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The PAYE Illusion

This article appeared in the Monitor section of “Public Service and Local Government” May 1983. “PAYE” is Pay As You Earn, the UK way of collecting personal income tax by making the businesses collect it at their expense from wages and salaries from their employees.


Corporate accounting

British Steel lost £358m in the year 1981/82. Or did it? Everything depends on how the books are cooked. In round figures, BS used £2,300m worth of raw materials and fuel, and turned them into finished products which were sold for £3400m. The difference of £1,100m represents the wealth created by BS’s 112,000 workers. Not too bad, is it? £700m of this added value was distributed to the workers in their take-home pay and pensions, £l00m was paid in interest. and £250m was ploughed back, leaving a small surplus. So where did the loss come from? In addition to the above BS contributed £64m to local authorities, in rate payments, and £480m to the Treasury (some 43.6% of value added).

No conventional balance sheet expresses the affairs of BS or any other company in these terms. Payments to workers are regarded as employment costs, and lumped together with the costs of raw materials, fuel, etc. under the heading of expenditure. The chief payment to government is reckoned to be Corporation Tax. This form of accountancy obscures the underlying reality: wages are paid out of the wealth created by the workers and are not a cost of proluction.

The prevailing belief that wages are a cost of employment is a fallacy with damaging consequences. It deceives both sides of industry, and helps fuel the customary antagonism between workers and employers. This fallacy also fosters the illusion of gross pay. To all intents and purposes gross pay is a purely notional amount. From personal experience we all know that we can call income only that which is available for us to spend. When we receive our pay, our main concern is for the amount actually in our pay cheques or wage envelopes. PAYE deductions are assessed on the gross pay figure and appear to be a tax on income. Once computed, however, tax becomes the liability of the employer. As proof we need only note that most business liquidations are instigated by the PAYE authorities.

Employer burden

Recognising that real wages must be equated with actual spending power we can appreciate that, despite appearances, the true burden of workers income tax and national insurance falls entirely on the employer. Effectively, we have a payroll tax, concealed by conventional accounting under the heading of employment costs, amounting, in the case of BS to a contribution to the Treasury of £480m in the year 1981/2. The full extent of these taxes is little appreciated, but in practice they amount to an employment tax surcharge of well over 50 per cent. In the case of a single person whose gross pay is £120 a week, take-home pay will be £82.50, and with employer’s National Insurance, the total cost to the employer amounts to £136.50, a surcharge of 65 per cent.

No relief

This view of Income Tax demonstrates not only that it is a burden carried by the employer, but that it takes no account of the employer’s ability to pay the tax. Even when a firm goes bankrupt there is no relief because the Inland Revenue goes to the front of the queue of creditors – despite being most able to bear the loss. The result is to destroy industry which would be economically viable but for taxes.

The economic consequences of such a tax are predictable. Just as the nineteenth century window tax meant fewer windows, so present employment taxes mean fewer jobs. The exact opposite of what is needed. Employers have every incentive to get rid of their workers. In the case of the manufacturing industry, automation is a natural consequence of technological development, but in the service sector, fewer workers invariably means less service. While conductorless buses, trains without guards and understaffed supermarkets are mereIy shifting costs by wasting their customers’ time. In national and local government, payroll taxes lead to the revolving money syndrome. Almost half the money which local authorities receive from central government in the form of Rate Support Grant is promptly returned as staff PAYE and National Insurance contributions, at great administrative expense.

The insidious effects of our tax system are obscured by the belief that wages are a cost of employment and that workers actually pay tax. It is as if the economy were suffering from a mysterious, debilitating and undiagnosed sickness. The only well-publicised consequences are the poverty / unemployment traps. Even amongst politicians, union leaders and experts in economics there is little awareness of the malady, which is why tax reform does not appear on anyone’s agenda for economic recovery.

What kind of reform should we be looking for? As a first principle, taxes should reflect the ability to pay tax. In the private sector, businesses which would be viable in the absence of a tax should be allowed to remain viable after they have paid their taxes. In the public sector, it is clear that the taxable capacity of BS and other lossmakers is at present zero. Furthermore, tax reform should put an end to the unnecessary circulation of funds between different goverment departments and between central and local government.

Net wages

Initially, the tax system should be changed so as to dispel present illusions. It would not make a scrap of difference if PAYE were labelled Payroll Tax and openly charged to the employer. With the present policy of removing personal allowances, such a change could easily be effected; indeed, by agreement with the Inland Revenue, this practice has already been successfully adopted in a number of firms, mainly in the textile industry, where workers are paid net wages for piecework, Psychologically, tax-free wages have the advantage that, with no deductions, there is no disincentive to effort.

Replacing PAYE with a payroll tax, at least, would simplify collection and dispel the notion that wages can be anything other than what employees can spend. Further, the Chancellor might then notice that payroll taxes completely disregard the taxable capacity of the employer. This would open the way for real reform.