I think it’s fair to say that most of us (who are not self-employed) do not pay income tax or national insurance personally. That’s because our employers transfer money to us through the PAYE system and simultaneously they transfer money to the government, as ‘income tax’ and ‘national insurance’, notionally on our behalf. But in effect what they’re doing is simply paying a levy to the government and leaving us with the amount of money that will persuade us to work for them.
I know it’s conventional to pretend that employers are making these payments on our behalf (us, the workers they employ). But it’s not the way we ourselves think about it really. In reality we all have what you might call ‘rational expectations’: we all make judgements about wages and salaries based on ‘take-home pay’; we all take decisions about offers of work after making allowance for ‘stoppages’. And certainly everybody recognises (in the light of numerous broadcast documentaries and News-items) that unemployed people evaluate offers of work in relation to post-tax earnings vis-à-vis out-of-work benefits.
This system of taxation, in which levies are paid to governments by employers notionally ‘on behalf of’ the workers they employ, operates across the economically developed world. Reviewing the way in which these levies are presented is quite interesting. The cost of making payments of income tax and social security contributions (national insurance) is expressed by the OECD as a ‘tax wedge’: the proportion of the total cost of employing workers that is accounted for by making such payments (i.e. both those that are being made notionally ‘on behalf of’ their workers - as ‘income tax’ or social insurance ‘contributions’ – and those made as explicit payments by employers qua employers).
Figures in the table below illustrate the size of this tax
wedge in various comparable North-West European countries. You can see that it
varies quite widely: ranging from 26.6% in Ireland to 55.8% in Belgium. The UK
(31.48%) is towards the lower end of the range.
The last two columns in the table illustrate what happens if the whole amount of employment cost (‘the tax wedge’) is expressed as a transactions tax (like VAT) explicitly levied on purchases of labour. These figures show that human resources are taxed more heavily than the general run of purchased inputs (taxed by VAT) in most of the countries considered here (though it’s fair to say that some specific inputs, such as energy, attract special supplementary purchase/transaction taxes). This is appropriate because the employment of workers is the best available indicator of the level of pressure on the country’s infrastructure resulting from the operation of any particular business (i.e. the tax levied on payments to employees is a proxy for costing the use of the infrastructure as a business input; it stands in for an explicit rent, payable for the use of the infrastructure).
It should be apparent from these data that the implicit transactions tax cost of employing workers in the UK is very competitive (i.e. low) compared with that in other North-West European countries. This suggests that there could be scope for an increase in this tax-rate without the prospect of damaging the country’s competitive position internationally. In fact an increase in the UK’s implicit employment transactions tax rate (and with the increase explicitly imposed on employers rather than workers), so that overall it was raised from 45.94% to nearer the Dutch level (58.58%), might be expected largely to eliminate the budget deficit.