Adam Smith Institute

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The tax wedge

Tom Clougherty
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In the comments under my blog on merging income tax and national insurance, and number of readers quite rightly point out that employers’ national insurance contributions are not really paid by businesses at all. In the long, the burden falls employees.

Putting it simply, most firms will have a staff budget, out of which they pay the employee's wages, income tax, employee NICs, and employer NICs. So when governments hike employer contributions, it ultimately results in wages staying lower than they otherwise would have, and employees getting a worse deal. So if we're going to be really honest about the income tax burden, we really ought to factor in both employee and employer NICs, and compare the total cost to the employer of an employee with that employee's take home pay.

Based on the combined income tax and national insurance table I put up yesterday, and factoring in employer contributions (set to rise imminently to 13.8 percent), you can say the following:

  • Someone with a salary of £25,000 will actually cost their employer £27,474. The employee will only receive £19,362 of that. 30 percent of the total cost of employing them goes directly to the government.
  • Someone with a salary of £50,000 will actually cost their employer £55,924. The employee will only receive £35,611 of that. 36 percent of the total cost of employing them goes directly to the government.
  • Someone with a salary of £75,000 will actually cost their employer £84,374. The employee will only receive £50,111 of that. 41 percent of the total cost of employing them goes directly to the government.
  • Someone with a salary of £100,000 will actually cost their employer £112,824. The employee will only receive £64,611 of that. 48 percent of the total cost of employing them goes directly to the government.

This gap between cost of employing a worker and what they actually receive is known as the 'tax wedge'. It is damaging to the economy because it makes many jobs uneconomic, as the gross cost for the employer of providing a reasonable after-tax wage becomes more than the work is worth.