If tax credits are revised it needs to be done gradually

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Tax credits have become the most divisive issue in British politics, splitting government from opposition, both leading political parties internally and the House of Lords from the House of Commons. But what are tax credits anyway?

The measures originate in a scheme devised under Margaret Thatcher’s government by Arthur Cockfield, a brilliant but impossible adviser (and in due course a key figure in the creation of Europe’s single market). Gordon Brown, the former Labour chancellor of the exchequer, loved the tax credit scheme and greatly extended it.

The idea was to achieve a partial integration of tax and benefits by providing credits that would reduce liability to tax, or in many cases turn it negative. In practice, the integration was more apparent than real. Tax credits, separately applied for, separately paid and separately calculated were a new name for benefits to families and low-paid adult workers.

A poverty line is usually defined as some proportion of mean or median earnings. But the measurement is complex, a result of differing housing costs across the country and differences in household composition. And should a measure of the poverty line be fixed or vary in line with the incomes of the non-poor? Extensive data on poverty over time in the UK has been compiled by the (independent) Institute for Fiscal Studies and the (more campaigning) Resolution Foundation.

But on almost any measure, child poverty was reduced significantly between 1997 and 2010, mainly because of the generosity of tax credits to working households with children. Pensioners also made significant gains because of the so-called “triple lock”, which provided annual increases of whichever is higher of the rise in earnings, prices, or 2.5 per cent. The least favoured in this period were childless adults with low or no earnings. They benefited from the introduction of a minimum wage, but this was set at levels such that those receiving it would normally still be designated as poor.

Labour’s policies from 1997 to 2010 were fairly successful in achieving their aims of tacking poverty among children and the elderly. But they were in aggregate expensive: the costs of extended tax credits and real increases in pensions totalled about 5 per cent of UK government spending.

George Osborne, the Conservative chancellor, appeared on this scene with a variety of objectives. The position of pensioners remained sacrosanct: baby boomers are too numerous, too vocal and too selfish. For the first time in British history people of pensionable age are better off than the rest of the population. But the feckless idlers with large families routinely featured in tabloid newspapers, who boast of receiving more in benefits than most working households could aspire to earn, enjoy no public sympathy or political clout. Even if there are few such households, their grinning faces jeopardise the legitimacy of a system that aids the genuinely needy. Yet this is not an easy problem: one might wish such cases did not exist, but is it either just or sensible to punish the children of these households when they do?

Mr Osborne’s proposals combine drastic cuts to tax credits with a substantial increase in the minimum wage. The primary objective is to spend less — but at the same time to shift part of the burden of supporting poor households from the state to business; and to redistribute from households with children to individuals who work.

Among hard political choices, these are not necessarily bad ones. But whenever you are dealing with the finances of people who live from week to week, any change must be gradual, and preferably imperceptible. The scale of the present controversy is a powerful signal that this principle has not been observed.

 

This article was first published in the Financial Times on October 28th, 2015.

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