Pay rises for teachers and the NHS will be self-funding

I posted this video this morning. In it I argue that while the Government will agonize over the costs of paying NHS staff and teachers their recom­mended above-inflation pay rises, it is absurd to do so. Taking taxes into account, a large part of the payments due goes back directly to the state quite quickly. Why doesn’t any politician ever talk about this?

The audio version of this video can be found here:

The transcript reads:

There will be a lot of discussion next week about whether the government will give people working in the NHS and education a 5.5 per cent pay rise. We know that the wage boards of both sectors have recom­mended this increase, and this is also correct, because without such an increase, which of course is above the current inflation rate, those who work in these sectors will not see their wages make up the losses, that they suffered during the 2021/22 inflation period.

So why will there be so much debate? Well, because Rachel Reeves will say, ‘There’s no money left.’ We can’t afford that.”

There will be hanging bells. It will be excru­ci­ating. And there will be claims that such a pay rise must be linked to an increase in produc­tivity in the NHS and schools, which, let’s face it, is pretty unlikely.

Why? Because asking a teacher to increase produc­tivity actually means providing less education to every child, and that’s not an outcome that society wants any more than we want a nurse caring for more people takes care.

So let’s look at this from a different perspective.

How much will this really cost the state? And I want to use some numbers here. Let’s assume that the total pay rise would cost £100. That’s it. This is of course unreal­istic, but you can multiply this number by any sum and it will still work the same way as in the example I’m going to use.

And let’s assume that the payment made is made to people who receive the basic income tax rate and pay national insurance on all their income, which is pretty fair because almost everyone who works in education in the NHS will be in this situation your previous income. For some the rate may be higher, but we’re not worried about that.

We’re also ignoring the conse­quences for pensions, but they would actually make the following calcu­la­tions more favorable to the government.

And we ignore the fact that no corporate tax is paid, so it doesn’t need to be taken into account in this calcu­lation, but in the private sector it is.

Now that £100 needs to cover not only the wage increase, but also the employer’s national insurance that is paid for that wage increase. In other words, £100 actually covers wages plus National Insurance at 13.8%, which is currently National Insurance. This means the actual pay rise will be £87.87 and £12.13 of employer National Insurance will be paid. If you add these two numbers together you get £100. But it gave us our first contri­bution back to the government. £12.13 of the employer’s national insurance is paid by NHS trusts, by school trusts, by local author­ities or by anyone else who provides NHS care and education.

Then the person who gets the pay rise, that’s a teacher, that’s an NHS worker, whatever they do, will pay PAYE for what they get. How much will they pay? We said that they are property taxpayers and therefore pay 20%. In other words, £17.57 in income tax, plus the employee’s national insurance, which is currently at 8%, so that’s £7.02 on the £87.87 extra wages they receive.

When you add these two factors together, £24.59 of the pay rise goes back to the government.

But that means that out of that £100 they will have a net pay rise of just £63.28 in their pocket. You can already see that an amount of over £36 has been paid back to the government.

But now there is another factor to consider. When they get their raise, the person will spend it. And they pay VAT. about what they spend money on. Now the VAT varies in rate. I fully agree that if they pay the entire rent increase there will be no VAT on it. If you buy an expensive car, you will have to pay more than VAT. There are also vehicle taxes and other things. But let’s assume a VAT of 20%. This is the standard rate. And it is a sixth of every­thing we spend if VAT is applied at this level. The actual amount we pay includes the 20%. Therefore, we need to divide the expenses by six to find the VAT included.

And that means that for a surcharge of £63.28, £10.54 of VAT could be paid on top of the employer’s PAYE and National Insurance already paid.

This means that £12.13 of the employer’s National Insurance plus £24.59 of total pay plus £10.54 VAT is now passed on to the government as the person in the NHS or training receives their £100 pay rise. Net result? As a result of paying the pay rise, a total of £47.26 will be passed on to the government, or almost half of that, as there will only be £52.74 left to flow into the rest of the economy as a result of spending their pay rise.

But now let’s think about what happens to that £52.74. If the money passed on to the NHS worker was £47.26, we estimate that approx­i­mately 47.26 per cent of the money will now be passed on to someone else to buy services as a result of the spending This person in the NHS or education service also results in a tax return. So 47.26 per cent of this sum, now paid by the person working for the NHS or in education, will serve as a further tax payment to the state. How much will that be? Well, that’s £24.92, leaving a net benefit of just £27.82 to pass on to the third round of this iterative process.

In this third round, £13.15 tax will be paid. And let’s stop here.

Now there is only £14.67 left, but of course we could repeat the process several times, returning smaller and smaller amounts of money to the government.

What you will have realized by now is that if we add all these figures together, a total of £85.33 is paid in tax out of every £100 that a pay rise cost.

And it doesn’t take long for all these processes to take place, maybe months at most.

My point is simple. This salary increase largely pays for itself.

And when we consider that happier employment in the NHS and education is likely to lead to better quality of service and therefore healthier outcomes for people or better educa­tional outcomes for our children, then we actually see a further benefit, not least in the case of the NHS as more people may be able to go back to work and produc­tivity will increase.

In other words, it is entirely possible that the gain to the government from a pay rise to keep NHS staff happy at work will be more than recouped by the extra taxes paid, let alone anything else.

So what is the government pondering when it comes to these wage increases? I wish I knew. If only they under­stood this process, called the multi­plier effect, then they would do their economic thinking about wage increases correctly and realize that they pay for themselves within reason. It really is time for them to do it.

Many thanks here to commenter Andrew for making me do this video.