Taxation and Jobs

23feb98: Professor Kim Swales1: Employment friendly VAT.

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Governments can influence employment levels with an appropriate tax and subsidy system.

The policy we have considered involves a fixed labour subsidy per worker, equal to 5% of the average wage, financed by an increase in VAT. This tax/subsidy scheme works by pricing workers into jobs and increasing the incentive to work. The scheme stimualtes the low paid the most so the policy has favourable distribution effect. Savings on unemployment benefits reinforce the policy.

Governments are concerned about the overall level of taxation and question the desirability of automatic subsidies. However, the type of subsidy and tax plan outlined could be operated as an integrated tax scheme in which the change in the firm's tax is calculated as the difference between the additional VAT and the per capita subsidy. As the scheme increases employment, and so reduces the cost of unemployment benefit, there is a reduction in overall tax. So the introduction of this scheme would simultaneously increase employment and reduce taxation.

There is an increased faith in "market forces" and a desire to reduce subsidies that artificially maintain inefficient or inappropriate industries. However, where there are high levels of structural unemployment amongst primarily low skilled workers, long-term labour subsidies should be considered. Such subsidies improve productive efficiency by offsetting market failures in other parts of the economy. They restore, rather than distort, appropriate price signals. They do not rob the private sector of resources but reallocate resources within that sector. Such subsidies generate an expansion, not contraction, of private sector economic activity.

If such subsidies can be packaged as tax rebates there we have a simultaneous fall in taxation and increase in employment.

(Precis of the summary of a report to DG5)

1Fraser of Allander Institute, University of Strathclyde

24feb98:David Chapman: Reforming the tax and benefit system to reduce unemployment

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Reforming the Tax and Benefit System to Reduce Unemployment

David Chapman

25 February 1998


Two reforms are proposed. The first is to modify the tax system so that it produces a labour subsidy, but without cost in terms of extra tax. This is done by simply making the employers responsible for paying each worker's income tax and employEE's national insurance contributions, in just the same way as they now pay the employER's NI contributions. Thus the employers will in effect be receiving a subsidy per worker equal to the value of one person's allowances on income tax and national insurance, that is, a subsidy probably of about 35 per week This subsidy provides a strong incentive for employers to spread whatever work is available among a greater number of workers, that is, to employ the unemployed. Thus the reform will increase not only the total number of workers employed, but also the SECURITY of employment, for those workers who are already employed.

The other reform is a new type of Earned Income Tax Credit, referred to as the Work-Related Benefit scheme, which is designed to give a better deal to the lowest earners, but in such a way as to avoid creating more of an unemployment trap or a poverty trap. A person who earns a low amount per hour, is given a benefit per HOUR OF WORK DONE, let us say up to 20 hours per week. The lower is the hourly wage, the greater is the amount of benefit given per hour. If the person does more than 20 hours of work, this benefit is withdrawn, but at a lower rate, the lower is the hourly wage. With a very low hourly wage, there is no withdrawal at all, and the person keeps the whole of any extra earnings which they make.

The WRB thus enables the low-paid to obtain both a guaranteed minimum income per hour of work, and a guaranteed minimum income per week. As compared with a standard EITC, the WRB allows a higher AVERAGE withdrawal rate to be used, without trapping the poorest into their poverty. Because of this better targeting of benefit, and because of the saving due to its greater reduction in the number of unemployed, the WRB scheme is likely to be less expensive than a standard EITC, providing a greater guaranteed minimum income, for any given welfare budget.

The two reforms are independent of each other--either could be used alone, or they could be used together, for maximum impact on unemployment.

David Chapman
Democracy Design Forum

03mar98: Chris Hewitt: IPPR's Green Tax Reform package

In 1996, IPPR proposed the following set of changes to the UK tax system over a period of eight years. The proposals were modelled by Cambridge Econometrics and the results are summarised below. Full details of the proposal are in the book Green Tax Reform, by Stephen Tindale and Gerald Holtham.

The package is fiscally neutral and modelled between 1997-2005. Main elements are:

  • a commercial and industrial energy tax, applied to all forms of energy at the point of end use, excluding household consumption. The rate would be $1 per barrel of oil equivalent in 1997, rising to $9 in 2005.
  • a waste disposal tax, levied at 7/tonne in 1997 for landfill and 2/tonne for inert waste landfill and incineration. Each would increase by 2/tonne per year so in 2005 the rates would be 25 and 18/tonne.
  • an increase road fuel duties by 8% per year.
  • a tax on quarrying, levied at 1/tonne in 1997, rising to 9/tonne in 2005.
  • a non-residential parking tax levied at 1 per week per space, rising to 8 in 2005
  • removal of company car tax perks, not a new tax simply a one-off reform of current system
The revenues produced are recycled in two scenarios:

Scenario A - The Economists' Package All revenues are used to reduce employer's National Insurance Contributions. Rates would be reduced by 1.3% in 1997 and by 6.9% in 2005. Scenario B - The Politicians' Package This scenario is designed to make the reforms more popular by reducing three taxes:
  • reduce VAT by 0.2% in 1997, finishing up with a cut of 1.7% in 2005.
  • reduce business rates by 3%
  • this still leaves room for employers' NICs to fall by 4.5 % by 2005.
Modelling Results

CO2 emissions would fall by 9.5% more than the base case. The main reductions are in road transport (19%), iron & steel (18%) and chemicals (12%). Waste production falls by 16% in 2005.

The main economic impact is the creation of 717,000 new jobs by 2005, two-thirds of which are full-time. Job creation is less using the 'Politicians' Package' but still 576,000 jobs are produced. GDP and inflation remain virtually unchanged in both scenarios.

How does this relate to the current debate on green taxes?

The package which we modelled is not necessarily the only way to design green tax reform and any such reform would probably need accompanying measures to make it politically feasible. In particular, there are concerns that increasing road fuel duty is regressive in rural areas and policies would be needed to address those concerns. Similarly there is a small section of industry who could suffer losses in competitiveness from an industrial energy tax. These energy intensive industries may need special treatment to help them adapt to a green economy. IPPR is currently undertaking work in both of these areas.

At the time of writing , the government is reviewing the landfill tax and consulting on the case for an aggregates tax. The Budget may will develop the Treasury position on each of these green taxes. Company car taxation and non-residential parking taxes are also under discussion as part of the integrated transport policy review. A White Paper is due in May.

25feb98a: Kim Swales: The New Deal - Smoking without inhaling.

The UK has a schizophrenic attitiude to labour subsidies.

Whilst politicians deride labour subsidies as not providing proper jobs, they are, in practice, addicted to them. Over the last two decades numerous schemes have been introduced that subsidise labour: YOPS, YTS, Employment Training, Employment Action, Action For Work, amongst others.

Unfortunately these schemes have been temporary, selective and narrowly targeted to specific disadvantaged groups. This has made them difficult to administer and unlikely to succeed.

They may have been cheap in terms of exchequer cost but they have been expensive in terms of real effectiveness. However, the politician's intuition is correct about the positive impact that labour subsidies could make, but labour subsidies should be introduced in a much more systematic manner. At present, like Clinton, we smoke but don't inhale.

Is the New Deal any different?

06nov98:Geoff Beacon: Employment through Tax Breaks

Employment through Tax Breaks

(A note to the Fabian Tax Commission)

Geoff Beacon, 6th November 1998


This note to the Fabian Tax Commission is mainly to introduce a proposal by Kim Swales and myself for the use of broadly targetted tax breaks that act as labour subsidies to the lower paid in order to tackle the problems of unemployment and inequality. We have done some work, under a grant from the European Commission which shows that governments can influence long-run employment levels by introducing appropriate tax regimes.

But this is one example of using the taxation system to encourage desirable outcomes and discourage undesirable ones. This general approach could be used more often. It certainly has some political advantages:

1. "Government expenditure" becomes "tax reductions".

2. "Taxpayers" not quangos make the decisions.

3. Little bureaucracy is needed.

4. They have a short lead time.

5. They use the "neutral" market.

For example, proposals for lower taxation on beer from small breweries is not seen a subsidy; tax breaks on gifts to the arts are not questioned with the same ferocity as Arts Council grants.

Much of the material for this note comes from postings I made on the "Third Way" internet debate hosted by www.netnexus.org.


The specific policy package which Kim and I considered involves the introduction of a fixed per capita labour subsidy, paid as rebates on VAT payments financed by an increase in nominal VAT rates. (The details of the scheme can be seen in the report to the European Commission. It is available on www.faxfn.org.) The scheme works through market forces by allowing for some substitution of capital for labour, but more generally by pricing workers into jobs through subsidisation and increasing the incentive to work, especially amongst lower paid workers.

The type of subsidy and tax plan that we outlined is operated as an integrated tax scheme in which the change in the firm's tax bill is calculated as the difference between the additional VAT and the per capita subsidy. The scheme increases total employment, and reduces payments of unemployment benefit, it allows a reduction in the overall tax rate for most firms and the economy as a whole. We can actually say the following:

"This scheme increases employment and so reduces the cost of unemployment benefit: There is a reduction in overall tax. So the introduction of this scheme would simultaneously increase employment and reduce taxation."

Our proposals seem to have had some acceptance in the European Union. Here is a paragraph from the Extraordinary European Council Meeting on Employment in November:

"68. - examine, without obligation, the advisability of reducing the rate of VAT on labour-intensive services not exposed to cross-border competition."

A copy of the report to the European Commission is appended.

To avoid any possible misunderstandings (like some in the nexus debate) we do not claim that switching taxation from payroll taxes to consumption taxes (eg VAT) by itself would lessen unemployment. At the risk of being too informal can I say that the main mechanism of our proposal is to "subsidise goods that use lots of labour and tax those that don't". A secondary mechanism is to make the production of particular goods or services become more labour intensive. Both of these are substitution effects which create jobs where they are needed: at the bottom end of the labour market.


The nexus "third way" debate, started by the Prime Minister, discussed topics that might find some middle ground between the inequality that characterises the North American economy (where welfare benefits are less supportive) and the unemployment that is said to be the product of the more comfortable safety net in Europe. Some political theorists believe that by training the unemployed they will be able to find useful jobs. This will cut unemployment.

But how does education and training increase employment? Train a million hairdressers and we do not create a million jobs. I know a good education can help my kids get good jobs. But is this simply pushing them up the jobs queue (ie. They will get the jobs that other kids will not get?) Training may help us compete for jobs on the world market, but this is less effective on a European scale because we are attracting the jobs from France, Spain and Germany etc.

In one contribution to the Third Way Debate Thomas Lunde gave his answer to the hairdressers' question:

"The same is true of skills. If 10,000 printers are required in the market and you have trained 12,000 printers, you still have 2000 printers unemployed so skills training has the double effect of redundant training expenses and surplus labour driving down the wages of those employed." (www.netnexus.org)

So some of the 2000 printers will get jobs because the wages for printers have been forced down. In another context Kim Swales answered this point: "... training a million hairdressers would create jobs by cutting the wages in hairdressing through competition. A further increase in employment would occur if standards were raised and we had our haircut more often, foregoing expenditure on less labour-intensive goods."

I think Kim meant this partly as a reducto ad absurdum: we both feel that other proposals, which involve tax breaks rather than goverment spending financed by large amounts of taxation can have a more direct effect.

In addition, I have particular worries about the effectiveness of current education and training which is unconnected with the theoretical effect on employment. These have been fostered by postings sent to www.faxfn.org. Some of these indicate a very serious disenchantment with current experience of training from the points of view of trainees and employers.

Areas of concern include nursing, mechanical engineering, civil engineering, building trades, media studies, civil engineering, sports science and linguistics. One constant theme is that for training to be effective it must be on-the-job training and, of course, on-the-job training requires the trainee to have a job.

Perhaps on-the-job training should start before a degree. As one posting from a small businessman starts:

"I have employed many college, university and TEC graduates and have found that they are generally institutionalised, overeducated, one-dimensional characters who for the main part have a chip on their shoulders because they feel as graduates they should automatically be placed at a management level. However, in reality, this is rarely the case.

"How, as an employer, can we employ a student whose only knowledge of his or her chosen career is theory based with the exception of a 2 week placement in a remotely related field.

"The students are taught by desk bound individuals whose knowledge is also theory based who have dipped their toe into the workplace only to decide it was actually hard work and actually they knew nothing and in a state of panic returned to the bosom of the education system to become tutors and lecturers.

"How can industry take these people as serious candidates for management posts. Many of them have been institutionalised by being in education until they are 19, 20 or 21 and have the social skills of a caterpillar. Can they manage an iron on a uniform? Can they manage to stand close to the razor? All they seem to be able to manage is to go home." (Roger Hind: Education and training: the view from a small business.)

Such comments may appear emotional and "off the wall" but his concerns ought to be addressed by our education and training industry. The second quote is from a Senior Lecturer in Community Nursing:

"The route taken has, however, been to make nursing more academic moving up from certificate to diploma and degree level and courses have moved from the Colleges of Nursing to Universities, often with the same teaching staff but with their emphasis now on university objectives where research has a greater role than training. Unfortunately this process has largely removed a vital ingredient from nurse training - practical experience...

"The change to an academic bias has caused other problems. Many students starting nursing courses are finding that more book learning is not what they expected and is not what they like so the drop-out rate on some courses is enormous. And because of the nature of the block grant received by universities, this drop-out rate does not affect funding. Courses in nursing are lucrative." (Nurse E: Senior Lecturer in Community Nursing: The Profession of Nursing)

An additional worry is that training seems worse in Britian than in Europe, particularly associated with the switch from apprenticeships to degrees. (See Peter Rook: Graduates educated to manage the dole office.) But as Wim van Welzen, MEP points out in his more heavyweight piece Training without jobs is pointless the basic problem is the same in Europe.


Some of the current difficulties in training and education may, in the long run, be improved by government initiatives. Employment may actually be increased. But, the situation seems urgent enough to consider other remedies, including ours, which create employment at the bottom end of the labour market through changes in taxation.