Where did they get the 65% withdrawal rate from anyway?

1. The suggested rate for the 'Single Unified Taper' has crept up over the past year:

Iain Duncan Smith's Centre for Social Justice suggested a maximum withdrawal rate of 55 per cent in September 2009 (page 303 of this pdf)

According to the Daily Mail a month ago"A withdrawal rate of between 60 and 65 per cent is being debated, according to sources."

The actual White Paper of last week says 65%.

2. These rates are misleading as they apply after PAYE is deducted, thus the effective rates after tax would be 69%, 73% and 76%. As I keep pointing out, 50% is the ideal rate because the administration would be very simple - it could be done via the tax system using K-codes for PAYE, i.e. a flat 50% of wages are deducted in lieu of income tax and National Insurance with no personal allowance.

What would the wider impact of this be?

3. Let's focus on people who earn the National Minimum Wage of £6 an hour (in round figures) of whom there are 747,000. This paper says that the price elasticity of the supply or labour in The Netherlands is 0.1 for men and 0.5 for women, which makes sense, because more men are in work than women, so it is easier to tempt relatively more women into work than more men. So let's assume that the price elasticity of the supply of labour is 0.3. What this means is that if wages offered increase by 10%, the number of people willing to work for that wage increases by 0.3 x 10% = 3%.

4. I explained in my previous post that with a 65% withdrawal rate, a worker also liable to PAYE keeps 23.8 pence for every £1 he earns if he earns above the income tax threshold, and HMRC and DWP between them take 90 pence. If we did the means testing using K-codes, the worker keeps 50 pence and HMRC takes 63.8 pence.

5. So let's assume those 747,000 people all work about 16 or 17 hours a week and earn £100 gross (to keep the numbers simple) and keep £23.80 net. If their net wages went up to £50 for the same hours and the same work, that's an increase of 110%, so we'd expect the number of people prepared to do such jobs to go up by 33%, so an extra 247,000 people would be prepared to take such jobs. This is perfectly plausible, there are about 8 million working age adults not in work in the UK, and the DWP claim that the Universal Credit system would reduce the number of workless households by "up to 300,000" (page 50).

6. Under DWP's plans, the amount of tax and benefit withdrawal that HMRC/DWP will be taking from those 747,000 people would be 747,000 x £90 a week = £67 million a week. If we reduced the Marginal Deduction Rate from 90 pence to 63.8 pence, then HMRC would be taking £63.80 a week from 994,000 people = £63 million a week, a fall of £4 million.*

7. Remember also that the DWP and HMRC between them are so staggeringly inefficient that it costs them about £34 per household per week to process benefit claims (including fraud and error), see earlier post. I think it's reasonable assume that my system, by which all means testing and benefit withdrawal is done at source via PAYE codes would get this cost down by at least a tenth (I would hope that it would get the admin costs down by about nine-tenths, but you can't budget for miracles).

8. So HMRC/DWP would 'lose' £4 million a week in PAYE and benefits clawed back, but the cost of administering the benefits for those 994,000 people also goes down by a tenth, call it £4 a week each, which will save HMRC/DWP £4 million a week.

9. But the most important thing about this is that instead of 747,000 people taking home £23.80 a week, we'd have 994,000 people taking home £50 a week. The total disposable income of those one million people would increase from £18 million a week to £50 million a week. On average, those people at the overlap between being welfare claimants and being workers would be £32 a week better off. That's £1.5 billion a year, which is still only one-tenth of one per cent of GDP, so not an unreasonable estimate (but well within the range of measuring error).

10. It's not going to get us out of recession at a stroke or anything, but it will make it absolutely clear that you are always better off working, so no need for these authoritarian gimmicks like forcing longer term claimants to sweep the streets every now and then. There are people who are happy to sweep the streets for whatever wage the council pays them, why not leave them to it?

Here endeth.

* For all these calculations, I've assumed that the workers concerned earn over the personal allowance for PAYE. Maybe they don't, in which case their net wages would go up from £35 a week to £50 a week, and the number of additional people prepared to do minimum wage jobs would only go up by 96,000. In this scenario, the DWP/HMRC would 'lose' £3 million a week and these 843,000 very low paid workers would end up collectively £16 million a week better off. Certainly still worth doing, because all that £16 million will go back into the economy as spending or rent, so the extra taxes generated will be at least £3 million.

There is a more pessimistic view, that the employers who currently pay £7 or £8 an hour and know that the bulk of their workforce claim Working Tax Credits would simply drop the wages they pay to soak up some of the tax saving. There will be some element of this, but not enough to distort the whole picture; in any event, the best thing we can do for employers (apart from scrapping VAT) is to reduce Employer's National Insurance and all the stupid employment regulations, which would benefit employers in particular but workers in general; is it so terrible if we adopt a measure which benefits workers in particular and employers in general?