View From City Road: The trouble with profit-related pay . . .

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The Independent Online
Like mortgage interest relief, married persons' allowances and other tax breaks, profit-related pay is difficult to justify intellectually but hard to give up once you have had the pleasure of it.

The idea has its roots in the argument made by the US economist Professor Martin Weitzman in 1984, that if an element of an employee's pay is variable it helps to reduce unemployment and increase production. By feeling the financial effects of good and bad years, employees would become more focused on their company's profitability. Endorsed by the Wall Street Journal as 'the best idea since Keynes', it was introduced in the UK as PRP in 1987.

Accountants, who have benefited greatly by selling their expertise in introducing the schemes, like to insist that government support for it is based - as with those other tax breaks - on some notion of public good.

But they admit that few companies opt for PRP with the intention of reducing unemployment. They are much more concerned about controlling costs. And a system that enables them to provide staff with pay increases of up to 7.6 per cent at no cost to themselves has got to be welcomed.

Just how powerful the tax incentive is can be gauged by looking at the take-up before March 1991, when employees could receive up to pounds 3,000 of their pay as PRP and receive tax relief on half of it. The Budget of that year more than doubled the benefit by raising the limit to the lower of 20 per cent of pay or pounds 4,000, and giving relief on all of it. The cost of this munificence to the Inland Revenue was pounds 300m in the last financial year.

The attractions for the employee, on the other hand, are less obvious. As Tony Groom of the accountants Ernst & Young accepts, communication is a big problem. Saying to the workforce, you're having a pay cut, but trust us you'll be better off, is a tricky message to get over. Especially since the whole point is that you will not necessarily earn more - that only happens if the company's profits go up.

This aspect has caused problems in the United States, where unions have insisted on rises in basic pay to compensate for large downturns in profits. On this side of the Atlantic, despite the accountants' claims of universal support, the Transport & General Workers Union, for one, takes a cautious approach.

While accepting that it might sign up for schemes in certain circumstances, it takes the view that profits in most industries depend on factors generally beyond the control or influence of a single person.

Smaller - and usually less unionised - companies have hitherto found it easier to get the message across and have accounted for the bulk of nearly 7,500 schemes in place. But proponents say that the coming months will see other large companies joining the likes of Boots, the John Lewis Partnership and Marks & Spencer in setting up schemes.

With 1,856,000 employees already covered, the arrival of such big guns will ensure that a significant proportion of the private sector workforce (those in the public sector are ineligible) enjoys this perk.

It is the mortgage interest relief story all over again. While there is little logic in the programme, it will be politically costly to claw back cash by abandoning it. But it ought to be allowed to wither away gradually over the years, like mortgage relief.