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There is no magic money tree

    “Britain needs a pay rise” according to a TUC march held on Saturday. It is certainly the case that there has been a painful squeeze in real wages across the economy. However, Saturday’s march was largely calling for increases in public sector pay rather than the productivity boosting changes to tax, regulation, competition and skills policies which would lead to stronger medium term wage growth.

    When we are still running an annual deficit of £100 billion, it is an absolute necessity to keep control over all aspects of spending, including the public sector pay bill. Richard Gates from the Unite union, with whom I had a radio debate on Saturday, disagrees. According to Richard, there is no need to control public sector pay, or indeed any aspect of public spending because the entire deficit could be eliminated by clawing back the receipts lost through tax avoidance. This is obviously ludicrous.

    HMRC’s estimates of the tax gap for 2012/13, the difference between the amount it expected to receive and the amount it actually received was £34 billion. Some of this can be reduced by a thorough and general simplification of the tax system as proposed by CPS Research Fellow David Martin. However, if the government wanted to go further, it could hire more HMRC staff which would reduce the total yield or indeed it could become quite draconian in how it tries to collect more revenue. Ultimately, this may become counterproductive.

    Either way, it is simply a fantasy to suggest that the deficit could be eliminated through clamping down on tax avoidance alone. Even if somehow, the entire £34 billion could be taken back, where does the other £65 billion come from? This is to say nothing of the dynamic effects of higher income tax receipts leading to lower consumption tax receipts because of reduced disposable incomes.  

    There are also other reasons for keeping control of public sector pay and it is not hard to see why some private sector workers are not too impressed by the shenanigans of union leaders. ONS figures from last year show that on average, pay in the public sector was between 2.2% and 3.1% higher than in the private sector after adjusting for the different jobs and personal characteristics of the workers. For the lowest earners, public sector workers earned on average around 13% more than private sector workers in 2013 when adjusting for the different jobs and personal characteristics of the workers.

    Since 2000, nominal private sector pay has increased by 49% compared to an increase of 57% in the public sector. Since the onset of the financial crisis, nominal pay in the private sector has grown by 9% compared to 14% in the public sector. Furthermore, average weekly regular pay for public sector workers is £44 a week higher than for private sector workers. 12 years ago exactly, this gap was £15.

    As far as the public sector goes generally, it is also worth remembering that whilst total employment has reduced (although many times offset through private sector employment growth), the number of central government employees has actually gone up since the election; 2.85 million now against 2.83 million in Q2 2010.

    As for pensions, 94.5% of public sector pensions are defined benefit compared to just 24% in the private sector and three quarters of all people with final salary pensions are public sector workers. In 2006, 3 million private sector workers had final salary pensions and whilst this has fallen to 1.3 million, there has been no change in the public sector. Most public sector workers will retire on 66% of their salary yet most private sector workers will be lucky to get near 40%.

    If we are going to increase public sector pay, we cannot just magic the money out of thin air. Either we have to cut spending more in other areas, borrow more, or raise taxes. Take your pick.

    Adam joined the Centre for Policy Studies as Head of Economic Research in January 2014. 

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