-time work.

Employers may justifiably say that the only reason their minimum wage is insufficient is that the government is taxing minimum wage work. But this is not to disparage the Living Wage campaign. They are right to say that some employers could pay more. We must also be careful not to replace the last decade’s policy of using tax credits to prop up stagnating incomes with a similar approach using tax cuts.

There are also very significant problems with the party’s allowance-raising policy, not least how to fund it. These are despite the attraction of not taxing those whose wages are not even deemed to give a basic standard of living. All these issues will be explored in a future CentreForum report.

For now though, it’s neat to note that an ambitious rebalancing of the tax system would at the same time deliver the Living Wage for workers in all sectors.

Acknowledgement: The Adam Smith Institute has (somewhat worryingly) come to the same conclusion. Also see Nick Thornsby’s article.

* Adam Corlett is economist analyst at the Resolution Foundation, and writes here in a personal capacity as a party member.

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15 Comments

  • Joseph Donnelly 6th Nov '12 - 3:31pm

    Really happy to see Lib Dems proposing this sort of thing. Where the solution to raise people out of poverty is actually less government intervention and not more its great to see us being the proponents.

  • Regardless it will always be society as a whole which bears the cost and whatever method is realistically possible gets my vote & it looks like the tax changes are making significant progress to that end

  • This should be a key manifesto proposal for the next election. After all, we will have delivered the £10,000 personal allowance, so will have credibility on this issue.

    As for being expensive, I’m not so sure it will be overall. It will encourage even more people to come off benefits and into work and make it easier for employers to recruit for roles paying the minimum wage. In theory it would allow a couple working full time to earn over £25,000 before paying income tax.

  • There is very strong public support for the living wage.
    The reason for this is the simple fairness that employers should pay wages their staff can actually live on.

    Note that top ups through the tax system (currently through tax credits etc) have not been accepted as a fair solution – this shows that the public want employers to pay a fair wage , not for the general public to be forced to top up scrooge employers who deprive workers of an adequate living. Why should these employers be rewarded with a tax break for paying too-low wages, when very often at the same time paying executives ridiculous multimillion pound salaries.

    The living wage is the wage required to reach a socially acceptable standard of living – and this includes being able to contribute towards hospitals, schools, and all the other important social systems that make our communities nice places to live.

    Therefore, the right solution is also the simplest: make the minimum wage a living wage.

  • Paul McKeown 6th Nov '12 - 6:36pm

    I agree, except for one detail.

    The manifesto should propose the Living Wage for a FTE as the tax free allowance. Somewhere around £16,000, adjusting downwards from £8.55 (London weighting) to allow for the removal of income tax from the needed rate.

    This would allow a future government to have a more credibly humane look at “in work benefits”, trimming the welfare budget, without harming the genuine interests of those on low incomes. It would also provide an even stronger incentive to work.

    It might require the starting rate to rise to 30% or thereabouts, to compensate, but coming in at £16,000 or so, most people ought to be better off. Naturally it might also require higher taxation on the wealthy to completely balance the books. Time to look seriously at LVT, higher council tax bands or other property taxes, perhaps.

    The Lib Dems have serious credibility on this particular issue. They should push it hard. I think the idea works “politically”. You can simply argue that no one should be subject to income tax unless they are bringing in sufficient to to provide themselves with at least a minimum subsistence.

  • I am totally against increasing the minimum wage, especially at a time when we’re looking for growth and jobs. We already have a huge problem with youth unemployment., the solution isn’t to make it even more expensive to hire young people or those with low skills. The best and most liberal solution is to take the low waged out of tax altogether. Let people decide where and how to spend their own money.

  • I think Paul’s comment gets to the nub of it. A higher personal allowance (of all payroll taxes), if you’re not willing to accept a huge collapse in income tax revenue (which of course might be desirable if replaced by wealth taxes, but that is very difficult ), requires much higher marginal rates, either explicitly or via that way the personal allowance is reduced above £100k.

    People used to worry a lot about marginal rates, and 30% income tax would equate to something like 50% with the NI, Would this had a serious negative impact? I don’t know.

  • This would need to be combined with higher tax rates at the top of the income scale. Recent research showed the optimum tax rate on high incomes was up to 75%.
    Some countries who have recognised the problem of high inequality have implemented higher top tax rates, such as France, and it will be interesting to see the effect. As other European countries are doing this it will also be much less of a risk to raise our own top tax rates.

  • Re: the potential shortfall in NIC and income tax this measure would entail.

    Given the evidence being presented by HRMC to the select committee, which we should remember is only the continuation of a long standing arrangement for large businesses to structure themselves so as to avoid tax and hence depress corporation tax receipts. It would seem that a greater proportion of tax revenue will have to come from indirect taxes such as VAT and levies such as those imposed on energy bills (yes the levies on our energy bills are a form of tax that doesn’t go via the Treasury).

  • A good article Adam.

    Although, I would argue that the proposed higher tax allowance is best delivered by way of a universal tax credit and a combined flat rate for income tax and NI, the principle remains the same i.e. net earnings below the living wage should not be subject to net tax/NI deductions.

  • Helen Dudden 8th Nov '12 - 9:50am

    I know that there are many who struggle, simply because of the level of wages at the lower scale. Of course, it would be a good idea that it pays to work, you actually have something other, than just enough to live on.

    If we are to get away from the benefits culture, it has to be with working and it pays. It most certainly is not fair that those who are on benefits have a better life style, than those who work.

    It also should be that those with drink and drug problems are encouraged to come clean, it again, is unfair that they are supported.

  • Adam Corlett 9th Nov '12 - 2:32pm

    Thanks for the comments, all. Raising the thresholds in this way would indeed have to go alongside increases in tax rates, and/or ending many tax breaks. Otherwise it’s completely unaffordable and – perhaps surprisingly – extremely regressive.

  • David Murray 8th Jan '13 - 2:47pm

    The NIC threshold is the problem. At just over £5,500 employee contributions are 11% but for those earning over £44,000 it drops to 1% !! If ALL employees paid 11% throughout the whole salary range, there would be enough extra revenue to raise the NIC threshold – a tax neutral adjustment which would benefit the lowest paid. Raising the income tax threshold is one thing, but it leaves the NIC threshold way behind.

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