One of the key areas discussed in the election was welfare and in particular what to do about those who remain long term dependent on welfare. How can the UK government encourage people back to work? A key issue is the poverty trap: some people are simply better off living on benefits than they are getting a job. Here, we’re talking about the marginal-tax-plus-lost-benefit rate. When you start earning, you get taxed, pay national insurance contributions and lose some of your benefits. All this leads to a situation where work doesn’t pay.
In a paper ‘Escaping the Poverty Trap’ by Lawrence Kay, he considered how much better off people are moving from different benefits into work, taking into account the high costs of actually finding a job and then starting work. He found that after 16 hours of work, someone on Job-seekers’ allowance would be £15.07 poorer and someone on Employment and Support Allowance would be £39.35 worse off. In many cases, people were facing a marginal effective tax rate in excess of 100%. Given this, it’s hardly surprising that Lawrence Kay found that ‘Long term welfare claims have been Britain’s blight for many years’.
However, the Coalition has plans to change this and make sure that those in work are paid more and are better off than those on benefits. By making working life a more attractive option, this should encourage those for whom work doesn’t pay to enter the labour force. This will obviously benefit them, increase the potential output of the economy (hence growth) and improve net taxes, as tax revenue rises and benefits expenditure falls. While this may not lead to tax cuts for those in work (as benefits spending falls), it may mean that more tax revenue is devoted to areas such as health and education or that the government can close the budget deficit.
The ‘universal credit’ aims to simplify the current system and make work pay, by re-introducing a culture of work in households. There is also a plan to place sanctions on those turning down work and place a cap on benefits to any single family. There was also be tax changes aimed at helping those moving into work keep more of their money, thereby removing, or at least reducing, the poverty trap. However, some families will lose out – as the IFS noted, any reform ‘creates winners and losers’. However, the reforms are a step in the right direction. As David Cameron said:
“I think that will, over time, solve the whole poverty trap issue that has bedeviled governments of all colours.”
The Labour party does back some of the changes, but questions whether there is enough help for people finding work. Another issue that must be considered is while it is undoubtedly a good plan to encourage more people to move into work and off benefits, which jobs will they move into? With unemployment still high, now is not exactly the best time to be looking for a job. However, whatever the state of the economy, providing incentives for people to move from benefits into work is definitely a good plan, but of course the methods used will be under constant scrutiny.
Articles
Iain Duncan Smith sets out Welfare Reform Bill plans BBC News (17/2/11)
Bill ditches housing benefit cut The Press Association (17/2/11)
Life on benefits is no longer an option Mail Online, James Chapman (17/2/11)
Universal Credit welfare switch ‘to hit 1.4m homes’ BBC News (12/1/11)
Nick Clegg blocks housing benefit cut for jobless Guardian, Patrick Wintour (17/2/11)
It’s time to end this addiction to benefits Telegraph (17/2/11)
Report
Escaping the Poverty Trap Policy Exchange, Lawrence Kay 2010
Questions
- What is the poverty trap? Which factors make it worse?
- Why does the poverty trap act as a labour supply disincentive for those on benefits?
- If taxes of those in work have to be increased, what happens to their incentive to work more hours? Think about the income and substitution effects of a real wage change.
- Why is it that working may not pay?
- How does the Universal Credit aim to alleviate the poverty trap? Who are likely to be the winners and losers from the government’s proposed welfare reforms?
- What is a marginal-tax-plus-lost-benefit rate? How do you calculate it?
- Are there any other policies that could also reduce the poverty trap? How effective are they likely to be?
With the UK economy borrowing 11% of GDP, it is undeniable that spending cuts are needed. Of course, the big question is should they be occurring now or delayed until the recovery is more stable. However, another question is now being asked. Should taxes be cut to help the worse off? David Cameron says that this is out of the question. While he is a ‘tax-cutting Tory’ who ‘believes in tax cuts’, any significant cuts in taxes specifically aimed at the poor would simply make matters worse, especially as the Coalition government is already helping to move thousands of families out of taxation altogether, albeit by increasing taxes on the better off.
“It’s no good saying we’re going to deal with the deficit by cutting spending, but then we’re going to make things worse again by cutting taxes. I’m afraid it doesn’t add up.”
Those in favour of cutting taxes include John Redwood, the head of the Tory’s economic affairs committee, who argues that they would help to boost the economy, by ‘encouraging the wealth creators and the private sector’. By reducing the burden on residents, disposable income will increase, helping to stimulate consumption and investment, which should in turn boost aggregate demand. This would be a much needed stimulus following the latest data which showed: a shrinking economy once again in the last quarter of 2010, consumer confidence at its lowest level in the past 20 years, the possibility of unstable markets should the government be seen to ‘twitch’ on the austerity drive and 57% in a YouGov poll saying that the cuts are ‘being imposed unfairly’. Public approval for the Coalition’s budget deficit reduction strategy has fallen from 53% in June 2010 to 38% in February 2010. Add to this rising inflation and unemployment and the last thing people want to hear is surely ‘No big tax cuts’.
However, the budget deficit must be tackled: now or later. Whenever it happens and whichever party is in power, spending must be cut and/or tax revenues must rise and everyone will have to play their part.
Cameron: ‘Tax cuts impossible right now’ Sky News (6/2/11)
David Cameron says major tax cuts not possible BBC News (6/2/11)
Cameron vows ‘No to big tax cuts’ The Press Association (6/2/11)
David Cameron: Sorry, but we can’t afford tax cuts Telegraph, Patrick Hennessy (5/2/11)
George Osborne faces Conservative pressure for tax cuts BBC News (1/2/11)
Nick Clegg’s tax cuts will cost £4.3 billion, says IFS Telegraph, James Kirkup (2/2/11)
Doubts mount over Cameron’s austerity drive Associated Press (6/2/11)
Sorry it is so complicated BBC 2, Daily Politics, Stephanie Flanders (14/6/10)
Questions
- What is government borrowing? Who does the government borrow from?
- Analyse the impact of tax cuts on the economy. Think about which groups will be affected the most and in what ways.
- Which components of aggregate demand will be affected by cuts in spending and rising taxes?
- ’Cuts in taxation would boost the economy.’ To what extent do you agree with this statement?
- What will be the impact of tas cuts on the government’s macroeconomic objectives, given your answer to question 3?
- What are the arguments (a) for cutting the budget deficit now and (b) for cutting the budget deficit later?
Two reports released by Incomes Data Services tell dramatically contrasting stories about pay in the UK. One report focuses on average pay in the public and private sectors, which are both likely to fall in real terms in 2011. Most public-sector workers will see a freeze in their wages and, whilst private-sector workers’ pay could rise by an average of 3%, this will still be below the rate of inflation. The press release Pay awards may rise but will trail inflation (6/1/11) to the report stated that:
Private sector pay settlements in 2011 could well be higher than in 2010, as long as the economic recovery remains on track. But following the latest increase in VAT, they are likely to trail inflation, meaning that the cost of living may be set to rise faster than average pay settlements for the second year running.
However, the press release to an earlier report, FTSE-100 bosses see earnings rise 55% (29/10/10), stated that:
FTSE-100 directors saw their total earnings boosted by an average of 55% while across the FTSE 350 as a whole total board pay went up by an average 45%, according to the latest Directors Pay Report, published by Incomes Data Services. (Year to June 2010)
On the back of these increases FTSE 100 chief executives took home £4.9 million on average in total earnings during the year.
Meanwhile, there is continuing public outcry over the levels of bank pay and bonuses. Despite billions of pounds of public money having been poured into banks to prevent their collapse, bank bosses are set to receive huge remuneration packages worth several million pounds in some cases. And, despite being condemned by the government, it seems there is little it can do to curb them.
So what are the causes of the growing income divide between those at the top and everyone else? And what are the economic consequences? The following articles explore the issues.
Articles: IDS reports
Year of pain predicted for workers.. while bosses’ salaries continue to grow Daily Record, Magnus Gardham (7/1/11)
Another 12 months of pay freeze misery for workers… but bosses enjoy a huge 55% salary increase Daily Mail, Becky Barrow (6/1/11)
Private-sector pay set to trail behind inflation People Management, Michelle Stevens (6/1/11)
Private pay deals to lag behind inflation Financial Times, Brian Groom (6/1/11)
UK boardroom pay rises 55% in an age of austerity Guardian, Simon Goodley and Graeme Wearden (29/10/10)
Private sector pay ‘to trail inflation’ in 2011 BBC News (6/1/11)
Staff morale warning over bosses’ pay rises Independent, Jon Smith (6/1/11)
‘Dose of reality’ call over top pay BBC Today Programme, Robert Peston, Brendan Barber and Garry Wilson (6/1/11)
‘Severe squeeze’ on average pay BBC Today Programme, Ken Mulkearn (Editor of the Incomes Data Services pay review) (6/1/11)
UK inflation rate rises to 3.7% BBC News , Ian Pollock (18/1/11)
Articles: bankers’ bonuses
Bank bonuses ‘to run to billions in 2011’ BBC News, (7/1/11)
Cameron says banks ‘should pay smaller bonuses’ BBC News, (9/1/11)
David Cameron warns RBS over bonuses Guardian, (9/1/11)
Banks say ‘no’ to bonus backdown Management Today, Andrew Saunders (7/1/11)
Banks to pay out billions in bonuses BBC News blogs: Peston’s Picks, Robert Peston (6/1/11)
Why government can’t stop big bonus payments BBC News blogs: Peston’s Picks, Robert Peston (7/1/11)
Diamond: ‘I am compelled to pay big bonuses’ BBC News blogs: Peston’s Picks, Robert Peston (11/1/11)
Data
Average Weekly Earnings Incomes Data Services
Questions
- Why are average earnings likely to be less than the rate of inflation in 2011?
- Why were the directors of the FTSE 100 companies paid an average 55% pay increase for the year to October 2010?
- To what extent can marginal productivity theory explain the huge increases of bosses of top companies?
- If remuneration committees base executive pay increases on the average of the top 25% of increases of equivalent people in other companies (to stop ‘poaching’), what will be the implications for executive pay rises over time?
- What market failures are there in determining executive pay?
- What will be the implications for staff morale if their earnings are falling in real terms while their bosses are receiving huge pay increases? Should these implications be taken into account when deciding executive remuneration packages?
- Are shareholders in FTSE 100 companies likely to welcome the pay increases of their top executives? If so, why? If not, why not?
We have covered the issue of bank bonuses in previous blogs. See for example: Banking on bonuses? Not for much longer (November 2009); “We want our money back and we’re going to get it” (President Obama) (January 2010); and Payback time (Updated April 2010). But the issue has not been resolved. Despite public outrage around the world over the behaviour of banks that caused the credit crunch and about banks having to be bailed out with ‘taxpayers money’ and, as a result, people facing tax rises and cuts in public-sector services and jobs, bankers’ pay and bonuses are soaring once more. The individuals who caused the global economic crisis seem immune to the effects of their actions. But are things about to change?
The Committee of European Banking Supervisors (CEBS) has confirmed tough new guidelines on bank bonuses applying to all banks operating in the EU. The CEBS’s prime purpose in recommending restricting bonuses is to reduce the incentive for excessive and dangerous risk taking. As it states in paragraph 1 of the Guidelines on Remuneration Policies and Practices:
Whilst institutions’ remuneration policies were not the direct cause of this crisis, their drawbacks, nonetheless, contributed to its gravity and scale. It was generally recognized that excessive remuneration in the financial sector fuelled a risk appetite that was disproportionate to the loss-absorption capacity of institutions and of the financial sector as a whole.
The guidelines include deferring 40–60% of bonuses for three to five years; paying a maximum of 50% of bonuses in cash (the remainder having to be in shares); setting a maximum bonus level as a percentage of an individual’s basic pay; appointing remuneration committees that are truly independent; publishing the pay and bonuses of all senior managers and ‘risk takers’. Although they are only recommendations, it is expected that bank regulators across the EU will implement them in full.
So will they be effective in curbing the pay and bonuses of top bank staff? Will they curb excessive risk taking? Or will banks simply find ways around the regulations? The following articles discuss these issues
Articles
Bankers’ bonuses to face strict limits in Europe BBC News, Hugh Pym (10/12/10)
Bankers’ bonuses to face strict limits in Europe BBC News (10/12/10)
Europe set to link banking bonuses to basic salaries The Telegraph, Louise Armitstead (10/12/10)
Some bankers may escape EU cash bonus limit moneycontrol.com (India) (11/12/10)
Banks to sidestep bonus crackdown by raising salaries Guardian, Jill Treanor (10/12/10)
Bonuses: When bank jobs pay Guardian (11/12/10)
Bank bonuses (portal page) Financial Times
Committee of European Banking Supervisors (CEBS)
CEBS home page
CEBS has today published its Guidelines on Remuneration Policies and Practices (CP42) CEBS news release (10/12/10)
Guidelines on Remuneration Policies and Practices (10/12/10)
Questions
- What are main objectives of the CEBS guidelines?
- Assess the arguments used by the banking industry in criticising the guidelines.
- In what ways can the banks get around these new regulations (assuming the guidelines are accepted by EU banking regulators)?
- What conditions would have to met for a remuneration committee to be truly independent?
- How likely is it that countries outside the EU will adopt similar regulations? How could they be persuaded to do so?
With government cuts and pay freezes, many people are worried about their future. Against this background it’s little wonder that people are growing increasingly resentful about the soaring pay of bankers and other leaders of major companies – especially when they reflect on the behaviour of top bankers who were largely responsible for the recession in the West and the debt problems that resulted. And the gap between those at the top and workers on average pay just goes on widening. As the final article below states:
The boss who sells Cillit Bang got paid a hefty £92.6m last year, while his counterpart who builds executive homes pocketed £38.4m and a top miner took home £27m. These are not figures from some international football league, but the bosses of Britain’s biggest companies, who received an average 55% pay rise in the year to June. A top FTSE 100 boss now earns £4.9m – 88 times the average worker’s pay.
On 9 November 2010, a high pay commission was launched to investigate the yawning pay gap between top executives and those on average incomes.
As the high pay commission, set up by the thinktank Compass and backed by the Joseph Rowntree charitable trust, begins its year-long analysis into the widening gap between the lowest and highest paid, a Compass poll shows that 99% of people believe that top executives are overpaid.
The commision will seek answers to questions such as the following: Why has the gap widened so massively? What is the role of globalisation in the process? Why has competition not worked to compete top pay down? Why don’t company owners impose more restraint on executive pay? Is there a form of collusion to push executive pay ever higher? Are executives worth it?!
Articles
Let’s make CEOs justify their wages Guardian, Martin O’Neill (19/10/10)
FTSE 100 bosses criticised as boardroom pay leaps by 55% Guardian, Simon Goodley and Graeme Wearden (29/10/11)
Investigation launched into soaring executive pay Guardian, Jill Treanor (9/11/10)
Eighty-five per cent of people say top executives ‘should be paid less’ Telegraph, Ian Cowie (9/11/10)
Top executives paid ‘far too much’ Financial Times, Nicholas Timmins (9/11/10)
A mission to the outer limits of pay Financial Times, Andrew Hill and Esther Bintliff (9/11/10) (first part of article)
Sharing the spoils of business fairly Guardian, Deborah Hargreaves (13/11/10)
The High Pay Commission
The High Pay Commission, home page
Questions
- Desribe what has happened to executive pay of the top companies over recent years.
- How are executive pay packages determined?
- How relevant is marginal productivity theory in explaining executive pay?
- What are the incentive effects of having extremely high pay?
- What scope is there for collusion in determining executive pay?
- Why don’t company owners impose more restraint on executive pay?
- What are the social impacts of excessive executive pay?
- What could the government do to address the problem?