The tax credit row: ignorance and obfuscation are rampant

Britain’s tax credit row  reached a milestone last night with a government defeat in the House of Lords. As I said last week, it doesn’t show British politics in a flattering light. Then I complained about the failure of the government’s critics to tackle the financial implications. But ignorance seems to be wilful on both sides. What is the row really about?

First, we need to understand what tax credits are. There are two systems: Working Tax Credits (WTC) and Child Tax Credit (CTC). WTC amounts to £1,890 to £4,525 per annum, plus more for those with disabilities. It starts to be withdrawn when income is above £6,420 and the rate of withdrawal is 41%. In other words, for every £1 you earn above £6,420 your benefit is cut by 42p. CTC is for parents responsible for children. This amounts to a basic £545pa plus £2,750 per child (plus extra if the child has disabilities). For those in work these amounts are added to WTC and withdrawn at the same rate. For those not claiming WTC, withdrawal starts at £16,105 (I’m not sure how that works, and why you would be in work and not claiming WTC, but I’ll leave that for now).

So what were the proposed changes? There are two sets. The first is due to be implemented in April 2016. The withdrawal threshold for WTC is to be cut to £3,850; for those only on CTC the rate is cut to £12,125. The withdrawal rate is increased to 48%. The second set of changes will be made in 2017 to CTC. The £545 family element will be withdrawn, and the benefit per child will be limited to two children. These elements will apply to new families, not those who are currently claiming.

So what do the changes mean? First: the basic amounts of the benefits are not being changed, until the changes in 2017, and the latter do not cover existing claimants. This allows the government to say that it the Prime Minister David Cameron was not lying when he said that “he did not want to cut” CTC, during the election campaign. But, of course, the changed withdrawal rules mean that the benefit is being cut for everybody earning more than £3,850. The impact will be concentrated on lower earners, who will face a high marginal rate of tax, starting at 48%, and rising to 60% as National Insurance kicks in, and then 80% as Income Tax joins the party.  This creates something of a poverty trap effect, reducing the incentives to work. But then again, the tax credits are not being abolished, and workers do keep some of their extra earnings.

The government’s chief advertised mitigation measure is raising the national minimum wage. This should put more money in the pockets of the poorest workers, provided employers don’t cut their hours. But much of the benefit of this will go to workers not claiming tax credits, and it will do little to alleviate the hardships of those worst affected. There seem to be two strategic aims. The first is to transfer some of the economic burden of lower wages to employers. There is a suggestion, for example, that employers are paying lower wages because they know that tax credits will make up some of the difference. The evidence that this effect is important is weak, however. A second strategic aim, not doubt, is to reduce the poverty trap element of the changes – so that workers are pushed through the levels of pay at higher marginal tax rates faster. The problem with these strategic aims that the new levels set for the minimum wage are arbitrary. Much of the cost will have to be borne by small and marginal businesses that can ill afford the cost – they may well choose to cut hours paid, and so undermine the policy.

The worst of the interventions in the debate, however, come from some of the suggestions made as to how to mitigate the effects of the changes. These have centred on raising the thresholds at which Income and National Insurance are paid. This is obvious nonsense. It may be clever to mitigate the withdrawal of a universal benefit by using targeted ones. The mitigation will cost less than the original change would save. To suggest the opposite, which is what these ideas amount to, is plain stupid. Worse, the poorest earners are not even paying these taxes, so exempting them will not help. And yet the BBC interviewer on the Today programme this morning sounded surprised when his interviewee pointed this out to him. This is wanton ignorance. The ulterior motive for these “mitigations” is to provide tax cuts to the better off, not to help the poor and struggling.

Moving on. Here are the points that should be being made in this debate, and either aren’t being made, or are being made by too few people:

  1. The government’s changes are tackling the symptoms of the disease of low pay and poverty, and not its causes. Raising the minimum wage may help, but not by much, and could backfire. The real problems arise from the economic pressures that cause lower wages, and from increasing housing costs that make that poverty harder to bear. The risk is that the savings made from cutting tax credits will ultimately be overwhelmed by the less direct effects of poverty on the state. Instead of making it easier climb out of poverty these changes make it harder.
  2. The cost of tax credits will fall if lower incomes rise. The whole design of tax credits is that their costs fall as the need diminishes.
  3. The 2017 proposed changes, are more harmful and ill-considered than the 2016 ones. Clearly the thought is that the level of benefits is encouraging poor families to be larger. I don’t think any strong evidence is being put forward to justify this. It looks positively vindictive.
  4. The government’s policies are not a vindictive attack on the poor, but an attempt to rebalance the system to something that is more sustainable in the long term. But they are a gamble. They are making several changes at once, without a base of evidence to support them. It is these risks that should be the focus of the debate.

Personally I feel that the basic, original, design of tax credits is reasonably sound. The fact that they are costing much more than originally planned is a problem in itself, of course. But it is also an alarm bell – it points to even deeper problems in our society. If we take away the short term cost to the taxpayer, it does not mean that this problem has been solved. I would tackle the funding problem through taxes on the better off (loosely defined, not just chasing the slippery very rich). But the real energy needs to go into alleviating the causes of tax credits. Nobody is talking about that at all.


One thought on “The tax credit row: ignorance and obfuscation are rampant”

  1. Thanks for the very comprehensive (and comprehensible) overview. Your conclusion points up the fundamental dilemma that, since the 1970s (with its roots in California (, millions of people have lost faith in the belief that high taxes are good for society or even the poor to whom their outcomes are supposed to be addressed and yet that the needs of those on low wages are increasing ever further (not least, as you point out, the cost of housing). There has got to be a realistic “Third Way” (and not just in a New Labour sound-bite sense!) or, as with climate change, it is very hard indeed to see how social cohesion is to be maintained.

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