Wednesday, 31 March 2010

The cost of shedding public sector jobs

I can't now remember where I saw it but a couple of days ago a singularly absurd comment was left on a blog. It might have been one of the BBC blogs. The topic under discussion was a televised debate between the chief treasury spokesmen of the UK's two main political parties and a dancing gnome bearing a yellow rosette. One of the points made by the author of the blog was that none of the three debaters gave sufficient details of where and how they would reduce government spending so as to make either serious inroads into the annual budgetary deficit or into the cumulative debt resulting from year-after-year of annual deficits.

It is noticeable how politicians often fail to distinguish between annual deficits and government debt. The point is really very obvious. If you have £20,000 to spend this year but actually spend £25,000 you run a deficit of £5,000 and start next year with a debt of £5,000. That debt doesn't disappear at the end of the year, it stays with you until it is repaid. The next year you might still have £20,000 to spend but actually spend £22,500. Your annual deficit has fallen by half but it is still a deficit and at the end of the year you owe £7,500 (£5,000 from the first year's over-spend and £2,500 from the second's). Reducing the deficit does not reduce debt it merely increases it by less than during your previous period of profligacy. You can only reduce debt substantively by running a surplus rather than a deficit - for example by spending £19,000 out of your £20,000 so that you can repay £1,000 of debt.

In the comments to the piece a whole range of points were made, as one would expect. Among them was a full-frontal attack on the concept of running a deficit at all and a call for government to cut it's spending very substantially so as to run an annual surplus of income over expenditure so that the debt can start to be repaid. In answer to this obvious and sound approach was the comment that caught my eye. It's quite interesting how the mood of a writer can be clear from the way he or she expresses himself on the page. One or other of my regular readers can probably tell when I've had two bottles of wine before setting out my verbiage and when I am stone-cold sober, but it is also possible to tell whether something is written in a calm and reflective state of mind or as a result of furious exasperation. The mood appearing from the comment in question was undoubtedly one of "how can you be so stupid?" I could almost hear the deep sigh issued by the commenter before he put digit to keyboard. Perhaps you can will be able to tell how loudly I sighed on reading his comment from what I am about to write.

The comment can be summarised as follows: it is counter-productive to cut public sector jobs because it reduces income tax receipts and increases the welfare bill. I had read similar comments before and each time my lower jaw has been drawn downwards by something other than the weight of my chins. People actually believe that shedding someone from the public sector payroll costs the Treasury money. It's really quite staggering. Actually, it can happen, but only if the cost to the Treasury of him leaving his job exceeds the cost of employing him. Say his salary is £30,000 excluding employer's National Insurance Contributions. That means the Treasury's piggy-bank is reduced by £30,000 each year (employer's NICs are neutral because they are just one office of the Treasury paying money to another office of the Treasury). He pays, say, £6,000 in income tax and employee's NICs, so £6,000 that was taken from the piggy-bank is put back into the piggy-bank. More accurately, his income tax and employee's NICs are also just transfers from one desk at the Treasury to another desk and represent neither expenditure by nor income to the Treasury. The cost of employing him is his take-home pay, £24,000 on the figures I have given.

The mistake made by the commenter was to overlook that people paid out of taxes do not in reality pay income tax and NICs - income tax and NICs simply reduce the amount that is paid to the State employee but they are not receipts to the Treasury. The story does not stop there, however, become people do not live in a vacuum and their income does not exist in a vacuum. There are three respects in which dispensing with a State employee (let's call him Mr Paperclip) causes costs to the Treasury in addition to the cost of paying benefits.

First, let's assume Mr Paperclip had a net income of £24,000 and now receives £10,000 in benefits. The saving to the Treasury is £14,000 but Mr Paperclip also has £14,000 less to spend. The figures can be minced anyway you want, I will assume he would have saved £4,000 and spent £10,000 of which £8,000 would have been spent on things subject to VAT at 17.5%. The VAT on £8,000 of spending is roughly £1,200 (because the figure of £8,000 is the total of the cost of goods and services at about £6,800 plus VAT at 17.5%). That is a loss of tax revenue as a result of him no longer being employed so the saving to the Treasury is reduced from £14,000 to £12,800.

Secondly, because he spends £8,000 less at Mr Patel's Merrymart, so Mr Patel receives £6,800 less (not £8,000 because £1,200 of it goes in VAT rather than to Mr Patel). Had Mr Patel received that £6,800 he would have spent £4,000 at Mr Choudury's Cheerful Cash-n-Carry buying replacement stock and pocketed £2,800 himself on which he would have been liable to income tax and NICs of, say, £900. The Treasury loses £900. Mr Choudhury receives £4,000 less which represents £1,500 profit and the loss of a further £500 in tax and so it goes on through a whole chain of transactions. At each link there will be a loss of tax as business takings and profits are reduced but at each link the loss to the Treasury gets smaller and smaller as Mr Paperclip's initial withdrawal of custom is diluted. The financial benefit from dismissing Mr Paperclip is reduced by these knock-on effects.

Thirdly, Mr Paperclip himself is only one person, it will take a whole warehouse of office equipment to lose their jobs before any real effect is made on the government salaries bill. There will be chain-reactions of loss of turnover for many businesses and some of them will have to lay-off staff or even close completely. The loss of a private sector job is a real cost to the Treasury. Income tax and NICs are no longer received and benefits are paid, all of which affect the books directly; there is no element of the Treasury losing money which would have come out of its own coffers in the first place unlike the nominal "loss" of income tax when Mr Paperclip joins the dole queue.

For these reasons reducing the public sector payroll saves the Treasury the immediate net cost of employing people but not the whole of that cost is saved because there are knock-on effects on tax receipts and the cost of benefits. Nonetheless a net saving will undoubtedly arise because not every redundant public sector employee will remain unemployed for life, not all will draw benefits and the chain-reaction of tax losses involves ever-smaller sums.


Norman said...

Being conservatively minded I take the view that it's not so much the money saved by Mr Paperclip's loss of employment but what we do with that money.

To me, the question is would I rather give that money to the private businesses you mention via employing Mr Paperclip in some government job or by lower taxes on the private sector?

If Mr Patel receives £100k and pays £30k in taxes with Mr Paperclip spending £5k in his shop I'd rather see £25k taxes and Mr Paperclip taking his chances in the private sector.

Brian, follower of Deornoth said...

Not quite, Norman. We're using the money to replay the National Debt, not cut taxes. Sacking Mr Paperclip will set us on the virtuous spiral (replay debt, therefore interest on debt falls, leading to debt being repaid faster).

Also, a large (and usually ignored) part of the public-sector debt is Mr Paperclip's unfunded pension scheme; sacking him certainly eliminates that.

Norman said...

I realise that the point is to get the debt paid off, but if I am given the choices of:

1) Public borrowing to be £170bn next year with things as are

2) Public borrowing to be £160bn with Mr Paperclip & friends laid off

3) Public borrowing to be £170bn with Mr Paperclips & friends laid off but with £10bn of tax cuts

I'd choose 3) first (as I believe the only way out of this mess is to grow our economy and our current tax regime is hindering that - no political party is offering me this choice, however), then 2) (Conservative's & Labour both seem to be promising this to a greater or lesser degree and is your scenario of paying down the debt via cuts) and choice 1) would trail a distant third (this is Labour's current policy of encouraging growth by redistribution of wealth rather than tax cuts)

Hope I made myself understood this time.

Stan said...

Fair points all clearly explained, FB. I've tried explaining the same myself on my blog using the church collection plate analogy (i.e. if you take ten quid out and put five back you are not really contributing the church tower restoration fund).

One small quibble, though - a public sector worker can be a net contributor to the overall tax receipts if he works in the productive sector. Our public sector today may not be much bigger than it was in 1976 (I don't know - it might even be smaller), but in 1976 a significant proportion of public sector workers were working in nationalised industries producing cars, coal and steel which brought in revenue. Now it's true that these were not always profitable - but it's still preferable to have a public sector that costs £x billion and brings in £y billion in revenue than it is to have a public sector that just costs £x billion.

Incidentally, Mr Paperclip might earn £24,000, but the cost to his employer (i.e. us) is considerably more what with employers NI, benefits and so on. If I remember from my days as an employer, the cost of employing someone was around 50% more than just their wages - so Mr Paperclip would cost around £36000 to his employer (i.e. us).

Antisthenes said...

It is obvious I lead a less sheltered life than you. I Find that this comment that so astounded you does not me. I often make this statement that reducing the public sector will improve economic stability and receive very similar reactions. Usually I am thrown the retort that "public sector workers pay taxes don't they" and no amount of explanation will change their way of thinking. When the bulk of the voting public have a similar mind set and they do then it understandable that Labour can still muster enough support to possibly be re-elected.

Einstein said "there are two infinites, human stupidity and the universe and I am not sure of the latter". Says it all really!

Mark Wadsworth said...

As Norman said, it wouldn't matter to Patel and Choundry if Mr Paperclip spent £14,000 less in their shops if they got a £14,000 tax cut.

The true cost of a superfluous civil servant is difficult to quantify - the real cost is

a) the deadweight cost of the taxes imposed on Patel & Choudry (not the taxes themselves, i.e. £1 raised in tax reduces size of economy by 50p - the 50p is more important than the £1. The only tax without deadweight costs is Land Value Tax, of course) PLUS

b) The output lost to the economy because Mr Paperclip is busy interfering in people's lives PLUS

c) The output lost to the economy because Mr Paperslip is not cutting people's hair, building cars, painting and decorating or teaching children to read and write or whatever. Think about it - if your factory employs 100 people making stuff, and I say that ten of them have to be employed filling in Elfin Safety Assessment forms, by how much does your ouput drop?

I guess that a+b+c are greater than the cash cost of salary minus income tax plus pension promise plus office space, stationery etc, but by and large, the cash salary is a fair estimate of cost to the economy.