Raising the minimum wage cuts the welfare bill
Trends in wages now have a very big impact on welfare expenditure, according to a new blog by IPPR director Nick Pearce that responded to the news that George Osborne has joined calls for an above inflation raise in the national minimum.
Nick Pearce, IPPR director, writes: “After pressure from various wings of all three main political parties, George Osborne has publically stated his desire for a substantial increase in the National Minimum Wage. The government’s submission to the Low Pay Commission argues for the main adult rate to hit £7 an hour by 2015. This is a significant move for a number of reasons.
“Given the salience of welfare spending to current political debate, it is worth a comment on the implications of this move for that debate. If the minimum wage rose to £7 an hour the financial gain to the low paid would be real and meaningful, while we should a priori prefer an economy where people earn their way to a decent standard of living, rather than relying on the state. However, it is also true that some of the gain of a higher minimum wage will accrue to the state, in higher taxes (largely National Insurance Contributions) and reduced benefit payments.
“This speaks to a larger point. Part of the reason why the cost of benefits and tax credits have risen in recent years is that they have played an increasing role in topping up the incomes of working households. That means that trends in wages now have a very big impact on welfare expenditure – in addition to patterns of employment. We recently did some modelling to underscore this point.
“We found that if average earnings were to fall by 1.5% in real terms in 2013/14 – as they did in 2012/13, and as the OBR predicts for this year – it would cost the Treasury almost half a billion pounds (£497m) more in tax credits and benefits than if earnings growth were to remain flat in real terms. More significantly, if earnings growth were to return to something approaching a normal level this year, such as a real terms rise of 2%, then tax-credit and benefit spending would be £1.1bn lower than it will be if the forecasted 1.5% real-terms fall occurs.
“The analysis also found that patterns of wage growth have an even larger effect on income tax and national insurance receipts. For example, annual revenue in 2013/14 would be £5.4bn higher if real earnings growth were to remain flat compared to earnings again falling in real terms by 1.5%, as they did in 2012/13. If real wages rose by 2% this year then the difference would be a staggering £12.5bn.
“This is almost equivalent to the annual amount raised by the chancellor from increasing VAT from 17.5% to 20%. And more than George Osborne says he wants to cut from the welfare budget in the next Parliament. Yesterday’s announcement was potentially great news for low paid workers. It should also lead policy makers to make the connection between wages and benefit spending, given that both will be central to the political battleground in 2014 and beyond.”