Credit Where It’s Due – why the Government would be wrong to ditch tax credits

Today the Prime Minister will give a speech justifying a further reduction in the real value of tax credits. The reasoning behind some of the arguments being used by the Prime Minister, and other senior ministers, is so flawed it either suggests that they don’t understand the tax and benefit system or have simply copy and pasted a press release on a different subject.

The Employment Minister Priti Patel has suggested that cutting a policy that supports people into work is a good way to lift people out of poverty. The Prime Minister has suggested that some of the most well targeted tax and social security measures should be cut because they’re not well targeted enough, whilst ignoring the parts of tax and spending which couldn’t hit a cow’s behind with a banjo

The Employment Minister was quoted this morning saying that the Prime Minister’s speech on cutting tax credits “is about reforming welfare so that we have the right employment opportunities, we invest in people, we get them off benefits, which will battle the culture of welfare dependency that trap people into poverty, into deprivation.”

This is bizarre as a description of tax credits when the evidence is crystal clear that they have supported people back into work. Much of the government’s previous rhetoric about “welfare dependency” that traps people in poverty centred on the idea that levels of social security were so high that people were no better off in work than out of work. As anyone who understands tax credits will know, they help solve that problem by making people in low paid work better off in work than if they were unemployed. Unless the Employment Minister thinks the best way out of poverty is to not be in employment, it is hard to see how the above quote can be an accurate description of cutting tax credits.

In his speech David Cameron is expected to criticise a tax credit “merry-go-round”. “People working on the minimum wage having that money taxed by the government and then the government giving them the money back, and more, in welfare.”

This may well seem like an odd system if that is how it’s described to you, but if you look closer at the policies he is advocating his criticism looks perverse. Cameron is advocating that it would make more sense than the current system of tax credits and income tax to raise the income tax threshold for people on low incomes and cut tax credits. The problem with this is that the groups of people who would be affected by these two policy measures barely overlap. Many of those receiving tax credits will not benefit from this rise in the personal allowance and most of those who benefit from a rise in the personal allowance will not be receiving tax credits. Raising the personal allowance for income tax will be a tax cut for many of the richest people in the country. Households in the richest 10% will benefit more than those in the poorest 10%. Meanwhile, cutting tax credits will overwhelmingly hit the poorest 30%.

People on low incomes are taxed heavily but this is not through income tax, it’s through indirect taxes like Council Tax and VAT which represent a far larger share of their income than income tax. If the Prime Minister were concerned about taxing people on low incomes then he should be talking about these taxes or any of the other regressive taxes which overwhelmingly hit those with the least. At the same time the government is providing large subsidies to people on high incomes, for example through the transport system. If he were concerned about giving out large amounts of government money to people who pay tax (although less a proportion of their income than people on low incomes) then perhaps he should be reducing these handouts for the well off.

Talking about cutting income tax for some of the richest households in the country (one of the most progressive taxes) and cutting tax credits (which redistribute only to the poorest and incentivise work) as a way to stop inefficient redistribution is inexplicable whilst  also leaving regressive taxes untouched and continuing to subsidise those at the top. 

Tim Stacey, Senior Policy and Research Advisor