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Two and a half cheers for tax credits Samuel Brittan Financial Times 06/07/07 Among the political cognoscenti the role of tax credits is often cited as Gordon Brown’s biggest mistake as Britain’s chancellor of the exchequer. On the contrary I believe that they are among his achievements. Tax credits are means-tested government grants. When income is high enough they are set against the recipient’s tax bill, which is thereby reduced. If he or she pays no tax or has a low enough tax bill, there is a net payment by the Revenue & Customs into a personal bank account or equivalent. The Commons public accounts committee and independent inquiries have said that the system is working badly. The Revenue paid out a cumulative £47bn in the three years from 2003, of which £5.8bn is officially estimated to be overpayment, much of which there is scant prospect of recovering. Frank Field, the former Labour social security minister, also argues that the system discriminates against two-parent families. There has been a problem of securing full take-up, although the Treasury argues that this has now much improved. David Willetts, the Conservative frontbench spokesman who formerly worked in Whitehall on welfare issues, long ago warned that this type of thing could happen on the grounds that collecting income tax on assessed annual income was an entirely different activity to welfare payments that had to be made quickly on the basis of need. My own view is that the case for tax credits remains sound and that the system needs to be reformed rather than abandoned. The issue has a long history. In the US, Milton Friedman for decades championed a negative income tax. In the 1980s and 1990s an earned income tax credit (EITC) became, with bipartisan support, an intrinsic part of the tax system. The first UK move was made by Keith Joseph, when social security secretary in the early 1970s, under the name of family income supplement, payable only to low-income families with children. The idea was they should not be better off on the dole than by taking low-paid work. Labour was traditionally hostile on the grounds that it encouraged employers to underpay and that it was much better to campaign for higher wages. Nevertheless, the idea attracted Mr Brown as part of his welfare-to-work project. But with characteristic caution he made no move until he received an imprimatur from an independent report by Martin Taylor, then chief executive of Barclays Bank and hardly a flaming socialist. Working tax credit is now available to all in employment; and there is a separate child tax credit as well as a pensioner credit to ensure a minimum income to those over 60. These credits are gradually withdrawn as original income rises. In conjunction with normal income tax this can lead to a poverty surtax higher than the top marginal rate paid by those on higher incomes. Unfortunately many people normally interested in economic matters, for example in the financial markets, allow their eyes to glaze over at any mention of the interaction of tax and social security. To be candid, the successful navigation of the system is as complex as the intricacies of equity buy-backs. One wonders why anyone able to carry it out should be in need of a tax credit at all. Nevertheless, a wake-up call should have come from the Meade memorial lecture given in London last month by Paul Krugman, the eminent American economist and scourge of President George W.?Bush. He tempered the usual mainstream economists’ enthusiasm for free trade with the well-argued fear that it was likely to depress the earnings of low-skilled workers in the developed world. He believes one of the most promising ways of tackling the resulting dilemma in the US is a large increase in the EITC. Direct comparisons are treacherous; but as far as I can see the maximum federal tax credit available to a two-child family in the US is under $5,000 a year compared with £16,000 ($32,200) in the UK. More may, however, be paid at the state level and there are also food stamps. As far as the UK is concerned, my own inclination would be to simplify the conditions for obtaining these credits and reduce some of the means-test elements. Ultimately, I would like to see, as James Meade did, an unconditional if modest basic income for everyone, whether working or not. The shift would not only drastically simplify the system but also bring the benefits of unearned income, such as the opportunity to drop out of the rat race for a while, to ordinary citizens. This does not fit in easily with the Brown gospel of work, but that is surely not the last word. A compromise was suggested a few years ago by another economist, Tony Atkinson, of a citizens’ participation income in which the definition of work was extended, for example, to full-time training, care work or voluntary work. Some disincentive effects should be conceded. We would have a higher gross domestic product if there were no welfare payments of any kind. But maximising GDP at all costs is an insane objective of policy. Meanwhile, a development of tax credits would be a much more promising way of helping the victims of globalisation than the tax raids on financial gains that have a greater visceral appeal.
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