Recalculating the Living Wage

I very much welcome the increase in the minimum wage to £7.20 an hour announced by George Osborne in his budget a few weeks ago, and that it would be set to rise to over £9 an hour by 2020. On the face of it, this 2020 figure would probably be in line with the Living Wage as calculated by the Living Wage Foundation.

When first introduced in 2011 the Living Wage was £7.20, and since then has risen by 25p in 2012 and by 20p in both 2013 and 2014 to now stand at £7.85. If that same annual increase were maintained for the next six years, then it would indeed be just over £9 an hour by 2020. Although, to be more precise, the Low Pay Commission (who recommend the minimum wage rate to the government) have been asked to ensure that the minimum wage reaches at least 60% of median earnings by 2020 ... which will probably be more than £9 an hour.

As a target sum, this would comfortably beat Labour's manifesto promise of £8 an hour by 2020, and be equal to what Plaid Cymru and the SNP had proposed. The LibDems didn't make any commitment. Only the Greens proposed something better: that the minimum wage would rise to £10 an hour by 2020.


The problem, as everybody realizes, is that the Tory increase in the minimum wage is going to be offset by cuts in tax credits. In some cases families will be worse off, although not in every case. There is a good article on this here by the Social Market Foundation. They assume that 60% of the median wage will result in a minimum wage of £9.35 an hour, and on that basis this is the worst case graphic from it:


But it is better for others, as this graphic shows:


The question I asked myself was to what extent the proper Living Wage, as calculated on behalf of the Living Wage Foundation, would need to be adjusted to take account of the fact that tax credits would now be cut. But in doing this I discovered something which surprised me, which I think most people will be unaware of, and which is the main reason for me writing this post.


The way that the Living Wage is calculated is set out in detail in this document. When the calculation was first made in 2011 the £7.20 rate it set was accurate, but the increases in the Living Wage since then have been limited by a formula which states that it should not increase by more than 2% above any rise in average earnings.

The effect of applying this cap is quite startling. This is from the conclusion at the end of the 2014 calculation:

Based on the above calculations, the ‘reference’ level of the Living Wage, reflecting actual minimum living costs, is £9.20 in 2014, but the applied Living Wage, resulting from the capped increase, is £7.85.

The difference is a huge £1.35 an hour.

I suppose I can understand the rationale behind the cap. The aim of the LWF is to get employers to become accredited Living Wage Employers; and in order to make a long-term commitment, it was helpful for there to be some method of cushioning large increases. Back in 2011 it was probably reasonable to assume that wages would rise following the worse ravages of the recession caused by the 2008 financial crisis, but wages haven't gone up by very much at all. So it's proved to be a false assumption. Whatever good intentions lay behind imposing this cap, the end result is that the current Living Wage of £7.85 is now way below what it should be in order to meet actual minimum living costs. Instead of rising by about 65p or 70p each year, the Living Wage has only risen by 20p or 25p each year.

Now consider what will happen over the next five years. It seems pretty obvious that the calculated Living Wage is going to rise further. In part this will be because of the effect of reductions in tax credits, but on top of that there will be the usual cost of living increases. What is currently calculated at £9.20 will certainly be over £10 an hour and probably closer to £11 an hour by 2020.


The definition of the Living Wage, as taken from calculation document, is "the wage that produces enough income after taxes, benefits and tax credits to cover [a family's] expenses." So it is clear that the next calculation of the Living Wage will need to take the reduction in tax credits into account. This will be a major change, and therefore will provide a perfect opportunity to reset the calculation without the cap imposed in previous years.

I'm sure this will result in a large rise which will make some accredited Living Wage employers think twice. But I think it's a bullet that needs to be bitten. If the Living Wage doesn't actually reflect what minimum income is needed to cover expenses, it is meaningless.

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