15 September 2015

George Osborne deserves the benefit of the doubt on tax credits


Tory MPs tempted to rebel over the chancellor’s £12bn saving on tax credits, to be partially offset by the introduction of the National Living Wage of £9.35 an hour, should think again. It is impossible to be sure exactly what the impact will be, but the numbers bandied around are somewhat suspect. We can only guess what the overall effect will be on behaviour, by firms and individuals, but we must hope it will be positive and should be encouraged.

In situations like this I, like everybody else, rely on the planet-sized brains in the Institute for Fiscal Studies, but I am not sure it has covered itself in glory on this subject. It has pronounced, ex cathedra, that the chancellor’s reforms will be catastrophic for low income households, without giving adequate emphasis to the uncertainties in the data or the dynamic nature of the economy. When confronted with a reduction in their income via tax credits, most individuals won’t just sit there, they will start work, get new jobs, ask for a promotion or a pay rise and indeed generally crack on. They will be incentivised by the higher living wage and, as Lord Wolfson, the chief executive of Next has said, the cost to companies of higher wages should be substantially met by higher productivity and a minor pick-up in prices.

As Wolfson works in retail, where they employ plenty of low-paid people, he should know. And it is no good saying he is biased because he is friends with the chancellor. He has never been afraid to speak his mind in the past.

Wolfson’s optimistic opinion, based on experience, is in contrast to the IFS. Its inclination is to assume the worst. It said last week: “Even if GDP, employment and hours worked are all left unchanged the increase in gross wages from the new NLW will need to come from someone. Either company profits will fall depressing returns to shareholders, or prices will rise or the earnings of other individuals will be reduced.”

The first piece of data produced by the IFS appeared immediately after the Budget. It was a chart called “Impact of tax and benefit reforms between April 2015 and April 2019”. It showed that some of the poorest households would be £1300 worse off after the summer Budget. It was presumably this chart that the distinguished Labour MP Frank Field referred to this morning on the Today Programme. It has also been endlessly retweeted by journalists and activists and quoted by the new modish Tory pressure group, the Good Right. The Tories “are hitting the strivers”, said Mr Field, and backbenchers would be right to vote against the government.

But this chart has several drawbacks. It doesn’t show the uplift in incomes from the National Living Wage, nor does it adequately explain the definition of “household”. That is an awkward Victorian word to describe the multiple and changing combinations of people living under the same roofs in modern Britain. Many people who live together do not, or do not want to, share incomes. That is why the overall number has been massaged by the application of so-called “equivalence scales” provided by the OECD, which I have to confess I don’t understand, but I am sure I am not the only one. One should be sceptical of this sort of manipulation as it claims exactitude in an imperfect world.

Last week, the IFS published new, in depth research, which it has revised slightly to reflect more recent data. It also had a shot at adding in the positive impact of the Living Wage. This is a difficult area because some who will gain from the Living Wage are in higher income households (though I don’t personally think that is particularly relevant if individuals run their affairs separately).

This new research shows that of the 8.4m households eligible for tax credits and with somebody in paid work, the combined impact of withdrawn tax credits and increased minimum wage would be a net loss of £556, in other words less than half the number quoted by Mr Field et al. The worst impact is not actually on “strivers” at all, but on households where nobody works and consequently they won’t get the benefit of the Living Wage. Here the IFS said that the net loss of income is £3,100. That is a truly huge amount, which if true, will surely mean some of the poorest in society could be reduced to penury by the chancellor’s reforms.

These are the people we should really be worried about. That said, their circumstances would obviously be dramatically improved if they did get a job, which is surely the whole idea. Even if someone from these households only worked 16 hours a week, they would be better off by a net £4,000.

Putting hard numbers on the precise impact of tax and benefit changes is incredibly difficult and the IFS deserves credit for having a go. But rather than accept the figures uncritically, we should all understand they are estimates, look at them in the round, and not assess their impact too gloomily or in isolation. The chancellor, and the Government are making a classic trade-off. They have taken the view that by reducing the deficit and balancing the books, the economy will grow, inflation will be kept down and that, related to this, society and individuals will be better off if people are encouraged to move off benefits and into work. That is why they are cutting tax credits and offsetting that with the new Living Wage. These big, strategic – one might even say moral – judgements have been taken in the face of fierce opposition, but so far have been proven right. George Osborne, Iain Duncan Smith & co deserve the benefit of the doubt this time too.

George Trefgarne is a Research Fellow at the Centre for Policy Studies