How can we change the tax credits system?

Last month, in a shock decision, the House of Lords moved to delay financial measures approved of by the House of Commons:  a reduction in working tax credits (WTCs). A twist of fortunes that is likely to have elicited a smile across the faces of Asquith and Lloyd George’s ghosts, no doubt. Whether we play this off as a constitutional crisis, a triumph for working people or a disaster for fiscal responsibility only but one thing is for sure – the Chancellor has been sent packing. Ignominiously sent packing. And with that, the Treasury finds itself back at the drawing board in Whitehall, ahead of next week’s Autumn Statement. Meanwhile, what’s to happen next is anybody’s guess.

 But let’s take a step back: why the furor?  In an effort to stem the tide of excessive welfare spending the government has sought to rollback on uncontrolled borrowing. And be under no illusion:  with 1% of the world’s population, 4% of the world’s GDP and 7% of global welfare spending it is, indeed, excessive. That is, excessive and/or grossly inefficient. Take your pick.  

Tax credits, in of themselves, have little to do with the payment of tax. Rather, they are a series of means-tested benefits that were introduced under the last Labour government to alleviate the burden on low-paid families. And secondly, they come in two types: the ‘Working Tax Credit’ and the ‘Child Tax Credit’, for those with children. However, now things are about to change. The current Tory majority government has drafted plans that would see this scheme being phased out, and reworked into a newly revised Universal Credit. These proposals, tabled in the name of “a low-welfare, low-tax, high wage economy,” are the latest in an attempt to siphon off £4.5 billion a year in savings from an item that accounts for 14% of our nation’s welfare bill.

Hardly the darling of the Left, WTCs haven’t always had Labourites swooning. Unquestionably, the policy has had its fair share of critics from both sides. Left-wing activists have long claimed that while tax credits are paid to the poor, they really come under the bracket of ‘corporate welfare,’ enabling retail giants to dish out lower wage packets. Similarly, and on the flipside, wage subsidies have enjoyed political popularity as they encourage work over welfare. Credits assist everyday low-earning workers. They make easier the lot of families working tirelessly but still struggling to make end’s meet. Hardworking families. Or, as they’re more commonly known, Cameron’s target audience in the last General Election. That is why the government has come under fire from some quarters, for sweeping the rug out from underneath the feet of those who are “doing the right thing.” A difficult sell.

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In a report conducted by the Institute for Fiscal Studies (IFS), it was found that low-earning single parents would be the hardest hit – losing £1,000 a year, as a result of cuts. This covers roughly three million people. Whilst, on the other end of the scale, middle earning couples with no children will be £350 better off. Is this a case of marginal returns and minimal gains? A study from the Census Bureau in America would seem to suggest so. It surmised that tax credits go a long way to reducing want. For instance, if the EITC were to be eliminated, the rate of child poverty would rise from 16% to 23%.

Where tax credits are concerned, the oft repeated refrain of, “if we want to have more money to spend on health, education and national infrastructure, we must be prepared to rein in welfare,” falls on deaf ears. This initiative alone is not enough to run a surplus, of course not. Instead, it is part of a package. A package that includes a National Living Wage, new personal allowance thresholds (£11,000 by April 2016 and £12,500 by 2020) and a doubling of the amount of free childcare for three and four-year-olds. Higher tax thresholds will save basic rate taxpayers £825 a year and lift 3.8 million people out of the tax system altogether. 600,000 families stand to reap the rewards of extended childcare, worth an extra £2,500 a year. So, where’s the catch? The answer: fulltime employment. Anyone who has landed themselves a fulltime occupation will likely notice an appreciable difference in their standard of living. Yet, for those in part-time work – those that make up the majority of tax credit recipients – they are at a distinct disadvantage. That is the sticking point, and that where I depart the train.

There is much to be said for promoting employment, especially when it comes at little or no cost to the taxpayer. Cameron has tried to achieve this through raising the minimum wage, but it remains to be seen if this will be enough to guarantee peoples’ security. A lot hinges upon a high-performing economy. And, without that, these policies seem detrimental to a particular, frankly destitute, segment of society. We need assurances. Osborne is right to reform tax credits, he is right to speak of “easing the transition in the interim” but it was also right – ‘equitably,’ if not constitutionally – for the Lords to vote down his plans. Now, the Chancellor has an opportunity to recast his ideas and develop them, in the full light of day and through robust debate. The Tories are still the party of the diligent. While Miliband was happy to kick off about zero hours contracts and “a low wage economy,” Labour seems more than willing to have the taxpayer subsidise low wages. It is unproductive and it is inefficient. Whether or not John McDonnell is on board with “a low-welfare, low-tax, high wage economy” is a little iffy, yet in principle he shouldn’t be. Of the 76p an hour the government forks out in tax credits for someone on the minimum wage, 72-79% goes directly to workers- the rest doesn’t. What a waste! Let’s acknowledge that and sort it out.