The Bank of England has been scratching its head for months about the state of the economy. Unemployment is much lower than Threadneedle Street envisaged when Mark Carney unveiled his forward guidance strategy this time last year, but so is the rate at which earnings are increasing.
Despite the fact that real incomes are barely growing, the numbers for consumer spending look surprisingly strong. Retail sales in the three months to June were 4.5% higher than in the same period of 2013, while new car registrations in July were up by more than 6% on a year earlier. The unbroken run of year-on-year increases in car sales is the longest since records began in 1959.
But here’s another twist. More people in work, together with tills ringing in the high street, normally means a big improvement in the public finances as higher income tax and VAT receipts roll in. But reducing the budget deficit is proving to be a long and slow process. In the first three months of the 2014-15 financial year, income tax and capital tax receipts were 3.5% lower than the previous year. Even taking into account the way in which many City bonuses were delayed until April 2013 to exploit the cut in the top rate of income tax, that is a weak performance.
So what’s going on? One explanation is that Britain has become a part-time economy. A feature of the labour market is the increasing role played by the self-employed, who account for more than 80% of the net rise in employment since 2008. A large number of the self-employed may be former full-time staff in well-paid jobs in, say, the public sector or construction, who are now scratching a living where they can.
What’s more, older people are now topping up pensions by doing a few hours a week stacking shelves or operating the tills at the supermarket. Sprinkle in the effect of a tougher benefits regime and below inflation rises in public sector pay and there you have it: an expanding but more casualised workforce.
But this does not entirely square with strong consumer spending. It is possible that raising the tax-free personal income tax allowance to £10,000 has been a factor, because people have come off benefits and into jobs that are not liable to income tax. They are better off than they were but not enough to be making a difference to the taxman.
However, for this to be a completely convincing argument, the state finances would still be benefitting from a rise in national insurance contributions. These are payable on earnings more than £153 a week (or about £7,500 a year). But the latest official data shows national insurance contributions were actually slightly lower in the three months to June 2014 than in the three months to June 2013.
So either the jobs that are being created are so low paid that they are not subject to either income tax or national insurance, or something else is going on. That something could be that people on benefits are doing some informal paid work but not declaring it to the taxmanbecause they lose almost as much in benefits as they gain from working. And that the new army of self-employed handymen, management consultants and child minders are not declaring all they earn to HMRC.
Of course, this is mere conjecture. Discovering how much paid for economic activity goes unrecorded because people hide it from the taxman is notoriously difficult. The most recent estimates suggest UK output would be just 10% higher were all the cash-in-hand jobs declared to HMRC.
A book published by the free-market Institute for Economic Affairs last year concluded that the size of the shadow economy had increased in the UK since 2007, although it is far less significant than in most other European countries.
But it is conceivable that Britain is becoming Del Boy Nation: doing a bit of ducking and diving, trying to keep one step ahead of the revenue. That would help explain why consumer spending is rising more rapidly than wages, and why VAT receipts are growing slightly more strongly than income tax receipts.
Let’s assume for a moment that there is more informal activity going on. What should the government response be? One option would be to employ more tax inspectors and launch a crackdown on evasion. That, though, would be an uphill struggle. The number of tax inspectors is small. Low-level evasion is large.
An alternative would be to encourage those working in the informal economy to join the formal economy. The impediment to that is a tax and benefits system that is hugely complex, means-tested and discourages those working less than full-time on low earnings from working longer hours (at least officially).
One radical suggestion is for everybody to receive a citizen’s income. Under this scheme, waged and unwaged, children and adults, the working aged and pensioner, rich and poor alike would receive the same basic income financed by the phasing out of virtually every tax relief and allowance. Those on benefits would not face high marginal tax rates if they took a job, but merely pay PAYE at the current standard rate of 20% on every pound they earned. Those working 20 hours a week on the minimum wage could work 40 hours a week without losing more than 50% of their extra earnings in lost tax credits.
There would be other advantages from such a system. First, it would be universal and hence avoid the stigma attached to benefits. Secondly, people taking a job or starting a business would have the security of knowing that they would still have their citizen’s income if the venture did not work out.
Concerns that a citizen’s income would encourage the idle to sit at home all day watching daytime TV do not appear to be supported by evidence from pilot schemes in other countries. Even so, there would be cases where this did happen and they would doubtless be highlighted as an example of a something-for-nothing culture. Other drawbacks include the failure so far to construct a citizen’s income that obviates the need for housing benefit, and the political difficulty in persuading voters that a millionaire should be getting the same citizen’s income as a milkman.
So far support for a citizen’s income is limited to the Green party, although the government’s switch to a flat-rate state pension is a step in that direction. The truth is that no tax and benefit system is perfect. But the one we have is costly, bureaucratic, ineffective – and ripe for reform.
