Taxes and pension contributions are squeezing workers’ pay

Allister Heath

IT WAS meant to be one of the most basic rules of economics: the more people produce, the more they get paid. It is a long-standing, near-universal relationship that helps to explain why some jobs are so much more lucrative than others.

But in recent years many have argued that the link has broken down, and that a combination of globalisation and technological change has led to wages falling behind productivity growth in the West. This shift was never thought to have happened in every industry – footballers’ growing wages continue to match clubs’ increasing revenues per player, for example – but on average the data has seemed to highlight some worrying going-ons in the labour market.

If wages no longer follow productivity, it would mean that the cost of living crisis is structural, rather than cyclical, and thus very tricky to resolve. It would also imply a rebalancing between capital and labour, after a few good decades for the latter, and that wages will in future account for a smaller share of the economic pie.

Yet none of this is true when it comes to the UK, according to a fascinating analysis from the Treasury. Its key point is that “pay” has been mismeasured. What matters is total employee compensation – wages, bonuses, benefits in kind and employer social contributions, including pension costs and employer national insurance (NICs). The latter is the one that is most often omitted: in economic terms, all NICs, not just the so-called “employee” element, are borne by workers. If “employers’” NICs were abolished tomorrow, wages would increase to compensate; the market rate for workers is their total cost to their employers, not just their actual wages. Employers’ NICs are a tax on labour, not a tax on capital, in exactly the same way as income tax or employees’ NICS.

So what exactly is happening? It turns out that when measured properly, total compensation has moved in line with productivity over the past two decades; since the crisis, the share of output going to employees has actually increased, not gone down, demolishing the received wisdom.

A separate paper by Joao Paulo Pessoa and John Van Reenen which examines changes in compensation, earnings and productivity over the last four decades also “found no evidence of net decoupling in the UK over the 1972-2010 period as a whole.”

Taking a base of 100 for 2000, the Treasury estimates productivity per worker has shot up from 78.9 in 1992 to 116.1 in 2007, falling to 110 today. Real compensation per worker rose from 81.7 to 110 at the height of the boom and has now hit 113.9. The overall relationship hasn’t changed; but a growing wedge has emerged between wages and total compensation: the gap increased from zero in 2000 (the base year) to 5.4 per cent this year.

So yes, real wages have diverged from productivity, but the reason is that a growing chunk of what workers have been earning is now being paid out in the form of employers’ social contributions. The proportion of compensation that went to these non-wage benefits increased from 13 per cent in 2000 to 17.2 per cent in 2012, driven by higher pension contributions and a stealthy hike in employer NICs.

Regulations were changed, leading to employers having to divert more cash into pension schemes, not least because of Scheme Specific Funding in 2005 and FRS17 in 2001. People have been living longer, private sector defined benefit schemes have shut to new members and bond yields have collapsed, all forcing employers to allocate more money – and hence a greater share of the wage bill – into pension pots. So there you have it: if the Treasury numbers stack up, the biggest reason for subdued pay in recent years – apart, of course, from a horrible drop in productivity – is higher taxes and pension contributions. It’s worrying – but certainly not as existentially so as most of us had feared.
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