Merlin Weekly Macro: Have Labour painted themselves into a corner?

‘Company’: noun; a body of persons combined or incorporated for some common object, especially to carry on some commercial or industrial undertaking (Shorter Oxford English Dictionary). 

Employer’s NI: well, is it a tax on ‘working people’ or not?

‘Company’: it does what it says on the tin. Sir Keir Starmer believes otherwise. He thinks that the employer and its employees, jointly the ‘company’ as in the definition, are two very different species: he cannot see they are one and the same. That is the only way you can explain why he thinks that raising the employer’s National Insurance Charge (NIC) is not also a tax on the employee. In his mind and his Chancellor’s, employers and employees are separate; they are divorced; they are counterparties. Even though the ‘bosses’ who manage the company are likely also to be employees and are themselves ‘working people’. It is his ‘oppressed workers of the world’ socialist ideology coming to the fore, touching in its almost puerile simplicity were it not so misguided.

He and Rachel Reeves have painted themselves into a corner with their manifesto pledge not to raise the rate of income tax or National Insurance levied on ’working people’. But this insistence that hiking the employer’s NI levy is not also a tax on ‘working people’ is either sophistry and a deceit, or it is an alarming ignorance of what companies do to mitigate against the worst of the financial burden that is imposed upon them. Who says so? No other authorities than the government’s own fiscal watchdog, the Office for Budget Responsibility (OBR), and the independent economic think-tank, the Institute for Fiscal Studies (IFS).

Here is what the OBR makes of employers’ National Insurance: “the tax is passed through entirely to lower real wages in the medium term, with 80% of the increases passed through to workers via lower nominal wages and 20% to consumers via higher prices”.¹ As Allister Heath in the Daily Telegraph concluded, “it is a tax on working people”.

As for the centre-left IFS, they arrived at much the same conclusion: “The economic incidence of the tax must always be on real people. When a tax is paid by businesses, as with employer NICs, it could be felt by the firm’s owners/shareholders (via reduced profits from the business) or could be passed on to the firm’s workers (via lower wages) or could be passed on to the firm’s customers (via higher prices) or suppliers (via lower input prices). In practice, it will almost always be a combination of these. Simple economic theory suggests that the incidence of employer and employee NICs should be the same, at least in the long run. It is likely that the long-run incidence of both employer and employee NICs is predominantly on employees, but the empirical evidence is not clear-cut”.²

Notwithstanding that fingers-crossed caveat at the end (and as above, the OBR suggests in its 80:20 split of the effect that there is empirical evidence), the weight of opinion is that if you load taxes on to businesses, workers carry most of the can: either their real earnings fall as a result and/or the company invests more to automate and reduce the number of increasingly expensive people it needs to employ.

It is being speculated that the means by which the additional employer NIC would be levied is by not only charging the 13.8% on wages (over an initial income threshold) but also levying it on the employer’s pension contributions, making it a charge on the fully-loaded employment cost. It is estimated it could bring in an extra £17bn of revenue to the Treasury in its first full year. However, inevitably the net burden falls entirely on the private sector: in the public sector it is simply recycling tax-payers’ money; it is circular financing in a nil-sum game. Think of it like this: the state is the public sector employer, so the state (here, the Treasury) is asking the state (another government department, e.g. the NHS, or the Ministry of Defence) to pay more NI as an employer which will be recouped by the state (the Treasury again) to pay for higher state expenditure (determined by the Treasury and delegated to the spending departments). You follow?

Pre-Budget theatre

That aside, the briefings and counter-briefings about the Budget over the past few weeks, currently building to a crescendo ahead of Tuesday 22ⁿᵈ October (the last date when the OBR gives the Budget proposals the nod), reflect two key things happening. First, ministers pitching for more funding (e.g. the NHS) and others (e.g. Justice) writing furious letters to Reeves in defence of their departmental budgets potentially being savaged. Second, all the public airings have an element of political and financial necessity to them: they are designed to show that in batting proposals back and forth between the Treasury and the spending departments, there is robust and rigorous discourse. It is also to demonstrate to the markets that the OBR is fully involved so that whatever policies are announced on 30ᵗʰ October, however draconian they might be, the fact that the OBR has given the green light and nothing is a surprise minimises the risk of the markets taking fright.

There is a perversity here as we discussed in last week’s column: it is fine to head towards national penury if it has the OBR’s seal of approval as to how we get there; as was the case two years ago in the Kwasi Kwarteng/Truss debacle, it is unacceptable to end up at the same destination if the OBR has been kept in the dark.

It is completely bewildering that the amount Reeves needs to find is rising almost exponentially day-by-day. It is no exaggeration that it has become a case of pick a number, any number, then double it. First it was £22 billion, the immediate post-election ‘black hole’ and itself a political fabrication; now it is £40 billion, because raising £22 billion would apparently only keep public services where they are. Will this Dutch auction in government spending go higher yet before the books close? What we are witnessing gives very little reassurance that there is a competent, firm hand on the tiller however much Reeves’s much-vaunted position as a former Bank of England economist was supposed to give us confidence she had unimpeachable qualifications to be Chancellor.

Waste not, want not

But while all the focus is on fiscal black holes, raising taxes and wanting to go big on total spend by bending the rules to be able to borrow more, what is not being talked about at all is how efficiently and effectively the money is being spent. Reeves thinks she now needs to find that £40bn discussed above: but look at how much money successive governments have wasted over the years. We published an analysis in February 2022 after Boris announced his War on Waste: it took very little effort to discover waste on a prodigious scale. The numbers are spectacular and frightening.

A cursory analysis of major capital projects and other initiatives spanning only the period in which the Tories were in office from 2010 to that point in early 2022 when Boris was still PM revealed the cost of flawed policy, mispricing, make-believe accounting systems and extensive overruns through bungled execution. Consider the excess costs over the original estimates of such projects as HS2 and Cross Rail; or the costs associated with the redesign of the two new aircraft carriers after the flip/flop decisions about ‘cat & trap’ or V/STOL³ landing and recovery systems; the failure to hedge the foreign exchange risk on the purchase cost of F-35 Lighting II aircraft over Brexit; the Ministry of Defence (MoD) procurement scandals of the Ajax light tank and the dithering over upgrading or replacing Warrior, both armoured warfare systems: it’s not difficult to reach a figure of around £80bn. Add to that the £4.7bn fraudulent claims under the Covid business loan scheme, plus the £37bn spent during Covid on the NHS Track & Trace programme which was never of any proven utility and is now redundant, and the total irrecoverable sunk or excess costs are beyond £120bn. The Tories were in equally bad company: the previous Labour government was forced to concede that on its watch £26bn was wasted on the installation of literally useless government IT systems alone.

At the then prevailing values unadjusted for intervening inflation, £146 billion of sunk, irrecoverable costs, 3.6 times the amount Reeves is trying to square away today. Where is the reassurance that the same profligacy with taxpayer’s money will not be repeated?

Tax & spend

Two years ago new Chancellor Jeremy Hunt talked of ‘eye-wateringly difficult choices’ to be made about the economy and government spending. He ducked all of them until after the election. Reeves and Starmer have talked also about ‘difficult decisions’ and ‘hard, unpopular choices’. There are areas of public service which the government is duty-bound to provide in full: defence; police; the criminal system; a minimum social safety net for the genuinely needy. Here the government has a duty to ensure the money is spent as efficiently as possible and the taxpayer gets maximum value for money (in the case of defence, literally the ‘biggest bang for its buck’). But for virtually everything else, health, old-age care, education, transport, housing and amenities etc, there are a plethora of alternative models of how best to deliver and fund those services. They are political choices. In this first Labour Budget, what should be the one that sets its stamp on the strategic direction for the remainder of the parliament, the new government appears not to want to challenge conventional tropes about how services are provided, let alone embark on full-scale public sector reform which is so obviously required. Instead, its strategy is no more sophisticated than ducking those hard choices while fully blaming all the ills of the world on its predecessors.   

It was not the intention that these musings should become a running commentary on the first Labour Budget since 2010; but Starmer and Reeves seem determined daily to provide more ammunition for us to question what it is they are trying to achieve. Feeling underwhelmed by our new Prime Minister is something we identified well before the election. Starmer has an almost invariable tendency to tell an audience what he thinks they want to hear: to business that he wants the economy to grow, he wants to create wealth, reduce regulation; to the unions and his left wing that there will be more government intervention, greater employment rights and freedoms, better pay and conditions, redistribution of wealth; to the ‘working people’ that he will not tax us more while leaving it unspoken that there are many ways of taking more tax from us despite leaving the rates at which income taxes (including employees’ NI) are charged; to investors that he wants us to open our wallets and join the great revival while simultaneously preparing egregiously to tax the returns and any accumulated wealth arising from taking the risk. It ends up in a web of inconsistencies. From which incoherent and contradictory confections we must try and make some sense.

On which score, at least one element of the fiscal fog is lifting: 30ᵗʰ October is likely to confirm that Keir Starmer’s government is a return to old fashioned Labour ‘tax and spend’. The risk, as Margaret Thatcher said, is that eventually you ‘run out of everyone else’s money’. Today, reflected through government bond yields, the markets remain much more impressed with this week’s welcome half point reduction in UK inflation to 1.7% and below the Bank of England’s 2% target, and preoccupied with whether the Bank will cut half a point off the interest rate by Christmas. That we could be about to embark financially on a long, slow journey to Hell in a handcart seems of little concern. We wait to be pleasantly surprised that it is not the case; we are not holding our breath.

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¹Office for Budget Responsibility, Economic and fiscal outlook, October 2021: CCS1021486854-001_OBR-EFO-October-2021.pdf

²Institute for Fiscal Studies, “National Insurance contributions explained”: National Insurance contributions explained | IFS Taxlab

³V/STOL – Wikipedia