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BRIEFING PAPER

Number 8235, 1 June 2018

Workers underpaid the minimum wage

By Federico Mor Jennifer Brown

Contents: 1. Background 2. Employers found to underpay

the minimum wage 3. Estimating the number of

underpaid workers 4. Unpaid time and the

minimum wage

2 Workers underpaid the minimum wage

Contents Summary 3

1. Background 5 1.1 What is non-compliance 5 1.2 What statistics are available on non-compliance 5

2. Employers found to underpay the minimum wage 6 2.1 Number of targeted and complaint-led investigations

conducted by HMRC 7

3. Estimating the number of underpaid workers 9 3.1 Survey data 9 3.2 Number of underpaid workers 10 3.3 Characteristics of underpaid workers 11

4. Unpaid time and the minimum wage 12 4.1 The importance of unpaid time 12 4.2 Estimating the impact of unpaid time 13 4.3 Number of underpaid workers 13

Cover page image copyright: CC0 License, no attribution required

3 Commons Library Briefing, 1 June 2018

Summary What is non-compliance with the minimum wage? Non-compliance with the minimum wage is when an employee is paid less than the rate they are entitled to under National Minimum Wage legislation.

To determine whether an employee is paid at least the minimum wage, the employee’s hourly rate must be calculated. The rate is calculated by taking the employee’s pay and dividing it by the hours worked:

Hourly rate = Pay / Hours of work

Employers found to underpay the minimum wage In 2017/18, HMRC investigators identified a record 200,000 workers who had been underpaid the minimum wage, more than double the number the year before. In total, these workers were owed £15.6 million in pay.

The increase is partly the result of a new online complaints service launched in January 2017, which contributed to a 132% rise in the number of complaints received in 2017/18 compared with the year before.

Estimating the number of underpaid workers There is considerable uncertainty around the total number of underpaid workers because earnings surveys struggle to accurately capture non-compliance with the minimum wage. It is not possible to point to a specific figure with much confidence, but only to a broad range.

Excluding unpaid time, estimates suggest that underpayment affects between 300,000 and 580,000 people aged 25 and above.

If unpaid time is taken into account, the number of people underpaid the minimum wage is substantially higher. The true extent of underpayment is very difficult to estimate, but a range of 1 to 2 million underpaid workers is likely, or between 4% and 9% of employees aged 25 and above.

Other Library papers on the National Minimum Wage

The briefing is part of a series on the National Minimum Wage, including:

The National Minimum Wage: rates and enforcement (April 2018) This briefing provides details of current and historic National Minimum Wage rates; discusses the introduction of the National Living Wage and different age-related rates; sets out the legislative mechanism for rate increases; explains the role of the Low Pay Commission; and discusses the various means of enforcing the National Minimum Wage.

National Minimum Wage Statistics (February 2018) This briefing looks at trends in the value of the UK National Minimum Wage, the number of jobs paid at the National Minimum Wage and how the National Minimum Wage compares internationally.

Economic impacts of the National Living Wage: in brief (March 2016)

4 Workers underpaid the minimum wage

This briefing provides an overview of the expected impact of the National Living Wage on workers, employers and the economy.

The National Minimum Wage: volunteers and interns (December 2015) This briefing provides an overview of the application of law around the National Minimum Wage to persons working in a voluntary capacity.

5 Commons Library Briefing, 1 June 2018

1. Background

1.1 What is non-compliance Non-compliance with the minimum wage is when an employee is paid less than the rate that they are entitled to under National Minimum Wage legislation.

To determine whether an employee is paid at least the minimum wage, the employee’s hourly rate must be calculated. The rate is calculated by taking the employee’s pay and dividing it by the hours worked:1

Hourly rate = Pay / Hours of work

Pay and hours of work are calculated by reference to a ‘pay reference period’. The pay reference period is a month, or shorter if the worker is paid wages by reference to a period shorter than a month.2 If a salaried employee works more than the basic hours set out in their employment contract, their hours for the purpose of the calculation is the number of hours actually worked in the pay reference period.3

So for an employee on an annual salary, the relevant pay is their monthly income and the relevant hours are the actual hours of work in a month.

1.2 What statistics are available on non-compliance

Statistics on the extent and nature of non-compliance fall into two main categories.

• Administrative data from HMRC describing activities to enforce payment of the minimum wage

• Estimates generated from surveys which gather information on employee pay, from a sample of either employers or employees.

Neither offer a complete picture of the extent of non-compliance with the minimum wage. HMRC cannot investigate all employers that may be paying their employees under the minimum wage, due to resource constraints. Estimates from surveys come with multiple complications (discussed later in section 3.1).

1 National Minimum Wage Regulations 2015 (SI 2015/621), regulation 7 2 Ibid, regulation 6 3 Ibid, Part 5 Chapter 2

6 Workers underpaid the minimum wage

2. Employers found to underpay the minimum wage

HMRC conducts regular investigations into businesses suspected of underpaying the minimum wage. HMRC investigates employers in response to worker complaints (‘complaint-led’ investigations) and also undertakes proactive ‘targeted’ investigations of employers where it believes there is a high risk of non-compliance.

In 2017/18, HMRC investigators identified a record 200,000 workers who had been underpaid the minimum wage, more than double the number the year before. In total, these workers were owed £15.6 million in pay. The increase is partly the result of a new online complaints service launched in January 2017, which contributed to a 132% rise in the number of complaints received in 2017/18 compared with the year before.4

2016/17 had also seen a very large increase in the numbers found to be underpaid, and it was the highest annual total to date. HMRC found 98,150 underpaid workers in that year. This was an increase of 69% from 2015/16.5

4 HMRC, 200,000 receive back pay as HMRC enforces National Minimum Wage (press

release), 9 May 2018 5 BEIS, NLW and NMW: Government evidence to the Low Pay Commission, July 2017,

p. 19 Figures show the outcome of cases closed during the year ending 31st March.

Therefore not all the underpayment identified in a given year took place in that same year. Moreover, investigations can review wage arrears dating back to a maximum of six years, so statistics will also include some historical underpayment.

0

20

40

60

80

100

120

140

160

180

200

2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18

Number of workers found to be underpaid the relevant minimum wageThousands

Source: Department for Business, Energy and Industrial Strategy, Government evidence to the Low Pay

Commission on compliance and enforcement: Table 4, July 2017, p. 19; HMRC press release, 9 May 2018

Notes: 101,259 workers were found to be underpaid between 2005/06 and 2009/10 but single year totals

are unavailable prior to 2009/10

7 Commons Library Briefing, 1 June 2018

The large increase in the number of workers found to have been underpaid in 2015/16 and 2016/17 was almost entirely attributable to an increase in the number of proactive, ‘targeted’ investigations conducted by HMRC (as opposed to investigations triggered by a worker complaint).

2.1 Number of targeted and complaint-led investigations conducted by HMRC

Details of HMRC’s enforcement activities in 2017/18 are not yet available. Therefore, the analysis below does not cover the latest enforcement figure of 200,000.

Before 2015/16, HRMC carried out few targeted investigations: only 151 in 2014/15 (7% of all investigations closed that year). By contrast, HMRC closed 1,473 targeted investigations in 2016/17, almost ten times as many. These targeted investigations accounted for 55% of investigations closed in 2016/17, and 70% of the workers found to be underpaid that year.6

HMRC found a non-compliant employer in 42% of the investigations closed in 2016/17, slightly higher than the average for the previous seven years (39%). This percentage is called the ‘strike rate’.7

A worker complaint is a strong indication that an employer may have underpaid a worker. So the strike rate for ‘complaint-led investigations’ tends to be higher (53% in 2016/17). Targeted investigations, on the 6 BEIS, NLW and NMW: Government evidence to the Low Pay Commission, July 2017,

p. 21 7 Ibid 19

National Minimum Wage investigations by type of investigation2014/15 2015/16 2016/17

Targeted

Opened cases 106 2,009 1,259Closed cases 151 1,091 1,473Cases found with arrears 60 206 494Number of workers affected 5,247 43,486 68,290

Complaint-ledOpened cases 2,222 1,237 1,516Closed cases 2,053 1,576 1,201Cases found with arrears 675 752 640Number of workers affected 21,071 14,594 29,860

TotalOpened cases 2,328 3,246 2,775Closed cases 2,204 2,667 2,674Cases found with arrears 735 958 1,134Number of workers affected 26,318 58,080 98,150

Source: Department for Business, Energy and Industrial Strategy, Government evidence to the Low Pay Commission on compliance and enforcement: Table 4 and 6, July 2017, p. 20

8 Workers underpaid the minimum wage

other hand, are based on risk factors. Still, 34% of the employers investigated by HMRC based solely on risk factors were found to be non-compliant in 2016/17.8

An example of a risk factor used by HMRC is jobs paid very close to the minimum wage. These jobs are at high risk of underpayment because any salary deduction or unpaid overtime is likely to push the hourly rate earned by these workers below the minimum wage.

Due to resource constraints, HMRC can only afford to investigate a fraction of jobs at risk of underpayment. Consequently, a large number of underpaid jobs are likely to go undetected every year.

For example, in 2016/17 HMRC prioritised retail, and retail workers accounted for 72% of the underpaid workers it found. As a sector, however, retail only makes up an estimated 17% of the jobs paid at or below the minimum wage.9

8 Ibid 19 9 Ibid 31-4

9 Commons Library Briefing, 1 June 2018

3. Estimating the number of underpaid workers

3.1 Survey data There are two main surveys that collect information on employee pay: The Annual Survey of Hours and Earnings (ASHE) and the Labour Force Survey (LFS).10

ASHE is an annual survey that asks employers what they pay their employees. The LFS is a quarterly survey of households that asks individuals about their working lives, including what they are paid.11

Each survey has limitations which make estimating the total number of workers who are underpaid the minimum wage difficult. The main problem is employers or employees misreporting pay and hours.

Neither LFS nor ASHE take into account benefits in kind received by employees. This missing part leads to overestimating levels of non-compliance with the minimum wage.12 On the other hand, the two surveys also miss payroll deductions, which leads to underestimating non-compliance. For example, HMRC reports that deducting the cost of uniforms from pay is a common cause of underpayment of the minimum wage.13 This type of underpayment is not captured by either ASHE or LFS.

ASHE is normally considered to offer the most robust estimates on pay. This is because ASHE is a larger survey, and because employers generally report pay more accurately than employees.14

However, there are reasons to believe that ASHE provides an underestimate of workers paid below the relevant NMW rate:

• Jobs that are not registered on PAYE schemes are not surveyed by ASHE. Because non-PAYE jobs are known to have low levels of pay, ASHE is likely to underestimate low pay.15

• For the same reason, ASHE does not capture the informal economy, for example, work paid cash in hand. Informal work is likely to have a higher rate of non-compliance with the minimum wage.16

• ASHE is unlikely to reveal serious non-compliance as it is employers themselves who complete the survey. Therefore, if an

10 The Family Resources survey also measures pay but it is known to be less reliable

than ASHE or LFS 11 ONS, Linking ASHE and LFS: can the main earnings sources be reconciled?, March

2007, p. 2 12 Some underpayment of the NMW can be legitimate, for example where

accommodation is provided by the employer. 13 BEIS, £1.7m back pay identified for a record 16,000 workers, 8 December 2017 14 ONS, A guide to sources of data on earnings and income, 12 August 2016 15 ONS, Annual Survey of Hours and Earnings, 26 October 2017, Section ’16. Quality

and methodology’ 16 Low Pay Commission, Non-compliance and enforcement of the National Minimum

Wage, September 2017, p. 12

10 Workers underpaid the minimum wage

employer knowingly underpays employees, this may not be picked up in ASHE.17

For these reasons, estimates of non-compliance are given between large ranges, where researchers have compared estimates from ASHE with estimates from the LFS.

3.2 Number of underpaid workers The Low Pay Commission (LPC) is the independent body that is tasked with advising the government on the level of the minimum wage. In September 2017, the LPC published a report on non-compliance and enforcement of the National Minimum Wage.

The LPC concluded:

Our best estimate suggests that, at its peak in the year, underpayment affects between 300,000 and 580,000 people. And while it has risen in the year following the introduction of the NLW, it has done so by less than might be expected given the increase in coverage.

This is equivalent to around 1-2% of workers aged 25 and above, and around 19-23% of low paid workers (those workers paid within 5p of the relevant minimum wage rate).18

The Low Pay Commission have estimated the number of workers underpaid the National Minimum Wage since 2014.

The level of underpayment varies throughout the year and is typically highest immediately after the minimum wage is uprated. The LFS estimates in blue illustrate the ‘frictional nature of underpayment’:

the number of workers affected is at its highest immediately following each uprating, but then falls by around half in the six to nine months that follow.19

17 Low Pay Commission, Non-compliance and enforcement of the National Minimum

Wage, September 2017, p. 12 18 Ibid, p. 10 and 12 19 Ibid, p. 11

11 Commons Library Briefing, 1 June 2018

Looking at the ASHE estimates in orange, the number of underpaid workers almost doubled between April 2015 and April 2016. Part of this was very likely down to the timing of the survey. The introduction of the National Living Wage in April 2016 coincided with the collection of pay data for the Annual Survey of Hours and Earnings. Given that employers are only required to increase pay from their first full pay period after the minimum wage uprating, the data may show some individuals as paid below the new minimum wage rate but only because they are still covered by a previous pay period.

3.3 Characteristics of underpaid workers The LPC found that underpaid workers are more likely to be women than men, part-time rather than full-time workers, and employed in the private sector rather than the public sector.

Underpayment affects workers of all ages, with around half of underpaid people aged 44 or less, and half aged 45 and above.20

20 Ibid, p. 15

0% 20% 40% 60% 80% 100%

Gender

Working pattern

Sector

Age

Male

Full-time

Female

Part-time

Public Private Other

45-54 55-6435-4425-34 65+

Characteristics of those paid under the minimum wageAged 25 and over

Source: LPC estimates based on ASHE data: Non-compliance and enforcement of the National Minimum Wage, September 2017, p. 15

12 Workers underpaid the minimum wage

4. Unpaid time and the minimum wage

4.1 The importance of unpaid time The LPC estimates discussed in Section 3 are calculated based on contracted hourly rates. They therefore do not look at overtime, either paid or unpaid.21 Including unpaid time has a significant impact on the number of people estimated to be paid under the minimum wage.

If an employee is contracted to work on or close to the minimum wage, a little bit of extra unpaid work can push their actual hourly rate below the minimum wage. Workers are entitled to the minimum wage whenever they are working, not just during their contracted hours.22

HMRC identifies unpaid time as a common cause of underpayment of the national minimum wage:

Common reasons for errors made include: failing to pay workers travelling between jobs, deducting money from pay for uniforms and not paying for overtime.23

Examples of unpaid time

The Business, Innovation and Skills Committee inquiry into Employment practices at Sports Direct found that unpaid overtime meant that certain workers were underpaid the National Minimum Wage at the company:

The Guardian carried out an investigation in December 2015, describing working practices at Shirebrook, which included […] making workers wait, unpaid, for a security check at the end of shifts, which brought their earnings below the minimum wage (resulting in a rate of about £6.50 an hour against the then minimum rate of £6.70 an hour for workers aged 21 or over).24

On 8 December 2017, the Department for Business, Energy and Industrial Strategy (BEIS) named and shamed Sports Direct for failing to pay £167,036 of minimum wage to 383 workers.25

A study by the University of Leicester in 2015 concluded the majority of the city’s garment workers were paid less than the minimum wage:

The starkest finding of this research, severe violations of NMW regulations, have been confirmed through both survey as well as interview data. Evidence demonstrates that the majority of workers are paid significantly below the NMW rate, at a much-quoted industry norm of £3.00 per hour (by contrast, the NMW currently stands at £6.50). Wages are mostly paid cash-in-hand and working hours are grossly under-recorded.26

In May 2018, the Financial Times visited Leicester’s garment factories, and reported:

21 Low Pay Commission, Non-compliance and enforcement of the National Minimum

Wage, September 2017, footnote 5 (p. 10) 22 See section 1.1 23 BEIS, £1.7m back pay identified for a record 16,000 workers, 8 December 2017 24 Business, Innovation and Skills Committee, Employment practices at Sports Direct,

Third Report of Session 2016–17, HC 219, p. 4 25 BEIS, £1.7m back pay identified for a record 16,000 workers, 8 December 2017 26 Centre for Sustainable Work and Employment Futures (University of Leicester), A

New Industry on a Skewed Playing Field: Supply Chain Relations and Working Conditions in UK Garment Manufacturing, February 2015, p. 32

13 Commons Library Briefing, 1 June 2018

Today, people in Leicester earning £5 an hour “walk out of factories with their heads held high”, says Mick Cheema, who runs a garment factory called Basic Premier that pays legal wages. He says the average wage in dark factories, as he calls them, is about £4.25 an hour. Factories often under-record hours, so people’s payslips look as if they have been paid the minimum wage. “Say you’re working 40 hours for £4 [an hour], but legally you should get almost £8 — so these people are showing 20 hours at £8 an hour,” explains Khilji.27

4.2 Estimating the impact of unpaid time The ASHE survey does not ask questions about actual working hours. Therefore, to estimate the impact of unpaid time on the number of worker who are underpaid, one must use the LFS.

The LPC’s high estimate of 580,000 underpaid workers is based on the LFS, but it does not take into account unpaid time. This is because the estimate is based on contractual rates of pay for employees paid by the hour.28 For employees not paid by the hour, the LPC uses a sophisticated method that assigns hourly rates based on the available data for employees paid by the hour (a method known as “nearest neighbour imputation”).

Data on unpaid hours is collected via other questions in the LFS. Looking just at those employees paid in hourly rates, the number who are counted as underpaid increases by around 50% when the unpaid time they report is included.29

The full impact of unpaid time on the LPC’s estimate of 580,000 underpaid workers is not readily available, since it would require rerunning the entire imputation process. So the full estimate is unlikely to be 580,000 + 50% = 870,000; it could be more than that, or less.30

4.3 Number of underpaid workers There is a potential weakness in using contractual hourly rates to estimate the number of underpaid workers. Data from the LFS indicates that 77% of those who usually do one or more hours of unpaid work per week are not paid a fixed hourly rate. In other words, most unpaid time is done by employees on a salary. Therefore, data on the unpaid time worked by employees on an hourly rate might not be a reliable way to estimate the unpaid time of employees on a salary.

An alternative is to use another LFS variable that calculates the effective hourly rate of all employees by dividing their earnings by the total hours they say they work.

27 Financial Times, Dark factories: labour exploitation in Britain’s garment industry, 17

May 2018 28 The variable used is the ‘stated’ hourly rate (HRRATE), that is, the hourly rate

provided by respondents who are paid a fixed hourly rate. 29 Library analysis of LFS Q2 2016 data. Note that no adjustment has been made here

to account for the fact that survey respondents tend to overstate the number of hours they work, as discussed further below.

30 This is because different values will be imputed to the 70% of employees without a contractual hourly rate, based on the revised data that includes unpaid time.

14 Workers underpaid the minimum wage

The calculated rate has two advantages. The first is that it is available for all employees (no imputation is required). The second is that the calculation matches the calculation in law to determine whether the national minimum wage has been paid, which is pay divided by hours of work in the pay reference period (see section 1.1).

However, a weakness of this approach is that it depends on respondents providing accurate values for both pay and hours. So there is more scope for error than when respondents are asked directly about their hourly rate (for those employees paid by the hour).31

People are known to round numbers, including when answering to official surveys. Respondents tend to report their pay to the nearest round figure, for example, rounding up £4.95 or rounding down £5.05 to £5.32 But the rounding goes both ways, so it is hard to know what the effect is, on balance. It could lead to an overestimate or to an underestimate of the number of underpaid workers.

The more serious weakness is that survey respondents are known to overestimate working time (overall, this error goes in one direction).33 So to avoid overestimating the number of underpaid workers, some allowance must be made for this bias. But because the size of the bias is not known, the true extent of underpayment is very difficult to estimate.34

Taking a cautious approach, a range of 1 to 2 million underpaid workers is likely, or between 4% and 9% of employees aged 25 and above (Q2 2016).35

31 Catrin Ormerod and Felix Ritchie (ONS), Issues in the measurement of low pay,

Economic & Labour Market Review, Vol 1 No 6, June 2007, p. 40 32 Catrin Ormerod and Felix Ritchie (ONS), Issues in the measurement of low pay,

Economic & Labour Market Review, Vol 1 No 6, June 2007, p. 40 33 Richard Blundell, Antoine Bozio and Guy Laroque, Extensive and Intensive Margins

of Labour Supply: Work and Working Hours in the US, the UK and France, Fiscal Studies, vol. 34, no. 1, 2013, p. 12

34 We are not aware of estimates of the size of this bias in official surveys such as the LFS. Therefore, our adjustments are not chosen by reference to other research, but illustrate the sensitivity and uncertainty of these estimates.

35 Library analysis of HOURPAY variable in LFS

300,000

Low estimate:1 million

580,000

High estimate:2 million

By contracted hours Including unpaid time

Estimates of the number of people paid less than the minimum wage

15 Commons Library Briefing, 1 June 2018

The lower value of the range assumes that employees systematically overestimate their work hours by 25%; the upper value assumes a bias of around 8%.

Using the same assumptions, data for Q2 2017 shows a similar range of around 1 to 2 million workers underpaid the minimum wage of £7.50 an hour (the rate was raised from £7.20 to £7.50 in April 2017).

Analysis of Q1 2017 shows that the uprating of the minimum wage (in Q2 2016 and Q2 2017) does not have as large an effect on the count of underpaid people as it has when using contractual rates (see section 3.2 on the frictional nature of underpayment). The 25% bias figure for Q1 2017 is 950,000, while the 8% bias figure is 1.8 million.36

So it appears that the driver of these large estimates is not errors linked to the uprating of the minimum wage (whether real errors of underpayment by employers or reporting errors in surveys).

Example of unpaid time

University teaching staff report working a large number of unpaid hours.

A 2013 survey by the National Union of Students (NUS) found that:

• The average contractual rate for postgraduates who teach was £19.95 an hour, but on average, they were working twice as many hours per week as they were paid for, resulting in an actual hourly wage of £10.39.

• Almost a third earned an actual hourly rate lower than the National Minimum Wage

The University and College Union (UCU) raised similar concerns. In a 2016 report, they explained that some hourly-paid teaching staff

are paid a comprehensive teaching rate for every hour of teaching that is supposed to cover other duties such as preparation, marking, administration and attending meetings. […] After spending many extra hours carrying out these other responsibilities, some members have calculated earnings to average £4 an hour.

The span of the estimates presented in this paper should draw attention to the considerable uncertainty in estimating underpayment. It is not possible to point to a specific figure with much confidence, but only to a broad range. It is nonetheless safe to say that the number of people underpaid the minimum wage is substantially higher when unpaid time is taken into account.

Finally, it is worth remembering that all the estimates presented here are for workers aged 25 and above. Therefore, they are in that respect an underestimate of the total number of underpaid workers of all ages in the economy.

36 With no adjustments made for the overestimation of time, the count of underpaid

people would stand at around 3.1 million in both Q2 2016 and Q2 2017. The unadjusted figure in Q1 2017 is 2.8 million.

BRIEFING PAPER Number 8235 1 June 2018

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