Taxes on Wages
Source: David Ricardo, On the Principles of Political Economy and Taxation, Chapter XVI, "Taxes on Wages" • Course status: full course day for the Ricardo principles course
Key terms
A wage tax looks as if it falls on labourers. Ricardo argues that, when wages are near the cost of maintaining workers and their families, the long-run burden moves to profits.
| Term | Meaning |
|---|---|
| Gross wage | The money wage before tax |
| Net wage | What the worker keeps after tax |
| Natural wage | The wage compatible with maintaining the labouring population |
| Market wage | The wage currently paid |
| Wage advance | The capitalist's wage payment before output is sold |
| Incidence shift | Movement of the burden from legal payer to another income share |
Ricardo's incidence chain
At first, the worker remits the tax and net wages fall. If the old wage was only enough to buy necessaries, that lower net wage cannot persist without affecting labour supply.
The tax is called a wage tax, but Ricardo treats its ultimate effect as closely resembling a direct tax on profits.
Worked miniature: restoring the net wage
Suppose the weekly natural wage is £10 and the state taxes gross wages at 20 percent.
If gross pay stayed £10, the worker would keep only £8. To restore a £10 net wage:
required gross wage x (1 - tax rate) = required net wage
gross wage x 0.80 = £10
gross wage = £12.50
| Item | Before | After adjustment |
|---|---|---|
| Gross wage | £10.00 | £12.50 |
| Wage tax | £0.00 | £2.50 |
| Net wage | £10.00 | £10.00 |
| Employer's weekly wage cost | £10.00 | £12.50 |
The worker sends £2.50 through payroll, but the employer advances £2.50 more. In Ricardo's model, profits absorb the difference.
Use the Lab to move the market wage away from the natural wage. The adjustment back toward subsistence is the mechanism Ricardo relies on when he says the wage tax cannot remain on workers indefinitely.
Why commodity prices do not generally rise
An individual manufacturer might try to add the higher wage bill to price. But the wage tax affects labour used in every trade.
Because the pressure is general, capital cannot escape it merely by moving from cloth to farming. Ricardo therefore resists the claim that a wage tax simply raises all commodity prices.
Wage tax versus raw-produce tax
The two taxes can both lower profits, but their first steps differ.
| Tax | First price effect | Route to profits |
|---|---|---|
| Tax on corn | Corn price rises | Dearer subsistence raises money wages |
| Tax on wages | Net pay falls first | Gross wages rise to restore subsistence |
The farmer can pass a corn-specific production tax into corn's price after marginal supply contracts. A general wage tax does not single farming out relative to manufacturing.
Assumptions and limits
Ricardo's conclusion is strongest under demanding assumptions:
- wages begin near subsistence;
- workers cannot permanently accept lower consumption;
- labour supply responds over time;
- the tax is general rather than confined to one occupation;
- employers cannot indefinitely earn less than the ordinary rate in one sector only.
If wages contain a large surplus above subsistence, workers may bear more of the tax for longer. The model is a long-run distribution theory, not a claim that every payslip tax is instantly reimbursed.
Key takeaways
- The legal wage-tax payer can differ from the ultimate bearer.
- Restoring a £10 net wage under a 20 percent tax requires £12.50 gross pay.
- A general rise in wage costs lowers the residual profit share in Ricardo's model.
- A wage tax and a corn tax can converge on lower profits through different paths.
- The conclusion depends on subsistence wages and long-run labour-supply adjustment.
Checklist
- [ ] Can you distinguish gross wages from net wages?
- [ ] Can you calculate the gross wage needed after a tax?
- [ ] Can you trace the incidence shift from worker to capitalist?
- [ ] Can you explain why all prices do not automatically rise?
- [ ] Can you name the assumptions behind Ricardo's conclusion?