Tax Credits, Babies, and Bathwater.

last night, I was listening to the World Tonight, which featured an interesting and constructive discussion between Polly Toynbee of the Guardian and Matthew Oakley of Policy Exchange. It’s well worth a listen. One of the rare political debates on a contested issue that sheds more light than heat.

The thing that stood out to me in the debate was that both shared a hostility to Tax Credits as a redistributive mechanism.

Polly Toynbee described the current system as “subsidising employers who are paying too little”, while Matthew said Tax Credits “reduced the wages paid to workers” to which Polly assented.1

There’s a risk in this analysis.

First, it’s not entirely clear it’s true.

You don’t need to know what this chart means. Just know it shows I’m right.

For example, This IFS study of Working Family Tax Credit found that tax credits had, if anything,  a positive impact on wages. “We find that WFTC did not reduce, and may even have increased, wage growth” the authors say, suggesting that as tax credits make workers more likely to continue to participate in the Labour market over time, and thus benefit from training, improved skills etc, leading to higher wages.

Further, this research by the Resolution Foundation, suggests that there is little or no evidence for a downward pressure on wages in the UK due to tax credits, perhaps due to the relatively strong “floor” provided by the National Minimum wage.

On top of this, Child Tax Credit also goes to people who are not in work. There are roughly 1.5 million such claimants, just over a quarter of the total number of tax credit awards, and nearly a third of all children who benefit from tax credits are in non-working households. There’s always a danger that this gets forgotten in any discussion of impact of tax credits on working families, especially when it’s suggested tax credits are a subsidy for employers. I’m sure this is unintentional on the left!

The second risk of an emergent left scepticism about tax credits is it neglects one of the core reasons why tax credits were introduced in the first place, which is that the same wage can be sufficient to lift a childless person or family out of poverty, but not be enough to give a larger family enough to live on.  So person X, a single man, would be happy to accept a job that paid £7 an hour for thirty hours, but person Y, who has childcare responsibilities, would find they were still in poverty if they took that same job. The impact of this is that society loses her (because it is usually her) expertise and contribution to the Labour market and that Person Y’s children are more likely to be brought up in poverty.

The rationale for tax credits is partly that they are discriminatory. They single out particular types of families, those more at risk from poverty due to higher living costs, and make work more rewarding for them. This encourages work among these families, and therefore reduces poverty levels more effectively than other redistributive mechanisms. By reducing tax credits over time, we might well reverse that process, thus increasing child poverty.2

This impact can obviously be ameliorated by increasing the floor of wages, which is what most on the left, me included, want to see (if the minimum wage were a million pounds a year, it wouldn’t be a significant issue!) but at any foreseeable level of minimum wage, the need for discrimination in state support between family types to reduce poverty will remain.3

So rather than an employer subsidy, perhaps we should think of Tax Credits as a targeted negative income tax which works to counteract the extra life extra costs faced by families, costs that cannot reasonably be reflected by employers in their pay decisions. If we start to bear down on Tax Credits because we start seeing them as a subsidy to employers, the risk is that we reverse the very positive trends in women’s and lone parents’ participation in the Labour market that we’ve seen over the last decade or so.

What’s more, if we inadvertently create a Labour market which is structurally harder for families with children, this would also obviously have consequences for child poverty. This is why I was so opposed to the freeze in Tax Credits announced in 2011, and so surprised it created so little ire on the left.

Clearly, I don’t think Polly Toynbee, or anyone on the left, wants this to happen. Instead, they would like to see wages increase by more than inflation, thus over time reducing the need for tax credits as an anti-poverty measure.4

However, that is not a reason to undermine tax credits now, because what the right want to do is hold down tax credits, reducing their value over time, without doing anything much to increase wages.5 Giving them the rhetorical ammunition to do this by apparently conceding that Tax Credits are a negative could be very dangerous for working families.

  1. Addendum: Actually, I should say it’s not just this discussion that sparked this thought. I’ve noticed a few other negative references to Tax credits as a sort of corporate welfare emerging from the left, so I’m not just trying to pick on Polly! eg Twitter also suggested that it was a point made by Owen Jones on Newsnight last night, -though I don’t watch Newsnight, so don’t know if that’s quite right or misreported!-, and it’s been mentioned in a few other leftish articles and blog posts recently []
  2. Conversely of course, as this US study points out, Tax credits can by increasing the Labour supply, lead to lower wages for young single men. The minimum wage should offset that, but if it is set too high, it could cause a double whammy for this group- increased labour supply at the higher minimum wage level, plus fewer jobs available due to employment effect= lower employment []
  3. plus of course there are other consequences of imposing a high minimum wage on the jobs market. I don’t know what the current impact on unemployment of a Living wage level minimum wage is, but I’m assuming it’s not a gimme, or leftish economists would be proposing it everywhere. This research by Matthew Pennycook seems to suggest that there would be substantial costs to certain sectors, which might impact employment levels, but with a markedly reduced cost if introduced at 90% of LW []
  4. Or at least, freeing up the resources to be used elsewhere in combatting poverty []
  5. and to be fair, increasing wages without negative employment effects would be pretty difficult at the moment []

7 Responses to “Tax Credits, Babies, and Bathwater.”

    • hopisen

      Indeed, but the paper i link to was a review of WFTC specifically. One of the duller problems of writing about tax credits is that the names of the supplements/credits change so regularly!

  1. Anna

    With regard to the point about tax credits being paid to non-working families: there was a concerted push at one point (which I experienced as a parent on IS at the time) to move lone parents across to CTC as a separate payment, rather than their receiving the child element as part of IS/JSA.

    The rationale behind this was that it would make the move into work easier, as CTC payments would already be up-and-running in the first month. In addition to which, I’d be interested to know how many of those claiming CTC whilst unemployed now, had previously been in employment (my understanding is that there’s been a fair bit of ‘churn’ in the un/employment figures over the last few years.

  2. donpaskini

    “Giving them the rhetorical ammunition to do this by apparently conceding that Tax Credits are a negative could be very dangerous for working families.”

    Yes indeed. See also ‘housing benefit is a massive subsidy to landlords’.

    • hopisen

      I always wonder about that one. I can see a clearer argument for it than I can for Tax Credits (in part because of the way HB does set a floor for rental prices, and because there no ‘minimum wage’ standard/quality equiv for housing which does that anyway)

      However, it seems that the obvious riposte from the right would be “Quite, which is why we’ve moved the HB payment from 50% of rents to 33% and restricted entitlements, both of which you’ve opposed.” How would you reduce the HB bill?”

      To which the answer would be “Big expansion of state housing provision, plus major new supply of private housing” (unless you’ve not read much economic history, in which case you might favour Rent Controls). So why make HB the issue?

      • donpaskini


        Then the next step of the conversation is where the Right go ‘so your plan to cut the welfare bill is to borrow another £60bn and spend it on building council houses, and you estimate that this will reduce spending on housing benefit by coughcoughmumblemumble per year?’

        And then we go, ‘well, there is a pamphlet by the ippr which says that this problem goes away if you give the housing benefit money to local authorities because localism, and also Land Value Tax FTW’.


Leave a Reply