Wages: Basic Principles
Peter Marshall Bsc (Econ) BA MBIM is a Fellow of the Society of Business Teachers, and an experienced educator in business subjects. He is also a prolific author and his books have been translated and sold worldwide. He lives in London, UK.
Wages and salaries are payments for people’s labour. They are called wages when paid weekly and calculated from the number of hours worked (hourly rates) or units of production finished (piece rates). When payments are made monthly, and there is no direct relationship between them and the hours worked or units produced, they are called salaries. Manual and unskilled workers are paid wages; clerical workers, managers and professional people are paid monthly salaries.
Often wage earners are paid a higher hourly rate if they work after the scheduled finishing time; they may be paid an even higher one if they work very unsociable hours. For example, working after 5pm may entitle them to 50% more pay per hour, and they may receive twice the normal rate for work done on a Sunday. These rates are popularly known as ‘time and a half and ‘double time’. To find a wage earner’s gross pay entitlement the wages clerk multiplies the hours worked by the rate concerned (e.g. 1, 11/2 or 2) and then multiplies the product by the hourly pay rate, e.g. £3.50.
Workers usually have to pay income tax on the money they earn. Everyone is entitled to some pay free from tax; the amount of exemption depends on their circumstances. For example people with dependant children have a higher level of tax exemption than those without. This level is called free pay and is identified by a tax code number. The wages clerk can simply look up the employee’s code number and read off against it the cumulative free pay to date (for that tax year) to which that employee is entitled. He then adds this week’s pay to total pay to date in the tax year, and deducts from that the free pay to date. He thus arrives at the taxable pay to date. He then calculates, by referring to a table, the cumulative tax payable on this; he deducts from it the tax actually paid to date to find out how much tax he must deduct this pay day.
Everyone earning more than a certain level of income (threshold level) must also pay regular National Insurance Contributions (NIC), to entitle them to free medical treatment and other state benefits. The wages clerk must also deduct NIC from the wages or salaries paid. The firm itself also has to make a contribution to each employee’s NIC cover; the amount is related to level of pay.
When an employee earns above a certain figure he is charged a higher tax rate for the amount over that figure. Employee’s wages are taxed at source. The company acts as a sort of sub-tax collector for HM Inland Revenue, just as it does for HM Customs and Excise for VAT. Income tax collected at source is called Pay As You Earn (PAYE).