In defence of tax credits

One of the most damning indictments of New Labour is that it's been rubbish at defending its policies. One example of this is its failure to make the case for the high marginal tax rates faced by those on low wages. In truth, there's a good case for these.
Start from the perspective that there's a case for boosting the incomes of the low-paid. Doing so combines egalitarianism with efficiency.  It's egalitarian, because it compensates people for the bad luck of having low skill. And it's efficient because it gives people an incentive to work rather than stay on the dole. When New Labour came to power, almost one-in-five children were growing up in households where no-one worked. This meant a generation were growing up to think it normal to be out of work. And social norms formed ealy in life can affect lifetime work incentives. Thanks partly to tax credits, the number of such children has fallen.
Now, given that in-work benefits are a good idea, the question is: how fast to withdraw them?  Before 1997, Family Credit was withdrawn quickly, with the result that over a million workers faced marginal deduction rates of over 70% (table 3.4 of this pdf). Tax credits are now withdrawn more slowly over a longer range of income. This means fewer face deduction rates over 70%, but more people face deduction rates of 50-70%, though some still face massive rates; the IFS have got the numbers (pdf).
This has two things to be said for it.
First, it's the counterpart of giving help to the median voter. This has the practical advantage of entrenching support for redistributive policies.
Second, the disincentive effect of higher deduction rates is tiny. This is because many of the low-paid just don't have the skills to earn more anyway. This paper by Mark Stewart shows that "low wage jobs typically do not lead onto better things." They are a stepping stone - but towards unemployment rather than a good job.
And this provides another argument for in-work support. They provide a way of insuring people against unemployment without jeopardizing incentives to stay on the dole, because people can use their temporary in-work incomes to self-insure (ie save) against future unemployment.
So, there's much to be said for the principle of tax credits, if not the administration. The questions are: why has New Labour been so bad at making this case? And what, if anything, is wrong with it?

Comments

[Surreptitious Evil]

Because the appallingly bad administration of the tax credit system makes so much better a media story (and you can trivially personalise it with families living on beans and toast because of the clawbacks) that the less said about the entirety of it, the better for the spin doctors.

Added to that, I doubt that issues around the "disincentive effect of higher deduction rates" appear in any party's "key issues for floating and undecided voters" lists.

[Mark Wadsworth]

You've changed your tune!

I thought you favoured the CBI approach where everybody has the same marginal deduction rate.

As to disincentive effects of high out-of-work benefits and high withdrawal rates, consider following cold hard stat's...

Employment rate for married mothers with a working spouse is 80% because they get no out-of-work benefits and they have an average withdrawal rate of 25% up to an income of £23,000.

The employment rate for single mothers is 55%, they have very generous out-of-work benefits and they face average withdrawal rate of 70% up to an income of £23,000.

Employment rate for mothers with an unemployed partner is only 44% because the household gets even more out-of-work benefits and the average withdrawal rate up to an income of £25,000 (or so) is 70%.

In the absence of any benefits at all, one would expect the relative employment rates of these three groups to be exactly in the opposite order!!!!

The figures for fathers are just as striking, it's 95% employment rate for men whose partners work, 78% for fathers whose partners don't work and 67% for single fathers.

So there!

[Geoff]

I disagree about your theory that "many of the low-paid just don't have the skills to earn more anyway" in fact most low paid people work part time and the marginal tax rates is a strong disincentive to work longer hours.

[Neil Harding]

I don't really understand any of this. Can someone explain it to me in very simple terms?

[Mark Wadsworth]

Neil H, what it means is,
IF you give people a lot of money for staying at home,
BUT take it all away if people get a job
AND deduct tax from their wages as well
THEN there is (purely from a financial point of view) little point in working.

e.g. in examples above, if unemployed single mum gets an average wage job of £23,000 p.a., she is only £6,900 a year better off.

[Tom]

Only £6900? How does that amount of money look to the average unemployed single mum? I must say it looks pretty large to this well-paid and full-time employed father of a nuclear family.

[Matt Munro]

The problem is that if you are on or close to the average salary the differential between your income and the that of the unemployed/low paid is reduced, particularly if you have children. Tax credits mean that some low earning/unemployed groups have more disposable income than those in middle income jobs and when you include the hidden subsidies like free or subsidised housing, travel, school meals, prescriptions etc etc, it means that an employed couple with children must now earn £52k to have the same disposable income as an unemployed single parent. This is a disincentive to working and creates resentment between the working/lower middle classes and the unemployed who are seen as undeserving of their relative economic status. My partner says you can tell the single parents in the playground as they are the one's whose kids all have new designer clothes, while the working parents all make do with cheaper or second hand stuff. The gap between the bottom and the middle has been reduced to almost nothing , but the gap between the top and the bottom has got wider is my uninformed opinion.

[Mark Wadsworth]

Tom, £6,900 obviously is not enough, which is why only 55% of single mothers and only 44% of mothers with an unemployed partner are in work. As against 80% of married mothers, for Heaven's sake!

Matt Munro, your opinion seems perfectly well informed and correct to me.

[john b]

Shorter Mark Wadsworth: "mothers who share parenting with a partner are more likely to be able to go out to work than mothers who have to do it all on their own. Shock! Horror!"

[Mark Wadsworth]

Shorter Mark Wadsworth: "women who have an unemployed partner to look after the children are about half as likely to go to work than a women whose husband works"

That's the true horror of the situation.

[dearieme]

"she is only £6,900 a year better off": which leaves her much worse off than doing a bit of work for "cash in hand" presumably. So the answer to the whole prob is to massively shrink the state so that you can do tax credits if you wish without excruciating marginal withdrawal rates. Yes?

[Mark Wadsworth]

Yes.