Chapter 1: Introduction

In our remit the Government invited us to review our recommendations for uprating the adult and development minimum wage rates in October 2006 in the light of present economic circumstances. The Government also asked us to review the level of the minimum wage rate for 16-17 year olds, the operation of the accommodation offset and the treatment of benefits-in-kind, including those offered as part of a salary sacrifice arrangement.

Chapter 2: Review of the Rates

In our 2005 Report, which made recommendations for October 2005 and October 2006, we said that we believed it was appropriate to increase the minimum wage slightly faster than average earnings over that two-year period. We also recommended that we should review the October 2006 rate in January 2006 to check whether economic conditions had changed in any way that made the proposed increase inappropriate.

Our review of economic conditions revealed some factors which could argue for a slight reduction in the October 2006 increase: economic growth in 2005 was less dynamic than we anticipated in January 2005, and forecast growth for 2006 has also been shaded down. Consumption spending was relatively subdued, with negative implications for low-paying sectors, in particular retail. Average earnings increased somewhat less than we anticipated over the last year (by 4.1 per cent not 4.5 per cent) and forecasts for 2006 suggest a similar shortfall. And the slowdown in average earnings growth appeared greater if we focused on the private sector alone, and particularly on some of the most affected sectors.

Conversely, we noted that employment continued to grow, both in the overall economy and in the low-paying sectors, and that corporate profitability continued its cyclical improvement. The latest data showed that, although total employment fell by 22,000 in the quarter to November 2005, it increased by 221,000 over the year to November. While some groups, such as young people, did less well, the employment rates of others, older workers for example, rose. Between September 2004 and September 2005, 38,000 net new jobs were created in the low-paying sectors, including 22,500 net new jobs in the retail sector. In 2005, private sector employment grew at its fastest rate since 2000.

By our latest calculations, 0.9 million jobs benefited from the 2005 upratings, and 1.3 million jobs are scheduled to benefit from the 2006 upratings. The percentage of jobs benefiting is 3.6 per cent in 2005 and slightly greater than 5 per cent in 2006. These numbers are similar to those of previous upratings.

Pending employment legislation will have implications for subsequent reviews of the minimum wage. The Government intends to extend statutory holiday entitlement to include bank holidays, giving a typical full-time worker 28 days annual leave. The timing of the introduction of this entitlement and, in particular, whether it is phased over a number of years or introduced in one, may have implications for the appropriate level of increase in the minimum wage rates over subsequent years. The nature of UK implementation of the Equal Treatment Directive is also relevant to the setting of the minimum wage rates, but the Commission is satisfied that the Government intends to introduce the legislation in such a way that the rates for young people retain their viability.

In response to our consultation exercise, employer groups tended to emphasise the downturn in the economy and the adverse impact this was having on businesses. They stressed both the impact of energy price hikes and likely forthcoming changes in employment legislation on employers' costs, and argued that the proposed increase in the minimum wage should be reduced or delayed. In contrast, union groups tended to focus on the strength of the labour market and employment creation. They pointed out that, while the economy was growing more slowly than in recent years, it continued to expand. Evidence from the Government highlighted the success of the minimum wage, and noted no untoward effects arising from the ongoing increases.

Given the above, we acknowledge that a case could be made to shave the 2006 increase by a small amount. In particular, we noted that, since average earnings growth had been slightly less than anticipated, the 2005 and 2006 increases would (if followed through) result in slightly faster progress towards raising the minimum wage relative to average earnings than had been anticipated at the time of the 2005 Report recommendation.

Although some Commissioners believed that this overshoot was sufficient to justify a reduction in the 2006 rate to, for instance, £5.30 or £5.25, we concluded that the divergence of economic outcomes from those anticipated was not a sufficient basis on which to agree a reduction in the 2006 increase. We therefore confirm our original recommendations. However, we do now consider that the phase in which the Low Pay Commission is committed to increases in the minimum wage above average earnings is over. Looking forward, we have no presumption that further increases above average earnings are required. In addition, we note that it will be particularly important over the next year to look in detail at trends in average earnings by sector, analysing, for instance, whether private sector average earnings growth continues to lag behind that in the public sector and reviewing, in the light of that analysis, the appropriate average against which to consider increases in the minimum wage which primarily affects private sector employees.

Chapter 3: 16-17 Year Olds and Trainees

In October 2004 a minimum wage for 16-17 year olds was introduced to prevent the exploitation of young people in very low-paid jobs providing minimal training and few development prospects. The data and evidence we have gathered indicate that the introduction of this minimum has not encouraged young people out of full-time education (FTE) or training, nor has it damaged their prospects in the labour market.

The labour market position for 16-17 year olds not in FTE has been weakening over a number of years, and we are concerned by the rise in the number that are not in education, employment or training. We do not believe, however, that the minimum wage has been a factor in this development, rather that the trends that were apparent prior to its introduction have continued.

We have no doubt that there continues to be a need to protect the position of 16 and 17 year olds in the labour market and we believe that to do this it remains appropriate to have a separate minimum wage rate set at a lower level than that for older workers. We see the main purpose of the 16-17 year old minimum wage as providing a wage floor to prevent exploitation, but we want to guard against the risk that young people may feel disillusioned with the world of work due to very low wages. We recommend, therefore, that the minimum wage for 16-17 year olds be increased to £3.30 per hour from October 2006. In arriving at this recommendation, we took account of the absence of any uprating in October 2005. We recommend that future reviews of the 16-17 year old rate be carried out in line with the timing of the reviews of the rates for older workers.

We also reviewed the use of the older workers' Development Rate and the 12 months exemption for apprentices under the age of 26. It was evident that the Development Rate remains little used and that it would be difficult to justify objectively an age limit on the apprenticeship exemption given forthcoming legislation to outlaw discrimination on the grounds of age. We believe, therefore, that the evidence is strongly in favour of abolishing the older workers' Development Rate and, simultaneously, of extending the 12 months apprenticeship exemption to cover all apprentices aged 19 and over. We submitted our findings to a review of these matters carried out by the Government in late 2005.

We also considered the other apprenticeship exemptions currently in place, but came to the view that it was too soon for a full-scale review. Instead, we recommend that the Government invite the Commission to carry out a full review of the apprenticeship exemptions and report in 2008.

Chapter 4: Benefits-in-kind, Salary Sacrifice Schemes and the Accommodation Offset

Since the introduction of the National Minimum Wage, accommodation has been the only benefit-in-kind that may count towards the calculation of minimum wage pay. For this report, we reviewed the operation of the accommodation offset and considered whether the provisions remain appropriate. We also considered whether there was a case for allowing other benefits-in-kind, including those offered by means of a salary sacrifice arrangement, to count towards the minimum wage.

We received evidence from employer representatives who argued that low-paid workers should be able to participate in salary sacrifice schemes, even if it caused their cash wages to fall below the minimum wage. They suggested it was unfair that these workers were denied the opportunity to exchange some of their pay for an attractive benefit with a preferential tax and national insurance treatment. Trade unions argued, however, that employers should not be able to offset benefits such as childcare vouchers against minimum wage pay. In their view, it would erode the value of the minimum wage and undermine its simplicity.

We acknowledge that some low-paid workers would benefit from participating in a salary sacrifice arrangement. But the evidence indicated that most low-paid workers would be better off claiming support for childcare through the Working Tax Credit system than by joining a company salary sacrifice scheme for childcare vouchers. We found that salary sacrifice schemes for home computers, bicycles to work and other benefits were less common and less well developed, and employee take-up rates in firms that offered these benefits were often quite low. In addition, many part-time low-paid workers would gain no advantage from these schemes. We conclude that allowing further benefits-in-kind to count towards minimum wage pay would undoubtedly complicate the National Minimum Wage while only benefiting a small number of workers. It would also introduce new risks: some workers might see their wages reduced in return for a benefit of little or no value. We recommend that salary sacrifice schemes should not count towards the minimum wage.

Our review of the accommodation offset found that, although many employers in sectors where accommodation has traditionally been provided were aware of the offset, awareness and understanding could still be improved. We recommend that the Government take greater steps to publicise the offset and to improve the scope and quality of existing guidance. There was a range of views about the appropriateness of its current level, but we continue to believe that an offset of £3.90 per day (rising to £4.15 in October 2006) represents a fair balance between the interests of workers and those of employers.

We received evidence that accommodation charges in excess of the maximum permitted under the offset provisions were common in agriculture and food processing. Employer representatives and trade unions both reported that an increasing number of migrant workers were employed in these sectors, often on the minimum wage, and were typically charged £40-60 per week for accommodation provided by their employer. Until recently the Department for Environment, Food and Rural Affairs (Defra) had advised agricultural employers that, based on its reading of the Agricultural Wages Order for England and Wales, the accommodation offset rules did not apply to agricultural workers when accommodation was provided under a stand-alone agreement. Following a review by the relevant government departments, Defra has now revised that view and confirmed that no worker may be paid less than is due under the National Minimum Wage accommodation offset provisions.

Some respondents from the agriculture sector argued, however, that the offset should only apply to workers who were required to occupy accommodation under the terms of their employment contract. They suggested that, in most cases, migrant workers were offered accommodation because of the difficulties they faced securing the deposits and documents required by most landlords. In their view, accommodation provided by employers in these circumstances was an optional service that workers could choose to decline, and therefore the two parties should be free to agree a rent between them. Trade unions, on the other hand, cited cases of severe overcrowding combined with high accommodation charges, and called for a greater emphasis on enforcement of the existing provisions.

We accept that there is a distinction in principle between accommodation that is offered to workers as an optional service independent of the job offer, and accommodation that workers are required to occupy as a condition of their employment. But we are not convinced that such a distinction could work effectively in practice due to the difficulty of establishing whether the worker had been given a genuine choice. We are also concerned that some employers have been exploiting vulnerable migrant workers by applying high charges for poor quality, overcrowded accommodation - in excess of the maximum allowed under the accommodation offset rules. We recommend that the offset provisions should continue to apply to all workers housed by their employer in all circumstances and that the Government should ensure that employers are fully aware of the legal requirements. We would also like to draw the Government's attention to evidence that existing housing standards are not being enforced consistently at a local authority level. We propose to continue to keep the accommodation offset under review, in particular the treatment of housing offered as an optional service not tied to the job.

Our consultation also revealed that some employers have deliberately sought to circumvent the existing offset rules by setting up a separate company to arrange accommodation for their workers. We recommend that the Government take the steps necessary to avoid abuse of such arrangements. Employers may make a variety of other arrangements with third party landlords, and in some cases there may be some doubt whether the accommodation offset applies. We believe that the employer should be regarded as the accommodation provider where a worker's ability to remain in a particular job, or to remain in particular accommodation, is dependent one upon the other. We believe that the offset should also apply if the employer receives a financial benefit from an accommodation arrangement. We recommend that the Government provide further guidance on these matters.

In our view there is a need to tackle overcharging for accommodation and evasion of the accommodation offset as part of a more concerted effort to ensure that migrant workers receive the minimum wage to which they are legally entitled. We recommend that the Government take action to prioritise targeted enforcement of the minimum wage in those sectors that employ significant numbers of migrant workers.