| 15 mins read
Forty years ago, the main method for evaluating social policy changes was to devise ‘profiles’ - examples of households in different circumstances – and examine how each fared under the new policy. The problem was that profiles could easily be unrepresentative of actual households, giving rise to misleading findings. In the 1980s, a superior technique called ‘microsimulation’ was developed. It models policy changes on data for several thousand households, generated by representative sample surveys. Profiles remain valuable for explaining and interpreting policies, but microsimulation is a check on the biased selection of profiles and gives a better account of the overall impact of policy changes. So it has proved with the Prime Minister’s current favourite profile: a family with two children where both adults work full-time on the minimum wage. They will, he claims, be better off by 2020 under the government’s new policy combo of reduced tax credits and a higher living wage.[1] A quick check of HMRC statistics shows that there are just 135,000 households receiving tax credits (out of 3.3m working households) comprising a couple with children where both adults work full-time.[2] Microsimulation results from the Institute for Fiscal Studies confirm the inference that this profile is hardly representative. They show that, once the current benefit changes are fully implemented, low income households will lose some £6 billion in tax credits and another £6 billion in other benefits. The best guess from the Office for Budget Responsibility is that households will gain £4b in wage income, with up to half of that gain going to households too high up the income distribution to compensate for lost benefits.[3]
It is not easy to unpick the process whereby cuts in tax credits have been sold to the public as a step down a golden road towards higher earned incomes. It’s true that tax credits have never gained a protective mantle of popularity, which is a pity, as they have been highly effective in raising the incomes of poor families. They grew out of policies to ‘make work pay’: to enable people with relatively high out-of-work benefit entitlements to take up low-paid work, which was otherwise the province of those without dependents. The low-paid work came from the deregulation of employment contracts and the rise of the service economy, not from the tax credits. The claim that tax credits are captured by employers and lead to more low-paid employment has proved irresistable to both left and right, despite the lack of more than anecdotal evidence.[4] The argument was invoked by Labour when it introduced the National Minimum Wage (NMW) in 1998; now it has been taken up with a vengeance by the Conservatives.
To be fair to Labour, it introduced the NMW alongside a huge boost to in-work benefits, and it was conceivable that the benefit changes would be so successful that they would make any work pay: that people would be so keen to leave unemployment that they would accept any offer of work. But there are natural checks to this tendency. One is that tax credits encourage people into work, but they do not encourage them to work long hours. Indeed, part of their usefulness was that they allowed households to juggle work with other responsibilities, and thereby escape monetary poverty without falling into the trap of time poverty.
This is something that will change as the Conservative cuts to tax credits kick in. The vast majority of tax credit-receiving households do not fit the Prime Minister’s profile. If they keep their present jobs and hours and the new living wage is fully complied with, their incomes will fall substantially. Presumably, few will be able to let that happen. They will have to find more work. The government believes that too many people on tax credits are choosing to limit their hours. It emphasises the situation of the small group of tax credit recipients in full-time work because it thinks that full-time work should be the norm. This is clearly signalled by the design of Universal Credit, which will eventually take in the last remnants of tax credits. A key feature of Universal Credit is that meeting the minimum hours threshold for tax credits (which has in any case been raised) will no longer be enough to satisfy the authorities. Those on low hours will be supervised to check that they could not be putting in more work.
Why this fetish for full-time employment? The personal and social gains from working do not depend on reaching this threshold. The obvious explanation is fiscal. As the economy has recovered, the growth in income tax receipts has been disappointing. People are not earning enough, due to a combination of low pay rates and low hours. By decreeing that hours and pay should rise, the government will magic up a fiscal improvement. Actually, there will be far-from-magical savings in tax credit expenditure regardless of how employment and incomes respond. The new model is one of self-reliance. Thanks to the high threshold for personal income tax (but not national insurance), low-income workers will keep most of what they earn, but if earnings fall short of their needs, they will not be topped up.
The adverse effects of this might be covered up, at least for a while, if the economy continues to grow and jobs are created at higher wages. Wages do indeed seem to be in something of a low-level trap, but not because tax credits are keeping them there. Most people in low-paid work do not receive tax credits, because they are too young (under 25) or do not have children. The main reasons why wages have stayed so low lie elsewhere: the erosion of unemployment benefits, the lack of financial support for students, the elastic supply of labour from elsewhere in the EU, the government’s own pay policy for public sector workers and, of course, the decline of collective bargaining. In the space between the minimum people are willing to work for and the maximum employers are willing to pay, wages have gravitated towards the lower bound.
The NMW went some way to correcting this. The new Living Wage will go further, but its intended beneficiaries may come to curse it. The living wage age limit of 25 has been chosen with reference to the tax credit system, not by considering how effectively someone aged 23 or 24 will be able to compete by accepting a lower wage. In any case, the withdrawal of tax credits will not help make jobs available at higher wages: on the contrary, it will hinder the process, as the primary effect of the changes will be to push people to seek longer hours of work, intensifying competition for jobs and providing ample incentives to evade the new wage, notably through the growth of already-rampant phoney self-employment.
How did we end up in this looking glass world, where policies are sold as a package when they will actually work in opposite directions? If a Labour government announced that wages and employment were about to rise by decree, it would be mocked for its Alice-in-Wonderland economics. The Conservatives have managed to turn this improbable story into an attractive message to voters with the aid of two false friends from the left. One is the idea that the policy cracks down on employers who exploited tax credits to pay low wages. Former No 10 policy adviser Paul Kirby has promoted a ‘Nixon goes to China’ interpretation[5]: only the Conservatives, it seems, have the political capital to tackle those dastardly employers. But the claim that employers captured a subsidy from tax credits is doubtful in theory and lacking evidence in practice, while the idea of ‘cracking down’ ignores the structural power of employers. Unlike workers, they can reduce employment or shut up shop.
The other false friend is the concept of a living wage. It is rather sad to have to admit the limitations of this idea, which has proved so effective in creating a social movement for higher wages. But the living wage has always been a mixed blessing. In the mid-twentieth century, it stood in the way of child benefits and equal pay. At that time, it was a ‘family wage’, based on the profile of a man supporting a wife and children. Nowadays, a lot of work goes into generating living wage estimates for a variety of household circumstances, but the result is a dog’s breakfast of calculations which has left the government free to choose from the numbers and bestow on its preferred value the moniker of a living wage.
One of the fundamental problems with the concept is the ambivalence of its proponents about the role of in-work benefits such as tax credits. Some living wage campaigners explicitly want to reduce workers’ reliance on benefits, while others see contributions from social security to the income of working households as normal and desirable. Yet others think that income tax and universal benefits should be taken into account, but not means-tested benefits. The sober social policy researchers who do the living wage calculations for London and the rest of the UK have taken the view that the results should reflect the tax and benefit system that exists. Thus tax cuts result in lower estimates for living wages on their calculations, while cuts to tax credits increase them.
This leaves the living wage vulnerable to being hijacked by the government, and, sure enough, it has been. It allows the government to frame the living wage as a by-product of tax and social security decisions, instead of providing a basis from which campaigners can defend not only wages but also social security. A more robust approach to the living wage would have been to take a stand on the appropriate role for in-work benefits. For example, the living wage could have been set to ensure that a single person in full-time work could make a living without needing benefit top-ups, and estimates of the additional costs faced by those with children could then have been used to make the case for adequate child benefits and childcare provision. The available data suggest that the living wage estimated in this way would be above the new minimum coming into force next April, but potentially similar to the headline figure of £9 by 2020. On this basis, it would be crystal clear that low-income families with children need support from the state even when a living wage is paid, and that increases in minimum wages do not substantially alter this fact.
The living wage campaign caught on partly because campaigners felt that the minimum wage recommended by the Low Pay Commission was too low. But the Commission had good reason to be cautious. It wanted a wage that would be self-enforcing, in the sense that any informed worker would feel able to insist upon it. The infrastructure for legal enforcement is minimal, and would be no match for the pressures for noncompliance that would come with high unemployment. This does not mean that the minimum wage is not binding: on the contrary, it seems to have been very important to have a well-publicised benchmark. There was also no harm in trying to push the benchmark up through social pressure, as the living wage campaign has done. But the Low Pay Commission was realistic about what could be achieved by government decree on this side of the looking glass. It might be thrilling to travel to the other side, but this will wear off, especially when you notice that it is George Osborne, not Jeremy Corbyn, who is there with you.
[1] Cameron’s claim, at Prime Minister’s Questions on 15 July 2015, was that they will be £5050 better off by 2020.
[2] HMRC Child and Working Tax Credit Statistics, April 2015, Table 4.2. The figure of 135,000 is the number of families where the main worker is working 35 hours a week or more, the partner is working 30 hours or more, and there are children present. There are 1.5m working couples with children receiving tax credits.
[3] A full review can be found in Resolution Foundation (2015) ‘Higher ground: Who gains from the National Living Wage?’, available at http://resolutionfoundation.org/publications/higher-ground-who-gains-from-the-national-living-wage/. See in particular Figure 7, p.30.
[4] See eg http://www.resolutionfoundation.org/publications/creditworthy-assessing-impact-tax-credits-last-decade-considering-means-universal-credit/.
[5] Paul Kirby (2014) ‘For a historic increase in the Minimum Wage, we need a Nixon in China moment….’ at http://paulkirby.net/2014/01/10/for-a-historic-increase-in-the-minimum-wage-we-need-a-nixon-in-china-moment/
