Stephen King: Lifestyle employment change could put revenue forecasts at risk

A large number of e-mails suggest that I am too "trusting" of the official unemployment data
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The Independent Online

Last week, I argued that something had gone wrong with Gordon Brown's tax revenues. This week, it seems that the Chancellor agrees. The Pre-Budget Report revealed that the fiscal position is even worse than the worst fears of City pundits. Mr Brown will borrow £37.4bn this year, the equivalent of 3.4 per cent of GDP, up £10bn compared with the plans put forward in the last Budget proper.

The Chancellor's big problem is not so much a lack of economic growth but, rather, a lack of tax revenues associated with decent economic growth. Last week, I suggested that this revenue shortfall was puzzling. Specifically, I argued that, while unemployment had come in persistently lower than expected both in the late 1990s and into the new millennium, tax revenues had first surprised on the upside and then, more recently, had surprised on the downside. On the basis that lower unemployment means more workers and, therefore, more tax revenue, this didn't seem to make very much sense.

A seemingly innocuous point, but one which has stimulated a large number of e-mails suggesting that I am too "trusting" of the official unemployment data. Instead, these correspondents suggested, were I to adjust for the impact of Government "fiddles" designed to "fudge" the unemployment rate, I would find it much easier to explain the revenue shortfall over the past three years.

I've decided to delve into this subject a bit more this week. After all, the revenue shortfall raises all sorts of difficult questions for the Treasury. If revenues continue to disappoint, there is a danger that the budget deficit continues to overshoot, eventually tarnishing Mr Brown's Golden Rule and rusting the Iron Chancellor's reputation.

So, is there a problem with the unemployment numbers? The simple answer is "yes", but it is not immediately apparent that the problem is directly relevant for tax revenues. My left-hand chart shows two measures of unemployment, indexed to equal 100 in 1992, with one falling much more quickly than the other.

The series showing the faster rate of descent uses the International Labour Organisation (ILO) definition of unemployment, not the claimant count that has been rendered rather meaningless over the past 20 years through countless revisions and re-definitions. The series showing the slower rate of decline requires a bit more explanation. It shows the ILO measure of unemployment again, but this time I've combined it with a measure of those people who are of working age, not entitled to sign on, not counted as unemployed on the ILO measure, economically inactive but who are, nevertheless, keen to work.

The chart suggests that unemployment, allowing for the economically inactive who would like to work, has fallen only gradually over the past 10 years, whereas unemployment on the "standard" measure has come down a lot more quickly. The message is quite simple: unemployment has fallen by 50 per cent on the standard definition, but by only 20 per cent when the economically inactive who would like a job - roughly 2 million at the moment - are included.

This, however, does not really help to explain the revenue shortfall now threatening the Chancellor's plans. The problem is fairly obvious: the gap between the two different measures of the economically "inactive" has been consistently growing over a good decade or so, yet, over this period, there have been both upside and downside surprises to tax revenues. It may be true, therefore, that there are plenty of people who would like to work yet are unable to find a job, but it cannot be the case that this argument alone can account for the recent revenue shortfall.

What about people who have temporary or part-time jobs but who would rather have a full-time job, where they might be contributing more to the Exchequer? Could this be a hidden form of unemployment? In theory, of course, the answer must be "yes". And, according to data from the Labour Force Survey, there are plenty of these disappointed people.

However, from the perspective of tax revenues, this story is also less than helpful. The proportion of part-time workers who would rather have a full-time job has steadily fallen over the past 10 years, from a peak of more than 40 per cent to a new low of 25 per cent. The proportion of temporary workers who would rather have a full-time job started off at a lower peak in the first place, a little less than 15 per cent, but has now come down to about 8 per cent. Had these numbers risen over time, suggesting that people had been forced into part-time or temporary work, there might have been a good case for associating changes in this area with tax shortfalls. But this has clearly not been the case.

How about the number of hours that people work? Again, there is evidence of considerable change in recent years. The number of people in work in the UK has risen steadily, from just over 25 million 10 years ago to approaching 28 million today. From around 1998, the number of hours worked by these people began to fall. In the mid-1990s, people on average were working more than 33 hours per week. By the end of last year, this figure had fallen to just over 32 hours per week.

Some of this change could be entirely voluntary, a reflection of lifestyle choices made by individual workers. Some of it may have come about because employers are offering more flexible working arrangements for their employees: the shift from private sector to public sector employment in recent years might have influenced this change. But I suspect that a good chunk of this is a sign that companies are trying to reduce their labour costs without wishing to incur hiring and firing bills. And the Chancellor will also be hoping that this is true: because, on that basis, he can hope that a recovery in both domestic and global economic activity will lead to a greater number of hours worked. If, though, we are seeing a permanent change in the labour market landscape, it will be a lot more difficult to make the Chancellor's sums add up.

Then there are the self-employed. My right-hand chart shows the growth rate of both employees and the self-employed over more than two decades. The self-employed have enjoyed - if that is the right word - a renaissance over the past couple of years, after significant declines in the late 1990s. Employee growth, however, has waned over the past couple of years. What's happening? This might be a story of people losing their jobs and deciding instead to set up shop on their own. Or perhaps the absence of real opportunities forces them into self-employment against their wishes. Once again, the Chancellor will be hoping this is no more than a cyclical effect.

However, at least some of these people will have decided simply to exit from the rat race, getting out of big companies and big cities and deciding to work to rule - specifically, to their own rules. And this is where the big threat to the Chancellor's tax revenues comes from. It is not so much a shortfall of demand, because he can always hope that today's shortfall will be tomorrow's healthy rebound. Rather, it's a lifestyle threat. I do not want to diminish the genuine suffering of those who are either officially unemployed or, more euphemistically, economically inactive, but Mr Brown's revenue undershoot may be more a product of lifestyle choice. People who choose to work fewer hours, who spend more time with their children during school holidays or who decide to work on their own terms may be signs of a thriving and flexible labour market, but they also suggest that revenues will not pour into the Exchequer as quickly as the Chancellor would like.

Stephen King is managing director of economics at HSBC