Tuesday, 25 March 2008

Business taxation 2 - full employment

OK. Let the right wingers yap on about reducing corporation tax (the second least-worst tax*) and increasing taxes on consumption (like VAT, the worst tax of all - see Business Taxation part 1); let the lefties yap on about increasing Employer's National Insurance Contributions to force employers to pay towards the Welfare State and increasing the National Minimum Wage**. As usual, they are all talking crap, the truth is much more mundane than that.

In the absence of any taxes, we would have 'full employment', which unfortunately does not mean that everybody would have a job, it just means that we would have the optimum/equilibrium level of employment and output, as follows:

Now, on a simplistic (and probably correct) level, employees work for their net salaries. An employee is indifferent between between £100 gross taxed at 33% (22% income tax plus 11% Employee's NIC) or £67 tax-free. So the tax is actually borne by the employer. But the employer gets corporation tax relief on the gross salary, so if we had a truly flat tax of (say) 31% for corporation tax and income tax/Employee's NI, the tax borne by the employer and the corporation tax relief thereon would cancel out; we would still be somewhere close to 'full employment':

Unfortunately, we also have Employer's NI Contributions of 12.8% of salaries. So a gross wage of £100 costs the employer £78.96 (£100 plus £12.80 Employer's NI less 30% corporation tax relief); but the employee nets £67, so that's an additional 18p lost in tax for every £1 that passes from employer to employee. So businesses are encouraged to use machines, automation or imports instead (in itself not a bad thing, different topic). So the net cost to the employer increases, the net salary received by the employee goes down and we have totally unnecessary unemployment:

As ever, things are even worse than that. The demand for labour is relatively price-elastic (look up 'determinants of price elasticity of demand') but the supply of labour is far less price-elastic. To put it bluntly, the most of us have no choice but to work, however low our net wages. Thus the reduction in overall employment levels is far closer to 18% than 9% (which it would be if demand for and supply of labour were equally price-elastic), as follows:

Now, here's that same diagram again, with the corners labelled A, B, C, D, E. (for clarity):

Right, let's expand those areas and put names and values to them:

If we scrapped Employer's NI, the government would lose £37 bn Employer's NI, but it would save (up to) £20 bn welfare payments; collect (up to) an additional £17 bn income tax/Employee's NI and collect at least another £11 bn in corporation tax. The deal would be more-or-less self financing!; it'd save employers a huge administrative headache; it'd help us towards full employment; and it'd enable us sack a few tens of thousands of civil servants.

Who's up for it?

Employer's NI is total NI of £97 bn from here x 72% (28% of workers are directly or indirectly employed by the state anyway, see Column M) x 54% (Employer's NI is 12.8%, Employees' NI is 11%, so Employer's NI is about 54% of the total).

Income tax is £149 bn from here again, less a fifth that relates to investment income and taxable pensions, plus Employees' NI (£97 bn x 46%).

Total working age welfare payments per DWP's Table 3 is £19.6 bn, plus £14 bn Tax Credits, plus £7 bn notional cost of below-market rents in social housing, makes £40 bn, knock off half for the elderly, the truly incapacitated and the totally unemployable.

I have guesstimated the missing figure; the additional income tax/Employees' NI that would be collected at £17 bn, or 10% of current receipts of £165 bn.

Scrapping Employer's NI (assuming it is borne by employers) would increase their profits by £37 bn, so the additional corporation tax would be 30% of that, or £11 bn, even assuming no increase in economic activity.

* Along with flat rate income tax, obviously. I fail to see any real difference between income tax and corporation tax.

** Of course, I would scrap the NMW and reduce the level of means-testing of benefits instead, different topic. And Working Time Directive and Maternity Leave regulations will go straight on the bonfire as well.


Anonymous said...

Interesting article, you make some interesting points .

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