Welsh public sector will take hit from NI increase

Eurfyl ap Gwilym analyses the impact of the National Insurance increase on the public sector in Wales

A great deal of heat has been generated over the last week following the Conservative’s pledge to abolish the planned increase in employers’ national insurance contribution (NIC). Analysis of their proposal gives rise to two issues: first, whether it is sensible to abandon the current Government’s plan to increase employers’ NIC and, second, if it is how will the loss of revenues be addressed?

When, in November 2008, the UK Government announced plans to increase the rate of employer’s NIC by 0.5 per cent from April 2011 it did so for a number of reasons: faced with the rapidly deteriorating fiscal position it needed to commit to actions to address the escalating financial deficit, but there were compelling reasons to delay such action until the consequences of the financial crisis worked their way through the system. It did not make sense to increase employers’ NIC and other taxes when measures such as the temporary reduction in VAT to 15 per cent were being taken to provide a short term fiscal stimulus to an ailing economy. It would not, of course, have escaped the Government’s attention that announcing tax increases but delaying their implementation helped reduce any political fall-out.

In the event, given the worsening fiscal deficit, the Government in the December 2009 Pre Budget Report announced an additional increase in employers’ NIC of 0.5 per cent with effect from April 2011. Thus employer’s NIC will increase by 1 per cent to 13.8 percent in April 2011. At the same time employee’s main rate of NIC will also increase by a total of 1 per cent.

As I pointed out in an earlier comment on the 2010 Budget, employer’s NIC is in essence a tax on jobs. In the budget there were a number of modest but useful measures to try and stimulate employment. Given this it is difficult to understand why the UK Government is simultaneously introducing a measure which is bound to destroy jobs.

In considering employers’ NIC it needs to be borne in mind that it applies to all employers including those in the public sector.

Private sector employers, in dealing with the increase in employers’ NIC, have a number of options. They can absorb the cost at the expense of profitability; pass on the cost to their customers through higher prices; seek higher productivity and reduce their headcount; or cut any planned increase in the pay of their staff to off-set the increase.

The options facing employers in the public sector are much more limited. Given that the public sector faces large cuts in funding over the coming years it will not be possible simply to absorb the NIC increases. Public sector employers are already under pressure to reduce costs. In the case of the Welsh Government it faces a cumulative cut in funding of approximately £3bn in real terms over the three years from 2011-12. The public sector cannot pass on the increase in NIC cost and the UK Government is already committed to introducing a cap on basic pay in the public sector of 1 per cent in nominal terms in 2011-12 and 2012-13.

Thus the only realistic option is to cut employment in the public sector over and above that which would be required if NIC were not increased. Some may point out that an alternative is to cut the public procurement budget which in the case of Wales is approximately £5 billion a year. However public bodies in Wales will already be having to plan severe cuts in this budget and this will leave little or no scope to avoid the impact of the increased employers’ NIC on public sector employment.

What will be the impact on employment in the public sector in Wales as a result of the decision to increase employers’ NIC? It is fairly straightforward to make an estimate. In Wales approximately 310,000 are employed in the public sector. The direct cost of public sector employees is their wage or salary plus employer’s NIC and pension contribution. Assuming the average employer’s pension contribution is 15 per cent of basic pay and given that NIC will increase from 12.8 per cent to 13.8 per cent the total direct cost of employment will increase by 0.8 per cent. If the total cost of the public sector is not to increase there will have to be a reduction in employment in Wales of approximately 2,400.

This may not appear too dramatic an increase but, taken in the context of the large public expenditure cuts foreshadowed in the 2009 Budget which will lead to the loss of many jobs in the public sector, it does appear to be perverse that the UK Government introduces a tax measure which directly exacerbates the position.

Some may ask what should be done if the planned increase in employers’ NIC is dropped. Invoking additional efficiency gains in the public sector lacks credibility unless specific actions are identified. The current government’s efficiency plans are already being heavily criticised for a lack of specificity and considerable doubts have been raised regarding the actual savings achieved in the past under the Gershon plans. In the case of Wales, the Wales Audit Office in its report last month noted that national efficiency targets of £600 million by 2010 would be missed by ‘some considerable margin’. The lack of detail in the Conservative’s plans merely amplify these concerns.

One way of avoiding such criticism would have been for the Conservatives to advocate alternative tax increases such as: raising the upper earnings limit on employee’s NIC; increasing the additional rate of NIC above the upper earnings limit; aligning capital gains tax and income tax rates; levying another tax on banks; or even raising VAT. However such moves, whilst making fiscal sense, would have defeated the political object of the exercise, which was presumably to be seen to advocate a tax cut without any corresponding pain. It is perhaps ironical that Labour saw increasing NIC as a pain free way of increasing taxes and the Conservatives, in turn, have sought to reverse this increase in a pain free way. The painful reality will become apparent after the UK general election.

Eurfyl ap Gwilym serves on the boards of a number of public companies, is an IWA trustee and an economic adviser to Plaid Cymru.

Also within Politics and Policy