The wage inflation tax proposed by Sushil Wadhwani (‘Time for the UK to tax inflation’ 5 September) would be inappropriate, impractical, and ineffective.
It would be inappropriate because it would prevent markets from working properly. The wages paid by each company to each employee, like the prices of any other good or service, should be free to respond to the forces of supply and demand.
Specifically, imposing punitive taxes on wage increases above a certain threshold would make it harder for businesses to recruit, reward and retain staff, especially at a time of severe labour shortages. It would also penalise those where higher productivity justifies higher pay.
It would be impractical. What if the government itself imposes a large increase in the national minimum wage? What about workers whose pay has been frozen, or even cut, in previous years? What about bonuses, allowances, or ‘promotions’, which are bound to multiply as firms look to avoid the new tax? Imagine the additional bureaucracy needed to police all this.
Last but not least, this proposal would be ineffective, because it would not tackle the underlying monetary causes of inflation. Wages are only just beginning to catch up with prices. If anything, inflation is fuelling wage rises, rather than the other way around.
In short, a revival of failed ‘incomes policies’ would simply distort price signals and make life more difficult both for businesses and their staff. It is a terrible idea.
This letter was published in the Financial Times on 11 September 2023
ps. I also recommend this piece by Ryan Bourne, which digs deeper into the point about the importance of price signals. Or as Ryan puts it, “calling Wadhwani’s proposal an “inflation tax” is a misnomer. It will be a tax that will deter the likelihood of thousands and thousands of relative price changes that would otherwise have occurred too. That’s important, because relative price changes are what provide the signals and incentives that make a market economy work effectively in reallocating resources in ever-changing conditions. By snuffing out many of these price signals, such a tax would create all sorts of economic dysfunction”.
Plain-speaking Economics 