30 October 2020

Who should pay for the Living Wage?

By

It will have escaped no one’s notice that the UK is in an employment crisis. In the OBR’s Central Estimate, unemployment is set to rise to record levels, surpassing even the peak of joblessness in the 80s. At the same time, social distancing measures have hit productivity hard. It’s not their fault, but a waiter is simply less productive in a world with the Rule of Six, Tier Two measures, and general customer unease about eating out.

To his credit, Rishi Sunak has been willing to act to protect jobs. At first with furlough and now with the recently expanded Job Support Scheme. But both policies are premised on employees working fewer hours. They’re badly suited to, for example, pubs who need more staff on call due to the switch to table service but are still seeing fewer customers through the door.

Labour markets, like all markets, are governed by the laws of supply and demand. When workers become less productive, demand for them falls. The typical consequence of a drop in demand is a fall in price. Think of how you can pick up bargains in the January sales when consumer demand inevitably slumps. But this isn’t possible in all markets. In labour markets, wages are sticky. Unlike petrol prices, wages don’t change daily in response to shifts in demand. Employers are hesitant to slash wages as it can damage employee morale and attract bad press. On top of that, bosses are legally prevented from employing any worker for less than the National Living Wage.

The ambition to end low pay is an admirable one, but the National Living Wage is a blunt mechanism. It has pushed up the annual costs of employing the lowest paid workers by £3,680 since 2016. At the peak of the pandemic in April, and in the face of opposition from the Resolution Foundation and the Institute for Fiscal Studies, not to mention employers, the Government raised the National Living Wage by 6.8% to £8.20 an hour. Compounding the problem, in 2021 the National Living Wage is scheduled to be expanded to cover workers aged 23 and 24 (younger workers have previously received a lower rate). 

The Low Pay Commission will soon decide on its recommendations for 2021 and it’s Chair, Bryan Sanderson has recently said he believes the planned 49p (5.6%) rise for next April is now unaffordable. He may invoke the ‘emergency brake’ and delay the rise for a year. Yet the damage has already been done. If the National Living Wage was set at a level that got the balance between wages and employment right before the pandemic hit, then its current rate is clearly out of kilter with the post-Covid labour market.

There is, admittedly, some debate on the link between the minimum wage and unemployment. But the vast majority of studies on the topic find that minimum wages do cause unemployment. Typically, minimum wage hikes don’t lead to immediate layoffs. Most employers will do what they can to protect existing jobs and layoffs typically strain employer-employee relationships. Instead, employers hire fewer new workers in the years following a hike. This might not be much of a problem when employment is at record levels as it was until recently, but it is when employment numbers have cratered leaving millions out of work.

Employment isn’t the only way minimum wages can bite either. Employers may instead cut back on non-wage perks. For instance, Caffe Nero stopped giving employees a free lunch when the National Living Wage came in. Similarly, when political pressure from Bernie Sanders led Amazon to pay all of its workers $15 an hour, they simultaneously cut monthly bonuses and stock awards.

Employers may instead decide to pass on the costs to consumers. This can undercut the policy’s progressivity acting as a stealth VAT. In the very best case scenario, employers cut back on profits, But the reality is typically a mix of the above.

To secure a labour market recovery, the National Living Wage needs to fall in real terms. This, by the way, is what happened during the Great Recession. Between 2008 and 2013, inflation was allowed to erode the value of the minimum wage. However, the scale of job losses on the cards suggests we may need to go further.

A one-year freeze might be politically saleable but I can’t see the Conservatives cutting the National Living Wage or veering too far from their goal of raising it to two-thirds of the median wage. The political cost is simply too high. Imagine the backlash of any politician opposing a wage rise for care workers.

Even if cutting the National Living Wage was politically possible, under-pressure employers are still unlikely to take advantage of the freedom to cut wages. It might accelerate hiring in the coming months, but it will come too late to save jobs.

But there’s a third way: the taxpayer could split the difference. Prof David Neumark has proposed a ‘High Wage Tax Credit’ to reduce the impact of minimum wage rises on employment. Employers of minimum wage workers receive a tax credit worth half the difference between the current and new higher wage. From the employer’s perspective, the minimum wage simply hasn’t risen by as much.

We could try something similar. What if employers got a refundable Living Wage credit worth up to half the difference between the National Living Wage and what the National Minimum Wage was in 2016. It would be a significant subsidy to employers, but it could prevent job losses and allow businesses to stay open when trading under significant restrictions. To reduce the cost of the scheme, it could be targeted at certain sectors facing restrictions, similar to the Job Support Scheme Open. Neumark suggests limiting the subsidy to people without a university education. The subsidy would be phased out gradually as workers move up the wage scale.

In the medium to long run, some form of the policy may be necessary to ensure that the plan to raise the National Living Wage to two-thirds of the median income, while also expanding eligibility to 21 year-olds, does not price workers out of the labour.

If we treat the Living Wage as just another form of redistribution, it raises another issue. Are minimum wages targeted at the right people? The answer is probably not. As the Institute for Fiscal Studies notes, less than a fifth of minimum wage workers live in a household in relative poverty. A Living Wage Credit, by contrast, could be targeted only at the workers who need it the most by attaching conditions to which workers qualify. You could target it at the long-term unemployed, or even use it to tackle specific problems such as the disability employment gap.

The key advantage of this approach is its relative progressivity. As Neumark puts it: “Most redistributive policies transfer money from high-income households to low-income ones via the tax system. The minimum wage, by contrast, takes money from business owners, who may not have high incomes themselves.”

Think of the small shops, pubs, nurseries, and restaurants struggling to stay open. I’d wager a guess that very few of their owners are in the top 1%. They are hardly the best targets to pay for redistribution. Why not have bankers, lawyers, and footballers pay for the Living Wage instead?

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Sam Dumitriu is Research Director at The Entrepreneurs Network.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.