George Osborne’s decision to raise the minimum wage sharply next year will cost private-sector employers about £1bn, according to a watchdog.

The Regulatory Policy Committee, an independent public body that scrutinises government proposals, said the policy would affect 1.7m employees and cost businesses about £804m in direct wage and non-wage costs such as national insurance contributions.

It predicted there would be another £234m “spillover costs” because some employers would have to raise pay rates further up the staff hierarchy to maintain the differentials and progression routes for lower-paid workers.

The figures only apply to the cost of the initial increase in the minimum wage for over-25s to £7.20 an hour in April. The final cost to businesses is likely to be greater, since the chancellor has announced plans to increase the rate to more than £9 an hour by 2020.

The RPC criticised the government for not assessing the total cost of the policy up until 2020. It was “not persuaded” by the government’s arguments that it would be inappropriate to assess the whole period to 2020 because the target was “not in regulation” and that to assume a path for the rate would undermine the independence of the Low Pay Commission, the body tasked with recommending the minimum wage rates each year.

“The announcement of the Government’s 2020 target is, arguably, a much more significant constraint on the LPC than setting out an illustrative path of how to get there,” the RPC said in its assessment. “The RPC remains of the view that best practice would be for the department to provide an economic appraisal of the full policy ambition, as announced by the chancellor, and not solely an assessment of the impact of the proposed first-year regulatory change.”

Economists are very uncertain about how employers will cope with the higher costs of the minimum wage. They could respond by cutting jobs, raising prices, accepting lower profits or trying to boost worker productivity.

A recent government survey of employers found that about 93 per cent of respondents thought the policy was “a good idea” and 88 per cent said it would make staff more productive.

However, some business leaders are privately critical of the policy, especially since the cost comes on top of other burdens such as the new “apprenticeship levy” and pensions auto-enrolment.

The business innovation and skills department said: “It is important that the impact of rises in the national minimum wage and the national living wage balance the need to provide a fair wage while not damaging business.” The government was introducing steps to mitigate the cost on business by increasing the employer allowance from £2,000 to £3,000, which would benefit up to 590,000 employers.

“We are also cutting corporation tax from 20% to 18% by the end of the parliament which will benefit over a million firms, save businesses £6.6bn by 2021 and give the UK the lowest corporation tax in the G20.”

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