Cameron's tax con

The Tories’ call for tax breaks to employers is a scam. A fiddle. A con. A fraud.
They propose that firms who take on a worker who has been unemployed for over three months be given a credit against national  insurance contributions. This will be £2500 for a full-time worker, and less for a part-timer. They claim this will create 350,000 new jobs, and that the plan will pay for itself in savings on unemployment benefit.
Nonsense.
What this ignores is the enormous deadweight cost of the plan. Hundreds of thousands of jobs are created every year even in declining industries or in recessions (pdf). By the Tories own figures (pdf), 1.5 million people unemployed over three months left the unemployment  count in the 1991 recession. And in September this year - a month which saw the biggest rise in net unemployment since 1992 - 227,400 left the count*.
This huge job creation means the Tories’ plan merely gives taxpayers’ money to employers for doing what they would do anyway. That’s not revenue neutral.
Of course, if this plan were implemented the Tories could no doubt point to tens of thousands of claims for the tax credit. But these claims would consist main of jobs created anyway, not of jobs created by the plan.
Granted, the plan will genuinely create some jobs, insofar as it lowers the cost of hiring workers. The extent to which it will do so depends upon the price elasticity of demand for labour.
But we know this is low. This is because the national minimum wage has not priced many workers out of jobs. Some, yes. But not many.
And here the Tories have form for exaggerating the price elasticity of demand for labour. Back in 1991 Michael Howard claimed that a minimum wage would destroy two million jobs. He over-estimated the response of labour demand to prices. Cameron is doing the same thing.
This said, there is one way in which this idea might create jobs, maybe many.  Remember there are tens of thousands of firms which expand even in recession**.
Put yourself in the position of an employer in one of these. You can expand in one of two ways - by increasing the hours of existing workers, or by taking on new staff. At the margin, Cameron’s plan encourages you to do the latter.
This might create lots of jobs. But it does so by depriving existing employees of the chance to work longer hours and earn more.
Now, this might be a good thing in one sense. The unemployed are much less happy than the employed. So getting them into work, even at the expense of others being less able to work longer hours, is a net gain in well-being.
What it is not, however, is revenue-neutral. If someone finds work only because others work shorter hours than they otherwise would, the benefit to the tax-payer is nugatory - and maybe negative depending upon the individuals concerned***. This is because the Exchequer loses the tax revenues it would have got, had existing workers worked longer hours. Add the employers' NIC credit to this and the tax-payer loses. (This is not the only way in which the plan is costly: Hopi describes another.)
Cameron’s plan is, then, a con. It’s a hand-out to bosses at the expense of tax-payers and low-wage workers.
* Table 10 of this pdf. Not all these went into work by any means. But many do. 
** Table 3.1 of this book shows that in the 1989-91 recession half of all firms actually increased employment and that 85% of the job losses in the 1989-91 downturn occurred in just 10% of firms.
*** Cameron claims, following David Freud, that the tax-payer gains £8100 net if someone moves from JSA to work over 12 months. But this estimate depends a lot upon who it is that moves. For example, if someone from a married couple with two children moves into a 30-hour job on the minimum wage, the taxpayer gains only £100 a week - £5200 a year - as it pays child tax and working tax credits. The gains from a single person moving are greater, as he gets no tax credits. But the gains from a lone parent moving are smaller. And these estimates assume a job is created, rather than carved out from other workers working fewer hours.

Comments

[Diversity]

Looks even worse than I thought it was.

Why do the LibDems seem to have all the best economic ideas?

[Matthew Sinclair]

I'm no fan of the Tory proposals, we'll have a TPA response out soon, but doesn't there empirical evidence (I agree it isn't exactly bullet proof but it is there) provide something of an answer to your point. I.e. they've got studies that say it will be roughly a third of those paid are genuine additional jobs which is why their payment (just under a third of the cost of keeping someone on unemployment benefit) will make the scheme revenue neutral.

I'm not saying this is a particularly strong argument but I think you need to tackle it to complete your argument.

[Nick Cohen]

Oh God does this mean we've got to vote for that scoundrel Brown?

[chris]

Thanks, Matthew. Let's do a back of the envelope sum. According to this, there are 2.76m jobs created each year normally.
http://research.nottingham.ac.uk/Newsreviews/newsDisplay.aspx?id=306
Let's assume, generously, that this won't fall in recession. And let's assume each job costs the employer, on average £25,000 - including tax and NIC - so the tax credit cuts the cost of hiring someone by 10%.
If the price elasticity of demand for labour is 0.6, then the number of jobs created is: 0.6 x 0.1 x 2.76 = 0.166 million.
This is less than half Cameron's claim.
If you want to argue for a higher price elasticity, you run into the question: why hasn't the minimum wage cost more jobs?
If you want to argue that the credit is more generous, then the jobs created are low wage ones which generate little net tax revenue for the exchequer.
And if you want to argue that "background" job creation is greater, then the deadweight cost of the plan - a tax break for jobs that'll be created anyway - is high.

[passer by]

bloody hell, politician playing politics, whatever next?

[Matthew Sinclair]

Chris,

Excellent. I wasn't really disagreeing with you, just thought that addressing that point would complete your - very powerful - argument. I'd upgrade that back of the envelope sum to an update in the post itself or a new post.

Matt

[diogenes1960]

any chance of a re-look at your exchange rate posting - re how sterling had not lost value against the Euro?

[Bob B]

Compare and contrast:

"It was another former Tory Prime Minister, Sir Edward Heath, who in 1988 described Nigel Lawson as 'in golfing terms…a one-club man', meaning that the then Chancellor was only prepared to use interest rates to influence the economy.

"Mr Cameron exposed himself to the same charge, levelled by Gary Gibbon of Channel 4 News, by declaring: 'The best stimulus we need is monetary policy.'"
http://www.telegraph.co.uk/news/newstopics/politics/3441645/In-place-of-a-spending-splurge-a-bacon-sandwich.html

However:

"Banks and building societies have quietly increased the costs for new borrowers to profit from sharp reductions in the Bank of England base rate."
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/3442324/Borrowers-taking-out-popular-mortgages-paying-highest-rates-in-seven-years.html

As Hegel put it: "What experience and history teach is this – that people and governments never have learned anything from history, or acted on principles deduced from it." [Philosophy of History]

[john b]

"re-look at your exchange rate posting - re how sterling had not lost value against the Euro?"

Still negligible: rate is 1.2ish now, 1.2ish last February. Next?

[Alex]

Another problem; the Tories want to restrict it to companies *where nobody has been laid off yet*. For one thing, this is likely to be quite a limited number of firms. For another, only a Tory would suggest helping only those firms that don't need it.

Also, why the hell are Tories trying to bribe industry to hoard labour? Shouldn't they be encouraging them to sack everyone, thus pushing down wage costs until the market clears? What happened to their principles?

[jameshigham]

This might create lots of jobs. But it does so by depriving existing employees of the chance to work longer hours and earn more.

Yes but that is the eternal dilemma of the employer, Chris.

[Bob B]

Try the leader in Wednesday's FT:

" . . Although the opposition Conservatives show they understand the need for a plan to repair the public finances, their short-term proposals for dealing with the downturn are paltry. Should the government go ahead with a fiscal stimulus at the pre-Budget report, expected this month, it must do better. . "
http://www.ft.com/cms/s/0/db19e6d4-b029-11dd-a795-0000779fd18c.html

[Jon]

Question from a (very) amateur economist:

Is the absence of a rise in unemployment following the introduction of the NMW in itself evidence that the PED of labour is low? Could it not be the case that the NMW had a substantially depressive effect on demand which was offset by the growth in the economy?

[Monevator]

Also, what's the hidden cost to productivity of specifically rewarding the taking on of workers who've been unemployed for *over three months*?

Surely the best employees will go fastest to the better, leaner employers, who will get no rebate?

Distortion! That three-month hurdle, while sounding morally appropriate, could effectively be a subsidy to the less efficient, less attractive employers. Though perhaps if they can all be consolidated away when the boom times return it's not the end of the world...

[Bill Quango mp]

Re minimum wage. The latest figures are that the young are the first out the door. Keep the experienced on and let the know nuffin' go.All labour now priced the same.

And the real scandal is a NATIONAL minimum wage. Who benefits the most from the inequalities in prices across the UK. A teenager in Guildford or a teenager in Blackpool?
The minimum wage was a goodish idea that hasn't done too much harm, but it was always for the client voter base.

[Bob B]

Re: the recommended blogging on: The End of Macroeconomics
http://www.turbulenceahead.com/2008/11/end-of-macroeconomics.html

It makes one very telling point. These repeating promises by governments and monetary authorities to do whatever it takes and apply unspecified actions in the future to avert a long and deep recession - or a deflationary spiral of falling prices - are generating uncertainty for business - and especially for financial institutions - where managers can't assess whether to act now or wait until some more beneficial support from government will be forthcoming in future.

[Charlieman]

I don't understand whether there actually is an incentive for employers to give somebody a job. Taking on any employee during at any time carries risk, and the incentive here is £2,500.

If the job creation costs the employee £2,000 in training, equipment etc after labour value, the return for that job is £500. That sort of return is not worth the risk. If there is no or little cost to creating a job, employer risk is reduced and the return may be the full £2,500 or a bit more. Even so, the return per employee suggests that the company is not particularly profitable and is financially vulnerable.

In the best case, an employer will take on a subsidised employee knowing that the job will create a return of, say, £7,500 in the first year. But that job would have been created anyway.

Tesco has a pre-tax return per employee of about £10,000 per annum (2006) -- the figures that I have seen are unclear whether these are full time employees or equivalents. I daresay that Tesco will employ subsidised workers, but are jobs being created?

[Bob B]

"I daresay that Tesco will employ subsidised workers, but are jobs being created?"

Quite so - although I believe the proposed £2,500 job subsidy is intended only for SMEs when taking on new employees who have been out of work for at least the previous 3 months. Even so, that doesn't deal with S&M's criticism relating to the large turnover of labour that continues during recessions anyway so much of the subsidy would be deadweight and wasted.

Btw did any blog surfers notice this by Andrew Grice?

"Until recently, you could hardly bump into a Labour MP without being told that Gordon Brown's days as Prime Minister were numbered. Now he is safe, the boot is on the other foot. Tory MPs speak of little else than whether George Osborne will keep his post as shadow Chancellor. He is judged to have had a bad economic war and to have lost the mad battle of Corfu he waged against Lord Mandelson by revealing what he said about Brown at their private dinner there in August."
http://blogs.independent.co.uk/independent/2008/11/today-in-poli-7.html

[Glenn]

years of research by the Uni. of Warwick's Institute for Employment Research points to evidence that 80% of job openings are to replace workers who retire or leave the workforce permanently (migrate, have babies, die, etc).

Its a complete myth that growth creates all the jobs. Replacement demand accounts for the vast bulk. That's why there's still a demand for new employees and entrants in seemingly declining industries.

[Bob B]

Poor George Osborne - I wonder who the next shadow Chancellor will be? John Redwood?

George's problem is that he's not an economist - unlike, say, Vince Cable - so he's pressed into synthesing a policy position from what Conservative Big Beasts and think-tanks say and the outpourings on Conservative Home, some of which are unhinged.

Nigel Lawson thinks: "fiscal stimulus bad, only monetary policy goood."

Unfortunately, some of us are sufficiently ancient to recall his resignation as Chancellor of the Exchequer in October 1990 leaving us with the unsustainable boom of the late 1980s.

His successor as Chancellor, John Major, promptly joined up Sterling to the European Exchange Rate Mechanism (ERM) with - let it be noticed - Gordon Brown cheering that on. Interest rates were duly hiked to rein back the unsustainable boom and to keep the Sterling exchange rate within the bounds required by the ERM.

Even so, Sterling crashed out of the ERM in September 1992 because of speculative pressures in foreign exchange markets. Meanwhile, John Major had become PM and Norman Lamont, who was then Chancellor, had to carry the can for a failing policy he had inherited. Kenneth Clarke took on the Chancellorship - and he wanted to take Britain into the Eurozone despite all the warnings of Walter Eltis, who was Michael Heseltine's economic adviser.

For all the enthusiasm expressed about joining the Euro - think of those lovely low mortgage interest rates and what those would have done for Britain's house-price bubble - there doesn't appear to be much lingering enthusiam now for joining the Euro.

Hazel Blears might note there are good reasons for the mounting cynicism about politicians.

[Matthew]

there doesn't appear to be much lingering enthusiam now for joining the Euro.

Really? I'd say enthusiam for joining the euro amongs, shall we say 'opinion formers', is at the highest it has been for about 10 years

[Bob B]

Matt: "I'd say enthusiam for joining the euro amongs, shall we say 'opinion formers', is at the highest it has been for about 10 years"

All I can say is that the Euro joining lobby maintains a low profile in the economics and financial media I read - like The Economist and the FT.

All the old fundamental issues remain unresolved:

At what exchange rate would Britain join and by what route?

When the Eurozone joining route was last officially raised, the EU Commission was insisting on applying the terms of the Maastricht Treaty (1992), namely that Sterling would have to rejoin the European Exchange Rate Mechanism (ERM) and remain in it for at least two years while maintaining a stable exchange rate prior to joining the Eurozone. That would leave Sterling vulnerable to the same kind of speculative pressures as in September 1992, possibly bringing the need for corresponding hikes in interest rates in future. Indeed, the present remit to the Bank of England to use monetary policy to target an official inflation rate would have to be abandoned. The UK would lose national autonomy of monetary policy on joining the Eurozone.

Having supposedly overcome the above problem - there is still the question of the consequences that would flow from having to live with the base interest rate set by the European Central Bank (ECB) to maintain an inflation target focused on the average price level across the Eurozone as defined by the (Harmonised) CPI for the Eurozone - which, incidentally, doesn't include house prices, unlike Britain's old RPI.

Since the launch of the Euro at 1 January 1999, interest rates in the Eurozone have been lower than interest rates set by the Monetary Policy Committee of the BoE to maintain a UK inflation target. What would lower ECB interest rates have done for the house-price bubble in Britain? Presumably, the government's fiscal stance would have had to have been significantly tighter - by hiking taxes or cutting public spending - so as to rein in the bubble.

The devil is in the detail.

[Matthew]

Bob, you talk as if no country use the euro.

[Bob B]

Matt: "Bob, you talk as if no country use the euro."

Perhaps predictably, that comment simply avoids resolving the fundamental issues raised above.

If you check back on FT sources, you'll find that only Luxembourg met the Maastricht entry criteria for joining the Euro.

This from a Google search seemed boringly topical until I noticed the date of the report: 7 June 2001:

"Sterling tumbled to a 15-year low against the dollar and fell against the euro amid speculation that Labour will use a landslide victory today to push for early entry into the single currency."
http://www.independent.co.uk/news/business/news/pound-at-15year-low-against-dollar-on-speculation-of-early-euro-entry-673081.html

Compare the UK's economic performance up to last year with that of the Eurozone. Spain and Ireland in the Eurozone have virtually as bad house-price bubbles as the UK through their loss of national autonomy in monetary policy. Since the final quarter of 1995, Britain has had lower unemployment rates and higher employment rates of working age people than the other major European economies.

The UK's present troubles are not because of being outside the Eurozone but because the government ignored explicit warnings from economists going back to 2000 and 2002 of the growing house-price bubble and - to cut a complex story short - because the UK banks had incentive systems which rewarded the making of deals and trades regardless of whether the deals and trades turned sour downstream - a classic principal-agent problem - and because of high leveraging by the banks through loans from the wholesale money markets.

Btw as for all the toxic debt, back in 2003, Warren Buffett was warning that financial derivatives could become a "mega-catastrophic risk" for the economy.
http://news.bbc.co.uk/1/hi/business/2817995.stm

[John R]

It's handy that you can just recycle this blog as a response Gordon Brown's recent policy announcement of a £2,500 incentive payment to employers who hire someone who has been unemployed for 6 months or more.

Who says the Government is short of ideas....?