Why has the fall in unemployment led to a FALL in tax receipts?

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October 15, 2014 by Paul Goldsmith

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In a fascinating article for the Times (click here to read), Ed Conway, the economics editor of Sky News, raises some interesting questions about the nature of the reduction in unemployment in the UK. The UK’s labour market performance is seen around the world as nothing short of remarkable. No other country since the start of the financial crisis, when, remember, it was suggestion our unemployment could reach record levels, has seen such a fall in unemployment as we have, nor such a rise in participation ratio (the number of people employed or actively looking for work as a proportion of the population of working age. Yet whilst that is no doubt something to be cheered, what is particularly economically interesting is the affect that this fall in unemployment has had on income tax receipts. You would have expected them to have risen, with so many more people in work. Yet they have in fact fallen. Conway looks at why – and what he finds gives us an important lesson in the effect of low pay.

The clue that there is a problem comes from the fact that the deficit (how much we receive in tax – how much we spend each year) has barely moved in the past year, having fallen from £150bn to £100bn in the first few years of the Coalition. This leaves us with more to do in order to repair our fiscal balance sheet than any major economy bar Japan. The reason we have this problem is because, contrary to what most critics of Chancellor George Osborne’s fiscal policies thought at the start of his campaign to get the deficit down, it has been harder to raise tax revenue than it has been to cut spending.

We should be celebrating the fall in unemployment. Yet it has come on the backs of British workers being willing to put up with the biggest real-terms pay cut since the Victorian era. When you earn less, you pay less tax. When you combine the raising of the personal allowance (the income on which you don’t have to pay tax), with the low pay that these new jobs provide (being, as many are, in retailing, food services and accommodation), you get a fall in income tax receipts of 0.8% over the year, when the Office for Budget Responsibility (OBR) had expected about a 6.5% rise. This is explained by the calculation that the average taxpayer in this country is paying about 33p in every pound of their salaries in tax and national insurance – compared to the expected 36p in the pound. Put simply, those that have found jobs since the recession have overwhelmingly paid less tax or no tax on their income.

Where do we go from here? Well, the prevailing economic orthodoxy was always that less people unemployed means less paid out in benefits and more tax receipts. But such is the low pay in this country that we are getting lower tax receipts AND in-work benefits are having to be paid (over £12 billion of them a year). The Conservatives in particular are unwilling to address the causes of the problem (the low pay) nor the symptoms (that they probably need to tax land and assets more to make up for the fall in income tax receipts). But they will need to..and soon.

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4 thoughts on “Why has the fall in unemployment led to a FALL in tax receipts?

  1. MH says:

    While i agree that this is a strange trend and one that should not be expected, I think a bit of patience is needed with the recovery. As you mentioned, the expectations were record low levels of unemployment, not increasing participation ratios and such a fall in the unemployment figures. I think this trend has come about due to the desperation of the situation and people should be commended for being willing to go out and take a substantial pay cut on their pre-recession wages perhaps instead of staying at home and watching the recession take its course and accept unemployment benefits, which is definitely the easier option. I appreciate that those in work may still be getting benefits but i assume those are less than if people were getting them unemployed. As for the reason for the low pay, it could be a bit of exploitation from the firms of the situation, or it could just be that at this moment of time that is what they can offer to start picking up again, and that is what this low-paid employment has done, kept the economy ticking over instead of completely crashing. It must be frustrating to not get the rise in employment accompanied with the other expected benefits such as the increased tax receipts, however i think the underlying reason for this shows that the economy is heading in the right direction and faster than expected. Further down the line, as firms are more confident, and employees are more stable and demand more perhaps or the labour market tightens as the economy grows, tax receipts should rise and this problem should be overcome.

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  2. Oh it’s possible all right. But it doesn’t mean it will happen. The minimum wage is becoming almost the default wage now – with companies who should need to pay a higher wage just paying the minimum wage and still getting people in to work for them (partly because if no UK worker will do it, an immigrant will).

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