U.K. general election.

I’m busy with the U.K. general election (6th May). So not many posts till after that date - just a few leads, e.g.:

Good interview with William Black on criminality at the top of U.S. banks.

Good article by Warren Mosler.

The great National Insurance row.

With the U.K. general election looming, U.K. politicians are desperate for something to argue about. They’re getting worked up at the moment about the proposed 1% National Insurance contribution increase (effectively a payroll tax).

I’ve got involved in an argument with the author of an Institute of Economic Affairs article by Kristian Niemietz. See http://blog.iea.org.uk/?p=2217

Comments after that article are limited to 700 characters which doesn’t do this point justice. So I’m trying to continue the debate here. Given that the result of the U.K. general election hinges on this point (ho, ho), the point clearly needs thrashing out. My response to Kris's latest comment is thus.


Kris: I’ll take the following sentence of yours first.

“You are, in effect, saying that it doesn't matter what the tax is levied upon, whether it's the purchase of labour or the size of your windows, as long as the total sum of tax money paid is the same in both cases.”

My answer: obviously it makes a difference at the micro level what a tax is levied on. E.g. tax windows and people will buy fewer windows. But so far as macroeconomics goes, it makes little difference what is taxed.

I’ll illustrate with a simple example, thus. Assume a closed economy. If the average wage is £10k and government imposes a tax increase of £10 million p.a., then about 1,000 people will be out of work. But if government then spends that £10 million (on anything you like) then around 1,000 new jobs will be created to make up for the 1,000 destroyed.

Re “labour-intensivity” I don’t accept that adding to the cost of employing people results in much of a move to less labour intensively produced products. Reason is that labour is the ultimate cost. That is the cost of anything can be broken down into cost of labour, machinery and materials. But the cost of machinery and materials themselves can be broken down into the cost of labour, machinery and materials. Go back far enough, and you discover that the only reason anything costs anything is that people have to be paid to do things (like make machines and produce materials).

I.e. raise the cost of labour by 1% and the cost of machinery will also rise by 1%. Of course the cost of already acquired machinery doesn’t rise, but if employers include replacement cost of machinery in their costing (which many do),the effective “cost of machinery” will rise very quickly to match any rise in the cost of labour.


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£1bn of “efficiency savings” will not reduce the deficit by so much as £1.

At election time, political parties always spout nonsense about the tax cuts they can achieve through “efficiency savings” in the public sector. But what’s different this time (the UK general election is probably in May 2010) is that these efficiency savings can allegedly be used to reduce the deficit or pay off the national debt.

When it comes to economics, politicians can be expected to talk drivel. But economists should know better. Unfortunately some of them don’t.

Suppose efficiency improves in the public sector to the extent that £X is saved and Y employees are then surplus to requirements. That means the deficit can be cut by £X. But hang on: what about the Y former employees? They cannot just be left unemployed. So the deficit has to be expanded again to employ them. Now were up sh*t creek.

How do we escape from this conundrum? Well, the truth is that the deficit (or surplus, come to that) needs to be held at whatever level maximises employment without bringing excessive inflation. And this level of employment will not be affected one iota by any efficiency savings (or lack of them). In other words the deficit CANNOT be reduced because of efficiency savings.

What WILL reduce the deficit is the decision by the private sector that it is holding sufficient or excessive net financial assets (i.e. government debt and monetary base). This will cause the private sector to try to dissave money, which will raise demand, which means an end of any need for a deficit. Alternatively demand from the private sector may rise for some other reason, e.g. “animal spirits”. Indeed if the private sector gets sufficiently confident and “spendthrift”, the public sector can then run a surplus, i.e. reduce the deficit (and perhaps even run a surplus).

Devaluing Portugal, Spain and Greece's currency.

One problem with pig countries is poor export performance (although some dispute this). A solution would be a substantial pay cut for all their employees, which equals a devaluation of their currencies. However there is a problem, namely that wages are “sticky downwards”, as Keynes put it.

A solution might be to reduce or abolish any payroll taxes in these countries (and/or implement a general subsidy of all employees) and funded by increased personal taxation. That would come to the same thing as the above “pay cut / devaluation”: the cost of goods produced in these countries for non pig country customers would decline.

Reducing pay by 1p an hour can lead to riots. In contrast a slow reduction (or slower increase) in living standards caused by income tax increases does not normally lead to civil unrest.

But the above idea is something of a “last resort”: clearly a country cannot go on increasing employment subsidies and personal tax for ever to counteract a failure to control wage increases.

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Payroll taxes destroy jobs?

The UK government has announced a National Insurance contribution increase – effectively a payroll tax. The increase is 1% of each employee’s pay.

This has produced howls of anguish from employers’ organisations, the Tory Party, and others looking for something to do. Supposedly this will destroy jobs. Well obviously this tax (indeed any tax) taken in isolation reduces aggregate demand and destroys jobs. But if government spends the money collected, the number of jobs so created ought to be very similar to the number destroyed by the payroll tax increase.

There is no obvious reason why the number of jobs created would be much different to the number destroyed, but if the number created WERE less than the number destroyed, no problem. Government can just give the economy a bit more stimulus. Also it is primarily labour shortages which spark off inflation. If additional unemployment results from this 1% increase, labour shortages will be alleviated, thus there will be room for more stimulus.

Having said that, there is just one channel via which jobs might arguably be destroyed, as follows. This 1% increase in the cost of employing people could be significant for those on minimum wages. If minimum wages destroy jobs, then on the face of it an increase in minimum wages will destroy even more. But not even this argument stands inspection. Reasons are thus.

If the value of the output of someone on minimum wages is marginally more than the costs of employing them, and costs of employment rise by 1%, obviously that person is out of work – ASSUMING PRICES REMAIN CONSTANT. But prices won’t remain constant. If the cost of employing everyone rises by 1%, then prices will ultimately rise by 1% (other things being equal). And that includes the price of stuff produced by those on minimum wages.

Stuff produced by those on minimum wages competes with stuff produced by others. If stuff produced by “others” rises by 1%, there is a good chance stuff produced by those on minimum wages can rise by 1% with impunity. Indeed, untill someone measures the cross elasticity of demand for min wage "stuff" versus other "stuff" it is just as likely that this 1% NI increase will EXPAND opportunities for minimum wage people as CONTRACT such opportunities.