Wednesday, April 7, 2010

The great National Insurance row.

With the U.K. general election looming, U.K. politicians are desperate for something to argue about. They’re getting worked up at the moment about the proposed 1% National Insurance contribution increase (effectively a payroll tax).

I’ve got involved in an argument with the author of an Institute of Economic Affairs article by Kristian Niemietz. See

Comments after that article are limited to 700 characters which doesn’t do this point justice. So I’m trying to continue the debate here. Given that the result of the U.K. general election hinges on this point (ho, ho), the point clearly needs thrashing out. My response to Kris's latest comment is thus.

Kris: I’ll take the following sentence of yours first.

“You are, in effect, saying that it doesn't matter what the tax is levied upon, whether it's the purchase of labour or the size of your windows, as long as the total sum of tax money paid is the same in both cases.”

My answer: obviously it makes a difference at the micro level what a tax is levied on. E.g. tax windows and people will buy fewer windows. But so far as macroeconomics goes, it makes little difference what is taxed.

I’ll illustrate with a simple example, thus. Assume a closed economy. If the average wage is £10k and government imposes a tax increase of £10 million p.a., then about 1,000 people will be out of work. But if government then spends that £10 million (on anything you like) then around 1,000 new jobs will be created to make up for the 1,000 destroyed.

Re “labour-intensivity” I don’t accept that adding to the cost of employing people results in much of a move to less labour intensively produced products. Reason is that labour is the ultimate cost. That is the cost of anything can be broken down into cost of labour, machinery and materials. But the cost of machinery and materials themselves can be broken down into the cost of labour, machinery and materials. Go back far enough, and you discover that the only reason anything costs anything is that people have to be paid to do things (like make machines and produce materials).

I.e. raise the cost of labour by 1% and the cost of machinery will also rise by 1%. Of course the cost of already acquired machinery doesn’t rise, but if employers include replacement cost of machinery in their costing (which many do),the effective “cost of machinery” will rise very quickly to match any rise in the cost of labour.

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