Tax credit cuts: a false economy

This blog originally appeared on Public Finance

If the Chancellor wants to help low- to middle-income households, he would be wise not to sacrifice tax credits, by far the most progressive way to help poor families

Seventy per cent of April’s new cuts to tax credits will fall on households in the bottom half of the income distribution band if the government goes ahead with proposed changes to working tax credits.

The cuts, announced at various points over the last two years and accounting for over £2.4bn in 2012/13 alone, are by far the biggest cuts to tax credits yet. Of the 2 million people on low to middle incomes currently claiming Working Tax Credits, all will be affected in some way. For some families, individual losses will run to several thousand pounds. Moreover, these cuts will disproportionately impact on households with children, as recently reported on by the IFS.

In the last decade, tax credits have done more and more to lift the incomes of people on low to middle incomes. With-real terms falls in wages, the highest under-employment in recent history and persistent rises in the costs of essentials like food and energy, they are only increasing in their importance to household budgets.

If the coalition wants to show low- to middle-income households that they are doing what they can (within their means) to help them get by, it might be an idea to zoom out from unnecessary arguments about the 50p rate. As Resolution Foundation’s budget submission shows, by far the biggest impact on households will come from cuts to tax credits, and the government must reverse proposed cuts of £1.3bn across three main components.

Perhaps the most essential of these are changes to the main elements of the WTC. From next month, the government has said WTC will not be up-rated in line with inflation, saving an additional £480m in 2012/13. This is a real-terms cut, making it that much tougher for families to meet the rising costs of living, and should be reversed.

Couples with children could also be hit by an increase in the hours that they must work before they are eligible for the WTC (saving £515m in 2012/13). With under-employment at record highs, it seems far from the opportune moment to impose such a cut when many parents simply cannot negotiate longer hours with their employer. Moreover, childcare costs can make extra hours difficult or unfeasible – a barrier made worse by last year’s reduction in childcare support (saving £350m in 2012/13). This can mean the high costs of childcare mean it makes little financial sense to work.

If the coalition wants to help low- to middle-income households, they would be wise not to sacrifice tax credits, by far the most progressive way to help poor families. Waiting for Universal Credit won’t solve these problems, and the arguments for an increased personal allowance are outweighed by those for tax credits which better target resources where they are most needed.