The Merry-Go-Round Is Just Spin

Donald Hirsch writes:

In its search for justifications for saving money on welfare, the government has placed much emphasis on limiting out-of-work benefits in order to avoid perverse incentives.

But cutting the welfare cap only produces around 1 per cent of the £12 billion cuts required.

A reduction in Child Tax Credit (and ultimately in the child element of Universal Credit) requires a totally different rationale.

This is because it goes to people in and out of work, so reducing it harms ‘hard-working families’ as well as those without jobs.

It’s hard indeed to see how a large cut in these credits is compatible with Universal Credit being presented as a flagship measure that will help families work their way out of poverty.

This helps explain why David Cameron has put so much emphasis on the supposed illogicality of a system of in-work top-ups that coexists with income tax, so that the Treasury takes in income tax with one hand and pays out in tax credits with another, sometimes to the same families.

This ‘merry-go-round’ is made to sound just like a bureaucracy for recycling money. Nothing could be further from the truth.

First of all, the majority of adults in families receiving tax credits pay no income tax at all – they earn too little to do so (or nothing at all).

Second and more importantly, income tax is based on individual earnings, while tax credits are based on family income.

So unless the individual basis for income tax were unravelled (something nobody is proposing), cuts in income tax matched by reductions in tax credits will cause low-income working families to suffer big net losses, not matched by tax cuts.

This all sounds quite complicated but there’s a simple way to think about it.

In very broad terms, there are six times as many taxpayers as families receiving tax credits.

So if you cut tax credits and so were able to cut the amount each person paid in tax, there would be enough to reimburse about £1 per taxpayer for every £6 cut per tax credit family.

The minority who actually are on the ‘merry-go-round’ (families receiving tax credits that contain a taxpayer) would still lose £5.

The neediest families, too poor to pay tax, would each lose £6. Only those too well-off to qualify for tax credits would gain.

But is the very existence of the merry-go-round illogical?

No – in-work credits and income tax are doing different things.

One is a social programme to help people who risk hardship as a result of low income.

The other is a simple means for individuals to contribute a proportion of their earnings to meeting the cost of the state.

We don’t think it’s illogical that some people’s pay income tax that funds the NHS to treat them when medical need arises.

Neither should we worry that some people paid just enough to contribute some of their earnings to the state should get something back based on their family’s needs and the income of its other members.