Who would win from a 2015 rise in the Minimum Wage?

Another year, another Autumn Statement, and with the forthcoming 2015 General Election mere months away, would the Chancellor do anything in terms of increasing the minimum wage? Might he even enforce the living wage? Whilst there were stamp duty reliefs and yet another regressiveincrease in the personal income tax threshold, the answer in terms of wages was a big fat no.

This omission from the Treasury is odd, given than wages have been on the lips of politicians, members of the public and businesses alike for much of the previous year. Indeed, with pay packets still a way behind their pre-2008 recession peak, it is perplexing to say the least that nothing was forthcoming from Mr Osborne. Further, with hardly any other issue more important to the electorate, issues regarding the economy and wages are likely to be at the forefront of political debate as we approach May 2015.

Many have called for a substantial rise in the minimum wage, with the Living Wage campaign gaining extra traction of late, it’s arguments backed up by recent findings from the Joseph Rowntree Foundation claiming that half of all poverty is found in working families. Proponents of the Living Wage have argued that the minimum wage should rise to ‘reflect the real cost of living’ to £9.15 in London and £7.85 outside. The question is though, will those in low pay see much of any rise in their wages once tax and benefit changes have been taken into account? To find out, I look at four family types on the current minimum wage (£6.50 per hour) and how much they’d gain from an increase to the Living Wage outside London (£7.85), before considering what can be done to help workers gain more from any rise in pay, before setting out how things might change under Universal Credit.

Winners and Losers

In order to establish who will gain the most from any rise in pay it is assumed that each family type is working 37 hours per week on the minimum wage, and will enjoy a rise to the Living Wage outside London on the same hours. I calculate the Marginal Effective Rate which tells us how much from the earner’s extra wages will actually go into the pockets of the household once tax rises and benefit withdrawals have been taken into account. At the minimum wage at 37 hours per week, an earner will be earning £240.50 per week, and at the 2014 living wage they’ll be bringing in £290.45, a difference of £49.95. How much of this extra income will each household see?

27 pence

That’s the amount each of the households identified in this article will gain for every extra pound earned. This means that from the extra £49.95 earned in a move from the minimum wage to the living wage, all the earners will stand to gain only £13.49 per week. Thus, in terms of tackling the in- work poverty noted at the beginning of the piece, this pitiful return may not be the silver bullet to eliminating in-work poverty some perhaps think it is. To explain further, from every extra pound earned, 20 pence will be withdrawn via Income Tax, 12 pence through National Insurance Contributions and a staggering 41 pence through Tax Credits withdrawal. Given this stark reality, what can be done to help alleviate the situation?

  1. Expand the tax credits system further up the income distribution

The withdrawal rates noted above reveal much about how we in Britain withdraw state support as one progresses up the income distribution. In other words, as one earns more income in work in one hand, state support withdrawal means it is substantially taken away with the other. One answer to this would be to make the curve less severe, withdrawing Tax Credits more gently as one’s income ascends. Although effective, this measure would be quite expensive for the taxpayer, yet if a Government can spend billions on a tax measure that mainly benefits those in the upper half of the income distribution (raising the tax free threshold to £10,600) then why not do something like this to help those in the lower half? After all, ‘we’re in it together’ aren’t we?

  1. Raise the minimum wage to a level where low paid workers are less reliant on state cash transfers

Essentially, the system we have now is a legacy of the New Labour Government’s ‘Third Way’ approach, whereby Labour enforced a minimum wage but set it low enough for it to be attractive to employers. However, if the state were to enforce a higher minimum wage instead of subjecting low paid workers to highly conditional state benefits, then previously in receipt of state transfers would only be subject to Income Tax and National Insurance deductions. Whilst this option has obvious attractions, employers would kick up a stink, claiming (not entirely without merit) that jobs would go if they were made to increase the wage to the levels that would be necessary to make up for substantial losses in state benefits.

  1. Introduce transferable allowances

This measure, introduced in very limited form in this year’s Budget essentially means that a non-earning spouse in a one-earner couple household can transfer part of his or her unused personal tax allowance to the earning partner. In the current system, this would result in a net gain for the couple of around £260 per year, which clearly has very limited benefits in terms of tackling in-work poverty. Worse, when implementation of the Universal Credit is taken into account, families in low pay would benefit by only around £91 per year. If, on the other hand Universal Credit payments were disregarded and the allowance were fully transferable , the policy would be more useful, lowering the earning spouse’s marginal tax rate by 20%, resulting in an extra 20p in the pound for a group the Joseph Rowntree Foundation say are at particular risk of poverty. Thus, whilst this measure in ‘full fat’ form could be useful, it only benefits the primary earner within one earner families and actually acts as a disincentive for secondary earners. Overall then, this measure could really only be considered as part of a whole suite of measures to raise rewards from extra income earned.

Future prospects – Universal Credit

Having considered three measures which may alleviate the problem, we now look to the future under Universal Credit, the system set to replace tax credits. I won’t go into a full nuts and bolts explanation of what it is, but supporters allege that it’ll both be simpler than the current arrangement and will help tackle stifling work incentives. Whilst it may be simpler to understand and administer than tax credits, the Department for Work and Pensions own Universal Credit Impact Assessment admits that those currently facing a withdrawal rate of 73% will face an increase of 3 percentage points to 76%. On the other hand, those on Housing Benefit will see their withdrawal rates fall from 91% to 76%. In sum, many families under Universal Credit will actually end up gaining less from any rise in pay than under the current tax credits system.

No silver bullets

Those believing that wage increases will bring with them a fall in working poverty are on the basis of the evidence seen in this article in for a shock. Tax Credits leave many earners with little to shout about when it comes to financial reward from extra pay, and whilst those receiving Housing Benefit may gain from the move to Universal Credit, they will still endure punitive returns from a pay rise, with many actually being worse off than under Tax Credits.  All this isn’t to say growth in low wages isn’t welcome, it clearly is; however we’re kidding ourselves if we think that wage rises on their own will lift millions out of poverty. Increases in wages must be accompanied by reforms to the welfare system so that workers keep more of what they earn.

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