This week is Living Wage Week. Most of you will be familiar with the concept of a Living Wage – a wage calculated according to the basic cost of living in the UK, or in other words, a wage that provides dignity for ordinary workers, allowing them to participate in society in a meaningful way.

Given the huge boost that a Living Wage can provide to poorer workers, it seems obvious that the effect of a Living Wage would be to reduce inequality.  But there are those who have doubts.

There are two arguments generally deployed to explain why a Living Wage might, in fact, increase inequality. The first is that a compulsory Living Wage would effectively act as a substantial increase to the current National Minimum Wage (and in fact, it would be a large increase to the so called ‘National Living Wage’ announced earlier in the year). A Living Wage for all workers, it is argued, would lead to high levels of unemployment, in turn leading to higher inequality.

There’s evidence to support this claim, but a voluntary Living Wage neatly sidesteps this problem, as it is only those employers who can afford it that sign up.

The second argument is that a large increase to the minimum wage (as a Living Wage would be) would decrease wage inequality but increase household inequality. This is because high income households are more likely to be in work and can also have someone earning the minimum wage (or in this case the Living Wage acting as a minimum wage).

If that seems counter-intuitive, consider how low and high income households might look. A low income household could include two people who are temporarily out of work. A high income household could include a high earning individual and a second earner on the minimum wage. The latter would therefore benefit most from an increase in the minimum wage. In addition, whilst low income households benefit more from a higher minimum wage before tax and benefits, after tax and benefits households in the top half benefit more. This is because households in the bottom half lose tax credits as their wage rises.

The first problem with this argument is that there is little evidence on exactly which households benefit most from the voluntary Living Wage. The second is that it fails to consider how a voluntary Living Wage can interact with other policies. In particular, there is good evidence that the interaction between the Living Wage and tax credits can have a strong effect on inequality reduction.

When a company pays the Living Wage, it reduces the amount of tax credits that need to be paid to its employees to top up low pay. Almost half of the gain from an increase to incomes of people in the lower half goes to the government in reduced spending. If the savings from tax credits are then channelled towards those households most in need, this can effectively reduce inequality.

Of course, the alternative conclusion is that a higher minimum wage (rather than a voluntary Living Wage) can allow for less to be spent on tax credits. This certainly appears to be the approach taken by the Chancellor, via the National Living Wage and £4bn of cuts to tax credits. Sadly, he’s got his maths hopelessly wrong, with cuts being so vast that they dwarf the planned increase to the minimum wage.

A third and final problem with the argument that a voluntary Living Wage increases inequality is that it fails to consider how firms respond to a Living Wage. Firms signing up can choose to pay for this increase in costs in different ways. For example they could decide to curb pay in more senior positions, a measure that would clearly reduce wage inequality and most likely household inequality as well. They could also look to increase productivity, which would have a neutral effect on inequality.

Wage policy is complicated and fraught with unintended consequences. But the voluntary Living Wage is not only an important measure to tackle low pay, it’s vital to tackling inequality.

John Hood, Media and Communications Manager