Sam Bowman: There's a better way of delivering a 'living wage' to the low-paid

Sam Bowman is Policy Director at the Adam Smith Institute. Follow Sam on Twitter.

Today is the first day of 'Living Wage week'. This is a promotional week run by the Living Wage Foundation to promote its campaign to get firms to pay their workers no less than £7.20 per hour (£8.30 in London) – what it says is the lowest wage needed to live decently in Britain*.

Especially at times like this, low pay is an important issue: people at the bottom of the earnings ladder are most vulnerable to rises in the cost of living, and the amount of money earned compared with the benefits rate plays a role in determining how likely people on long-term benefits are to look for work.

To coincide with this, we at the Adam Smith Institute have released a new paper (PDF) that reviews some of the Living Wage debate and proposes a way to leave more money in the hands of low- and middle-income earners. We applaud the motivations and methods of the Living Wage Foundation: instead of lobbying the government for a hike in the National Minimum Wage (NMW) rate, the Foundation has worked directly with private firms to persuade them to pay their workers more. The power of good PR can be an enormously effective tool in effecting social change. Unfortunately, some people will inevitably think that the NWM needs to be raised to reach the Living Wage rate. This is the policy that our paper aims to argue against.

It seems very likely that an increase in the minimum wage will, in practice, lead to greater unemployment overall. The theoretical argument against raising the minimum wage is clear enough: the minimum wage acts as a price floor on labour, making it illegal for firms to hire workers for what their additional labour is worth to those firms. This creates a shortfall in demand just as it would for any other good. In other words, unemployment.

Does this relationship hold in reality? The evidence is, as ever, inconclusive, but a 2009 meta-study of 102 studies by David Neumark and William Wascher found that two thirds gave a “relatively consistent … indication of negative unemployment effects of minimum wages”. These unemployment effects were felt most by young and unskilled workers – exactly the people for whom low-paid jobs can act as a first step on the ladder to acquire skills for future earnings. In Britain, the Low Pay Commission has acknowledged the danger of raising the minimum wage by freezing the youth rate last year. It seems set to do so again this year. We believe that the risk of creating unemployment should preclude any rise in the minimum wage rate.

What can be done? One surprising fact that is ignored all too often in the debate surrounding the Living Wage is that the National Minimum Wage rate before tax (£12,875.20 a year, full-time) is actually higher than the Living Wage rate after tax (£12,715.72 a year, full time). In other words, the only thing holding us back from having a Living Wage for all full-time workers is tax.

This ought to be a national scandal. If a minimum wage is the amount the state determines is the lowest pay morally permissible, then it's clearly immoral for the state to then turn around and take a hefty chunk of that for itself. These are the people at the very bottom of the jobs market, and we should not tax them at all.

As part of its efforts to make work pay and relieve the burden of the state from people the Coalition should raise the tax-free personal allowance to the £12,875.20 a year, so that only people earning above the NMW have to pay income tax and National Insurance. At a stroke, this would bring about the ends sought by Living Wage campaigners, add to the Coalition's welfare policy of making work pay, and likely stimulate the economy by leaving more money in the pockets of everyone earning under £100,000 a year for them to spend.

The cost of this policy - above the Coalition's existing plans to raise the threshold to £10,000 - would be approximately £14.4bn. This is a substantial cost, but it would be offset at least partially by a reduced welfare bill and the economic growth that we should expect to see from this kind of stimulus. Electorally, this should be a masterstroke – a tax cut for the strivers who have borne the brunt of the recession so far. For once, there is a simple and effective way to help people on low incomes: just leave them alone.

* Note: the Living Wage level is set by the Centre for Research in Social Policy and is expected to change today.