Buying out employment rights: a very limited proposal

 

After apparently backing away from comprehensive schemes for liberalising the labour market, the government yesterday made a small gesture in this direction. In his Conservative conference speech George Osborne unveiled a plan to allow firms to buy out a number of employment rights, including unfair dismissal, redundancy payments and some maternity entitlements, in exchange for company shares. Capital gains on these shares would be tax-free.

Mandated employment rights raise costs to employers in the first instance. However economic theory and a good deal of evidence suggests that in competitive markets this burden is passed on to employees. The demand for labour is reduced while there may be some increase in supply as working becomes marginally more attractive. These changes together tend to reduce pay and, depending on the average worker’s valuation of the right, probably also lead to lower employment. In the case of minimum wage workers, where pay cannot fall further, mandated rights unequivocally reduce employment.

Removing these rights directly would in the long run benefit most workers, but the government clearly baulks at such a radical move.  In principle Mr Osborne's plan to allow these rights to be bought out by employers makes sense, then, as it gives firms greater flexibility and employees more choice.

If the proposal was to allow all employers to buy out rights for cash it would be a very interesting development indeed. However the proposal to make payments only in shares severely limits the application of this approach. The idea seems to be to tie it in with the encouragement of smaller start-up businesses. There may conceivably be a case for stimulating such businesses, though that needs to be made separately. But these businesses will always have high death rates, so a fair proportion of shares (which in any case must be difficult to sell or even value) will turn out to be worthless. Employees are not stupid, nor are they all risk-takers – in any case, even rational risk-takers would be advised not to put all their eggs in one basket. If the firm goes bust they lose both their jobs and some of their financial assets.

I can see that this type of offer could appeal to some individuals in fast-growing businesses, but it seems unlikely that a majority of employees would freely take such a gamble. Would it become compulsory for new employees? This may create problems by discouraging mobility between jobs and setting some groups of workers against each other. It is likely, therefore, as the CBI has said, to have only a ‘niche’ appeal. And, by the way, it will complicate the tax system yet again, surely not something to applaud.

Private equity or foreign-owned businesses will not be affected. Nor, more importantly, will the public sector or small unincorporated businesses, where arguably the need for reform of employment rights is greatest. Moreover, even where employees agree to sell some of their employment rights they will retain others. If dismissed it is likely that a large proportion will identify themselves as victims of gender, racial, age, sexual orientation or other form of discrimination and proceed to tribunals on these grounds. A more significant reform would involve limiting the grounds on which discrimination could be claimed, and capping the amount of compensation which tribunals could award.

I’m not going to dismiss Mr Osborne’s proposal out of hand. Any attempt to shake up employment laws is worth looking at, and it will be interesting to see if something useful does come out of the scheme. If so, its scope could be extended. But I’m not holding my breath at this stage.

Michael Forsyth on the Daily Politics today pointed out two serious flaws in this limited proposal. First, giving away equity is extremely expensive for the founders of such firms, in the event that the firm prospers; and second, there is an annual allowance of £10,000 tax-free for capital gains, so the 'tax-free element for employees is unlikely to be worth anything in nearly all cases.

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