Cut taxes or spend more? Tackling unemployment at next month’s Budget

Blog posts

4 Jun 2020

Tony Wilson

Tony Wilson, Institute Director

If the March Budget was about responding to this crisis, the recently trailed emergency Budget in July will be all about how we support the recovery.  The centrepiece will be measures to boost job creation – through cuts to employer National Insurance, major new investment programmes or both.  So what should the Chancellor do and what impact might it have?

The first point to make is that we are in the middle of an unemployment crisis that is greater than any that we have experienced, and this is going to get worse.  I won’t reprise all of the statistics again, but unemployment is almost certainly the highest that it has ever been – higher even than the Great Depression – and as the Job Retention Scheme starts to unwind in August it may well reach levels that would have been unimaginable until a few months ago.

This is being driven by a collapse in demand due to the direct impacts of the virus, but with changes in the ‘real’ economy too – including weak business and consumer confidence, and likely lasting changes in demand in sectors like hospitality, high street retail, transport, the arts and higher education.  And our analysis of online vacancy data shows that hiring is still not recovering – with new vacancies running at just a quarter of their levels of a year ago.

So the government is right to be looking at how it can stimulate demand, in the next 3-6 months at least.  In the longer term, the picture is far less clear but there are some reasons for cautious optimism: we don’t have a ‘credit crunch’ as we had in 2008-9; household incomes have held up, thanks to the Job Retention Scheme in particular (leading to the largest pay-down of household debt in memory); and government has been at pains to rule out any return to austerity.  If we can suppress the virus, and if we can avoid a crash-out Brexit, then there’s every chance that we could see a strong recovery in demand next year.  But clearly, there is a lot of uncertainty – and some still worryingly large ‘ifs’ – in there.

If we want to address a gap in demand over the next six months then, top of the list at the Treasury will be doing something about employer National Insurance Contributions.  These are the single largest non-wage labour cost that employers face – a tax of 13.8% on earnings above £8,788 a year, which adds around £2,400 to the cost of employing someone on an average wage.  Reducing non-wage labour costs can have a short-term, if often modest, positive impact on demand (for a useful summary see this review published by Eurofound in 2017). However, National Insurance also raised about £140 billion last year with about half of this coming from Employer NICs, so any reduction will be costly.

Infrastructure investment and green jobs, the other part of the government’s trailed jobs plan, will unfortunately do nothing for demand in the short term.  The lead-in time for projects is always more than a few months (and is usually measured in years), and in this crisis the huge disruption to labour and supply chains, as well as the challenges with making workplaces and construction sites safe, will further delay things.  That being said there is a near-universal wide consensus that we should take this opportunity to upgrade our infrastructure and green our economy, but the benefits of that will be felt over the coming years not the next few months.

On employer NICs, then, the best way to reduce costs for employers would be to raise the threshold at which they start being paid.  Raising this to £18,000 for example, would mean no employer NICs for anyone on a minimum wage and would halve the cost for those on a median wage.  The government then faces two big choices in how it designs any stimulus, both related to how any relief is targeted.

The first choice will be whether to reduce employer NICs for existing and new employees, or just for new hires.  Doing the former is of course more costly, but would mean that all employers would get an immediate cash stimulus.  Much of this would likely be used to repair balance sheets, but part of any stimulus would support more hiring.  The latter course – restricting to new hires – would particularly reward those with higher turnover or those who intend to recruit and could recruit more.

This choice is probably best illustrated by thinking about our own places of work.  For example at IES, my NICs bill is about £150,000 a year.  If it were half that amount then we would likely use part of that saving to recruit (or recruit sooner).  On the other hand, a reduction for new hires only would not make any difference to our ability to recruit now (but of course would save us money in future).

However the killer argument for reducing NICs in the short term for existing rather than new employees isn’t about employers like us, it’s about those looking at making redundancies when the Job Retention Scheme comes to an end.  Reducing NICs for existing staff would almost certainly have a bigger impact on employment retention – and in fact restricting it to new hires would have the perverse effect of incentivising employers to lay people off and hire (or re-hire) to access the subsidy.

The second big choice for government is whether and how to target any NICs cut at particular groups.  Here the evidence suggests that targeted measures are generally more impactful (and cheaper) than non-targeted ones, but of course have lower take-up.  One simple way to target would be to reduce or waive NICs for young people, as young people are particularly affected by recessions and are more likely to be off on furlough.  NICs were effectively zeroed for under-21s in 2015, but unfortunately there is no evaluation of the impact of that change.  However there is pretty compelling evidence from Swedish reforms between 2007 and 2015, when payroll taxes for young people were halved, leading to an increase in employment of 2-3 percentage points (as a proportion of the workforce).

Other groups could also be targeted, and/ or government could focus right in on those groups least likely to enter work like the long-term unemployed.  However the more that you target, the lower the take-up, and the more this shifts from being a demand side stimulus to a supply side measure to tilt the scales for specific groups.  As you would expect me to say, we need a lot of supply side measures to tilt the scales (see the Help Wanted paper) but hiring subsidies would be near the bottom of the list of priorities, and the evidence on this is explored in an annex to that paper. 

So I would argue that government should reduce NICs for existing staff and not just new hires, that we should do it by raising the threshold, and we should err on the size of big but short-term stimulus – for example, a six month stimulus to raise the threshold to the level of the Personal Allowance for all (£12,500) and to waive NICs entirely for those aged under 30. 

What impact could this have?  Clearly, this depends on how responsive (or elastic) employer demand is to changes in their costs.  Plausibly, for employers using the JRS quite a large part of any saving could feed through into increased retention in the short term; although the impacts on new hiring are likely to be more modest.  But even if the effect was at the lower end of those found in Sweden (2 percentage points of the workforce), then that would be equivalent to 700 thousand fewer people unemployed, or 90 thousand fewer young people.  To put this another way, this could be the difference between unemployment of 3.3 million instead of 4 million, or youth unemployment of 1.4 million instead of 1.5 million.

And this brings me to my final point.  Short run demand stimulus can make an important contribution to addressing this crisis, but it cannot be all of the response.  Even more important is what we do on supply – to ensure that unemployed people are getting the help that they need to fill the hundreds of thousands of new jobs being created every month even now, and what will be over a million new jobs each month during the recovery.  I set out on Monday some immediate priorities for how this could be done quickly, building on the Help Wanted report and will write more next week on what this means for the Budget.  

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Any views expressed are those of the author and not necessarily those of the Institute as a whole.