Labour’s increase to employer National Insurance as part of the 2024 Budget may well have been the worst tax rise it was possible to come up with – leading only to lower wages and reduced employment. Now Reform UK appear determined to find the worst possible tax cut, with their proposal to exempt overtime from income tax.
The party calls it a ‘hard work bonus’, says it will cost £5 billion a year, and that welfare cuts will pay for it. It is a clever and bold piece of PR. It is also, on almost any view, terrible.
Reform have caught a disease normally found on the left – they’re ignoring incentives. They think their policy encourages more overtime. The actual inventive it creates is to encourage more work to be labelled as overtime
Reform have tried to stop the relief being exploited by high earners by saying it will only apply to those earning less than £75,000. That creates a cliff edge of almost comic proportions.
Take someone on a £60,000 salary who has £14,999 of overtime. Their total pay would be £74,999, and their overtime would be income-tax-free. But give them a £1 pay rise and the exemption would disappear. Their tax and NIC bill would jump up by about £6,000. The marginal tax rate on that final pound would be 600,000 per cent. That is not a typo. They would have to earn £85,000 before they were back in the same financial position. A policy supposedly designed to reward hard work would, at the £75,000 point, punish it catastrophically.
Then here’s an obvious equity problem. Imagine two plumbers, both working 50 hours a week, and both earning £50,000 – but one has 50 contracted hours and the other has 40 contracted hours plus ten hours of overtime. The second will be £5,000 better off under this proposal. That makes no sense. So what will the first do? Obviously try to change their contract. They won’t work a single additional hour, but will suddenly have ten hours magically labelled ‘overtime’.
The effect of this would be massive. About £868 billion of employee pay sits below the £75,000 threshold. If even 5 per cent of that pay were relabelled as tax-free overtime, the cost of the policy would be about £10.8 billion. But we don’t need to guess – we can look at what happened when France introduced a very similar policy in 2007. There was no significant effect on actual hours worked at all – but a sharp rise in declared overtime, concentrated among skilled workers whose hours were hardest to verify. The French abolished the relief in 2012. If we take the French outcome and extrapolate to the UK, we see that the cost of the policy isn’t the £5 billion claimed by Reform, but around £12 billion.
That, however, is just the start. Take the self employed. A self-employed plumber obviously doesn’t have overtime – the policy does nothing for them. They will likely see that as unfair and respond rationally – by incorporating and paying themselves a salary plus overtime. People who already have ‘personal service companies’ can just restructure how they’re paid. This would add even more to the cost of the policy – Tax Policy Associates’ central estimate is £3 billion, but it could be much higher. It takes the overall cost of Reform UK’s proposal to £15 billion.
Robert Jenrick, Reform’s shadow chancellor, has defended the scheme by saying there would be, of course, anti-avoidance rules. But that is easier to say in a television studio than to write into law. There is no clean legal distinction between a 50-hour contract and a 40-hour contract plus ten hours of ‘overtime’. Policing the boundary would require HMRC to scrutinise ordinary employment contracts and decide between real hours and spurious overtime. This would be a bonanza for tax lawyers, but not so good for the rest of us.
None of this would matter if the policy led to growth. But the problem is that overtime only makes up a relatively small proportion of the UK economy. The ONS estimates that only £16.8 billion of overtime is paid to those earning below £75,000. The numbers are tiny relative to the cost of the measure, at best dropping the net cost of the policy to £14 billion.
Reform have caught a disease normally found on the left – they’re ignoring incentives. They think their policy encourages more overtime. The actual inventive it creates is to encourage more work to be labelled as overtime.
There are many better ways to deploy £5 billion of tax cuts. Cutting employee national insurance, raising the personal allowance, fixing the £100,000 taper, smoothing the universal credit taper, abolishing stamp duty on shares, reducing stamp duty land tax, cutting basic rate income tax – any of these policies would be better than this.
We can calculate the ‘bang for the buck’ of each tax cut: how much GDP growth it delivers for each pound deployed to cut tax. And if we put them in order, Reform UK’s proposal languishes at the bottom:
Every one of the above policies generates more growth than Reform’s proposal; none of them creates a six-figure-per cent cliff edge; and none of them invites every company in the country to redraft its employee contracts on the morning after the Budget.
In the end, anyone looking to cut tax should follow Nigel Lawson’s advice: ‘The objective should always be to charge lower rates on a broader tax base. That is the best way to improve incentives without an unacceptable revenue cost’. In other words: stop fiddling with special rules. Just cut rates.
Reform deserve some credit for at least coming up with a specific tax cut. This, however, is exactly the kind of tax policy economists warn against: something attached to a label rather than to real economic activity; with a cliff edge so steep it becomes absurd; and a boundary HMRC cannot sensibly police. A serious tax-cutting party should cut rates, broaden the tax base and remove distortions. Reform could become that party before the next election – but this policy suggests they are not there yet.
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