The Living Wage and the Impact of the July 2015 Budget. Communities Analytical Services, October 2015

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1 The Living Wage and the Impact of the July 2015 Budget Communities Analytical Services, October 2015 October 2015

2 THE LIVING WAGE AND THE IMPACT OF THE JULY 2015 BUDGET COMMUNITIES ANALYTICAL SERVICES, OCTOBER 2015 Summary The purpose of this note is to bring together the findings of independent analysis of the UK Government s new National Living Wage (NLW). In particular, it examines the distributional impacts of the NLW and to what extent the NLW will compensate for further benefit reductions. Further material includes: An explanation of how annual increases in the Living Wage are currently calculated Projections to 2020 of the Living Wage and UK minimum wage An discussion of the implications of the July 2015 budget for the Living Wage Evidence on the impact of the NLW on employers. Key messages from this analysis are: The NLW is not targeted at the lowest income households. Independent analysis by the Office for Budget Responsibility and separately by the Resolution Foundation conclude that around half the cash gains in household income may accrue to the top half of the household income distribution Independent analysis agrees that the NLW does not compensate for benefits cuts that affect those on lower incomes. In summary, this is because the NLW is not targeted at low income households, whilst cuts in working age benefits are. In recent years, annual increases in the Living Wage have been capped to earnings growth plus 2 percentage point whilst living costs have risen more steeply. The gap between the Living Wage ( 7.85) and a wage that reflects actual minimum living costs ( 9.20) is now at Whilst around 271,000 workers in Scotland over the age of 25 will benefit from the NLW, the NLW will remain much lower than the Living Wage. By 2020 the Living Wage is expected to be around 10.75, whilst the NLW will be around Scottish Government analysts estimate that the July 2015 budget announcements should increases the reference Living Wage 1 by Most industries will experience relatively low impact from the introduction of the NLW, but some economically important industries in Scotland such as food and drink (3 per cent of GVA) and retail (5.4 per cent of GVA) are expected to see substantial increases in the total wage bill. 1 The reference Living Wage is the wage that reflects actual minimum living costs, which reflects what members of the public have identified what items people need for a minimum acceptable standard of living, costed at national chain stores.

3 Background: July 2015 emergency budget measures will result in 12 billion of additional benefit cuts The emergency budget included a higher National Minimum Wage badged as the National Living Wage (NLW) for those over 25 with planned increases from April It will start at 7.20 and rise to an estimated an hour by The National Minimum Wage (NMW) is currently worth 6.50 an hour. The Budget also announced considerable additional cuts to benefits, including: A 4 year freeze to most working age benefits (worth 4 billion in ) Cuts to tax credits / universal credit ( 6 billion) Remove tax credit/uc entitlement for third and subsequent children from 2017 Abolition of family element in child tax credit (and equivalent in UC) from 2017 Cuts to work allowances reduction in how much families can earn before tax credits /UC start to be withdrawn e.g. from 2016, tax credits will be withdrawn once family earnings above 3,850 rather than 6,420 The rate at which tax credits are withdrawn will increase from 41 to 48 per cent Reduction in benefit cap: cut to 20,000 ( 13,400 for single adults without kids) The combined effect of these changes are explored in the following sections. Who gains from the new National Living Wage? There are approximately 271,000 workers in Scotland over the age of 25 who currently earn less than 7.20 an hour. The Office for Budget Responsibility produced an analysis 3 of gains from the planned increase in the NLW by 2020 across the household income distribution which estimates that around half the cash gains in household income may accrue to the top half of the household income distribution, in part because workers in higher income deciles that gain from the measure will receive a larger average cash amount (see chart below). In fact, NMW earners are well distributed across the household income distribution because there are fewer earners in the lowest 30 per cent of household, many NMW workers are second earners, often part-time workers (mainly women) and will include many younger people living with parents. The Resolution Foundation also assessed distribution impacts and produced the chart below which illustrates the impact from three perspectives: 1. Gross wage gains (red bars) - those in the bottom 10 per cent of households and those in the top 10 per cent record the smallest average gains. The households that gain the most in gross terms are those in the middle, 2 The target for the NLW is to reach 60 per cent of the median hourly earnings of those aged 25 and over by April This is currently estimated by the OBR at Office for Budget Responsibility pdf

4 between deciles 3-7. On this measure, households in the bottom half of the income distribution receive 52 per cent of the total wage gains from the NLW. 2. Net income change (blue bars). This takes into account taxation and state support. What is noticeable is the proportion of the gross gains lost by households in the middle, particularly in the lower-middle (deciles 2-4) part of the distribution. The requirement to pay tax and National Insurance (NI) on these additional earnings explains part of this shift. In addition, members of this middle group of households are more likely than others to be eligible for Universal Credit (UC) for each pound earned above around 5,000 a year by a household, 65 pence of UC entitlement is deducted. This means a worker gaining the full 1.10 hourly boost implied by a NLW of 9.35 in 2020 (using the Office for Budget Responsibility s projection) would only be 39p an hour better off, falling to 26p if they also pay tax and NI. 3. Proportionate change in income (blue line) the greatest benefits will be felt by those in lower-middle of the income distribution (deciles 2-7). The actual percentage increases are small however. Figure 1: gains from the National Living Wage by household income decile, 2020 Source: Resolution Foundation,

5 Does the NLW compensate for tax and welfare changes? The extent to which the introduction of the NLW compensates for welfare and benefit changes has been considered by the Institute for Fiscal Studies (IFS) for different household types 4. The IFS is clear that the New NLW will provide some compensation for those who will lose from the cuts to benefits and tax credits that the Chancellor announced in the Budget. But it is also clear that the compensation can, at best, only be partial. This is because: 1. The cuts in benefits and tax credits are larger in aggregate than wage gains from the NLW. 2. Some of increased earnings will be lost through higher tax and lower benefit entitlement. 3. Many who lose out on tax credit and benefits changes cannot benefit from increases in the NLW. E.g. people who are not in paid work, selfemployed, already paid above the NLW, or below the age of 25, Households that do not receive benefits or tax credits but contain someone with a low hourly wage can benefit from the NLW. For example second earners in a household with enough income to take them above tax credit and benefit thresholds. So whilst some may benefit, the IFS makes clear that The NLW is therefore not a substitute for targeted benefits and tax credits when it comes to helping poorer households and tackling poverty. In aggregate it is not big enough. And it is not targeted at the same group. The figure below shows the average losses due to tax and benefit changes by household income decile. The next figure shows the distributional impact of gains from the NLW. The final table provides the net impact on different household types. 4

6 Figure 2: Estimated distributional impact of personal tax and benefit measures announced for implementation in the current parliament, Source: Figure 3: Estimated distributional impact of gains from the new NLW Source:

7 Figure 4: estimates impact of tax and benefit changes and better case gains from the new NLW by household working status and whether or not the household contains children Source: 6

8 What is the Living Wage and how is it increased? This section explains how the Living Wage is currently increased annually, what it actually represents and how that relates to the Minimum Income Standard (MIS). The Living Wage recommended by the Living Wage Foundation is commonly misunderstood to be the amount required to achieve the MIS the amount that members of the public think people need to achieve a socially acceptable living standard 5. The 2014 Living Wage Foundation calculations for annual uprating applied an earnings cap, meaning that: at any one year, employers should not be asked to award pay rises more than 2 per cent above the average e.g. if earnings rise on average by 3 per cent, the rise in the Living Wage should be capped at 5 per cent. 6 The rationale for this cap was: If the income needed to sustain a minimum acceptable standard of living rises much faster than average earnings, there will be limits to how far it is acceptable for employers to increase wages for the lowest earners to meet their increased needs. The capped Living Wage is called the applied Living Wage ( 7.85 in 2014) whereas the Living Wage Foundation also calculates a reference Living Wage which is the hourly rate that reflects actual minimum living costs ( 9.20 in 2014). Due to the limits applied to annual increases, the applied Living Wage is currently lower than the reference Living Wage. If the current method for increasing the applied Living Wage continues, then it may converge again with the reference Living Wage, based on the Office for Budget Responsibility s (OBR) projected earnings growth (see next section). The annex below provides estimates of November s increase in the minimum wage. Based on the current method, the estimated maximum increase in the applied Living Wage is Projections of minimum wages and the Living Wage The chart below shows how the NMW would have been expected to have increased up to 2020 without the introduction of the National Living Wage. To compare, projections of the NLW, and applied and reference Living Wages are included. Key points are that: The NLW represents a cash increase of around 1.10 compared to the NMW in But it remains well below the applied and reference Living Wage. The applied Living Wage could eventually converge with the reference Living Wage, assuming increases in the reference Living Wage follow projected CPI 5 The MIS for the United Kingdom reflects how much income households need to afford an acceptable standard of living. Developed between , in collaboration with the Family Budget Unit at the University of York, this programme is now carried out fully by Centre for Research in Social Policy, with on-going funding from the Joseph Rowntree Foundation. MIS is updated annually, at least with inflation, with new research every two years ensuring that it reflects changing social norms. 6 Full uprating paper available at: 20London%20Living%20Wage%20in% pdf 7

9 growth and the current method for increasing the applied Living Wage continues. Figure 5: Projected Living Wage, National Minimum Wage and National Living Wage NMW then NLW from 2016 Baseline NMW Applied LW Ref LW (CPI) + July Budget Source: OBR, and Scottish Government calculations. The projections are reliant upon OBR projection of earnings and inflation and therefore are subject to uncertainty. The underlying calculations also rely on the following assumptions: The reference Living Wage is projected from 2015 in line with the OBR s projected CPI, and for simplicity, adjusted in 2016 for the impact of emergency budget measures on costs of living (see next section). The impact of the benefit cuts may in reality be spread over a longer period. The applied Living Wage is increased from 2015 in line with earnings growth plus 2 percentage points in line with the current method. It is constrained not to rise above the reference Living Wage. The NLW is projected to start at 7.20 in 2016 then rise in a straight line to 9.35 in 2020 (as projected by OBR). The NMW baseline projection uses the NMW as a starting point then projects based on projected earnings growth as thought the NLW had not been introduced. Impact of emergency budget measures on minimum living costs When calculating the reference Living Wage, the Living Wage Foundation takes into account the income an individual will receive through the welfare the tax credit system. The cuts to tax credits and other benefits announced in the budget would therefore further increase the living wage required to achieve the minimum acceptable standard of living. Scottish Government analysts have modelled the impact of the key emergency budget changes on the 9 household types used by the Living Wage Foundation to calculate annual increases in minimum living costs. 8

10 Based on this analysis, the impact of the budget announcements increases the reference Living Wage by 0.68 once all the measures are introduced. The Joseph Rowntree Foundation recently published a report 7 and interactive infographic 8 which projects the effects of fiscal austerity and the NLW for various family types. In particular it estimates how far various households will fall short of meeting the MIS in 2020, compared with 2010 and The results show that none of the modelled households meet the MIS now or in It suggests that households that are expected to increase living standards closer to the MIS over the years to are: people aged 25+ working full time with no children on the NLW; couples with two children where both are working full time on the NLW. Whilst households that are expected to decrease their living standards further below the MIS are couples with children where both adults are not working full time, and; lone parents. Figure 6: will people earning the NLW be closer to affording the MIS in 2020? Source: JRF website, 7 JRF (2015). Will the 2015 Summer Budget improve living standards in 2020? Available at

11 Impact of NLW on employers The target of a 9.35 NLW by 2020 implies above inflation increases of the minimum wage. This is likely to have widely varying effects on different employers. The Resolution Foundation has recently considered 9 the impact by industry and occupation and looks at the pressure they face through three indicators: Share of employees affected The NLW as a proportion of the industry / occupation median wage Size of the total wage bill. The following chart summarises all of these indicators and gives a feel for which sectors are most under pressure. It presents sectors in three groups Group 1, 2 and 3 with limited, moderate and largest impacts respectively. The vertical axis shows the proportionate wage bill increase, while the horizontal axis sets out the bite (the NLW as a percentage of the industry median wage). The size of the bubbles relate to the number of employees affected. Key points are that: The majority of industries (with 42 per cent of all employees) sit within Group 1 (low impact) illustrated in the chart by the green bubble. Individual firms within these sectors may face more sizeable challenges but most will face modest cost increases as a result of the NLW. Group 2 (red bubble) identifies industries in which the NLW will generate aboveaverage increases in wage costs. It suggests that firms in these sectors might be expected to face greater challenges in relation to implementing the NLW. Importantly this includes the retail industry. In Group 3 (blue bubble), the NLW represents more than 90 per cent of median wages, and the wage bill increases in these sectors are expected to be greater than 2 per cent. There are fewer industries in this group, but they comprise a comparatively large share of those affected, (21 per cent of those likely to see a pay rise in 2020). Some of the key industries highlighted as particularly affected are economically important in Scotland. For example, the food and drink industry represents around twice the proportion of total GVA than it does in the UK (around 3.0 per cent compared to 1.5 per cent in the UK 10 ). The retail industry represents around 5.4 per cent of GVA 11, around the same as the UK s proportion. 9 Resolution Foundation figures used for comparison figure used. 10

12 Figure 7: NLW as percentage of industry median wage, number employees affected and percentage total wage increases National Living Wage as % bite of industry median Source: Resolution Foundation Other points to note include: Small firms face bigger challenges through lower economies of scale and lower profits. Firms with less than 10 employees will feel the greatest impacts and will adapt in different ways to larger firms. For example owners of smaller firms may take on more hours themselves to cut back on staff. Some larger firms (Tesco, Whitbread and Sainsbury s) have indicated that their reaction will be to raise prices. The majority of employees affected will be in the private sector which will also see greater increases in total wage bill (0.8 per cent compared to 0.2 per cent in the public sector). Accommodation and food services, cleaning and residential services are estimated to have the most substantial increases in total wage bill of 3.4, 3.0 and 2.8 per cent by

13 Annex: estimated maximum increase in Living Wage to be announced in November 2015 This annex applies the method Loughborough University use to estimate the annual increase in the applied Living Wage. However, it uses the latest available earnings data, and therefore not quite the data that Loughborough will eventually use for its November recommendation. The latest earnings data suggest that annual earnings growth could be around 2.4 per cent. Weekly Three month average earnings Apr-June Apr-June Annual increase 2.4% That implies that whatever happens to the reference minimum wage (which was 9.20 in 2014 outside of London and the applied Living Wage was 7.85) the new applied Living Wage will be a maximum of around 4.4 per cent higher giving an estimated maximum new Living Wage of around Max increase 4.4% 2014 Living Wage Living Wage 8.20 This implies that there is potential for the reference Living Wage and the applied Living Wage to decouple substantially when earnings growth is lower than inflation The 2014 Living Wage of 7.85 is about 17 per cent lower than it would be if the reference Living Wage were applied. 12

14 Crown copyright 2015 This publication is licensed under the terms of the Open Government Licence v3.0 except where otherwise stated. To view this licence, visit nationalarchives.gov.uk/doc/opengovernment-licence/version/3 or write to the Information Policy Team, The National Archives, Kew, London TW9 4DU, or Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned. This publication is available at Any enquiries regarding this publication should be sent to us at The Scottish Government St Andrew s House Edinburgh EH1 3DG ISBN: (web only) Published by The Scottish Government, October 2015 Produced for The Scottish Government by APS Group Scotland, 21 Tennant Street, Edinburgh EH6 5NA PPDAS57659 (10/15) w w w. g o v. s c o t

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