In his review of tax credit reforms, the Chancellor George Osborne should remember and esteem the proposals of the most influential free market economist of the 20th century.
Ahead of the Autumn Statement at 12.30pm, during which the latest tax credit reform proposals are due to make some kind of appearance, it is worth considering and highlighting the libertarian merits of tax credits. Though it was the House of Lords which ultimately put an end to initial plans to cut tax credits, the rejection of cuts should have been advocated by any true free market favouring Conservative and celebrated as a victory. Indeed, it is not difficult to draw the conclusion that the recent priorities of the Chancellor have not exhibited libertarian and free market principles.
It was during the last government budget that we saw the extent to which David Cameron and George Osborne planned to reduce and limit tax credit payments. Currently, full working tax credit payments are afforded to an individual until they earn £6,420 – a limit the government intended to cut to £3,850 as soon as April and the payments tapered more rapidly over time. This was as well as confining child tax credits to two children per family. Aside from the plans themselves, the issue of whether David Cameron actually broke a pre-election promise not to touch child tax credits has been a contentious one. The proposed reforms are rooted in the Treasury’s endeavour to save £4.4bn from the welfare bill, however in its first Comprehensive Spending Review since October 2010, it is now expected to listen to concerns that have been raised across all parties.
Considering the case for safeguarding tax credits above other areas susceptible to cuts, we can look at the economic rationale behind them. Tax credits are a means-tested mechanism through which the state can boost the incomes of those earning under a certain amount and, importantly, it should be noted that they can be received by full-time workers. This leads to the notion that work is made more attractive, since a level of income for subsistence is guaranteed no matter how low-paid the job is. Because tax credits are not a traditional work-disincentivising form of welfare, rather the opposite, they are permissible as a pro-worker stance – something that Osborne too, bizarrely, hails as his stance. Moreover, as opposed to minimum wages, the guaranteed level of income they offer does not damage that flexible labour market which we accept to be desirable.
With tax credits established to be one of the least market-distorting and most work-encouraging ways to boost low incomes, we can also consider what the ultimate godfather of free market economics, advisor to Thatcher and Reagan, has to say. Many libertarians and free market advocates will be familiar with Milton Friedman, Nobel Prize winning economist and the famed economic liberal of the 1980s. Friedman could be described as a pragmatic libertarian, who held a belief that government was necessitated for very few but vital strategic interventions to stabilise the macroeconomy. He also accepted that a replacement of the entire welfare state with a revival of laissez-faire public policy and voluntarism was neither a realistic nor credible position to take. His ensuing suggestion was that substituting welfare programmes with a negative income tax was the ideal compromise. The idea was that those with no income would receive some money from the government and as incomes rise, the amount received would be reduced up until a defined breakeven point is reached, at which point you would start paying income tax on your earnings. This design of welfare support has been heralded as one of the parents of America’s Earned Income Tax Credit, for example, and is a comparable recommendation to the UK’s present programme of tax credits.
The justification for this type of income support has been that tax credits as a government programme cost much less and are more simple than most, thus dramatically less bureaucratic, are able to target income relief to the truly poorest in society, thus alleviating poverty better, and finally, preserve incentives to work – all whilst avoiding labour market distortions and interference with personal freedom. More on Friedman’s stance can be found in his renowned book Capitalism and Freedom as well as his very paper entitled The Case for a Negative Income Tax. If a government’s role is to assure some level of economic welfare, it should not be difficult for anyone, let alone a pragmatic libertarian, to see the benefits of advocating this superior form of doing so.
It might come naturally to someone right-wing like Osborne to champion the reduction of taxes on low-paid workers as a good, small-state poverty-reduction tool, but because low-paid workers have typically only paid very little tax, altering tax thresholds is simply not sufficient to meet the income loss felt by tax credit cuts, just as the National Living Wage too is insufficient.
Of course, in recognising that tax credits might on occasion reduce incentives to earn slightly more, as they fall when income rises, low or no taxes for low-paid workers remain important so as to not exacerbate this. From those moving from unemployment into low-paid work, tax credits do however remain a sure way to encourage and boost employment, so in net terms the resulting employment is still positive. When the first form of tax credits was introduced in the UK through the Family Income Supplement in 1970, it was intended to ensure that no one was better off unemployed than employed, and this remains true today.
If Osborne wants to substantiate his claims to be pro-worker, he should do all of three things: ensuring work pays, raising levels of employment and offering the dignity of work to a wider group of people, low-skilled included. These can be achieved by concretely championing tax credits above other forms of welfare, deregulating hiring practices and reversing his disastrous National Living Wage.
The Chancellor is being politically cunning, as he often is, and has made a grave economic mistake by touching tax credits and instead distorting the labour market to make work pay for those already in work. The National Living Wage is undoubtedly detrimental to labour market ‘outsiders’ – those out of work and typically the low-skilled who are priced out of jobs they would have otherwise been willing to take and compete for with lower wage equilibriums. As a previous blog for Conservatives for Liberty touched upon, the National Living Wage is one of the more painful of Osborne’s policies to the free-market ear, with the OBR adding to the pain by immediately suggesting that such an increase will prompt 60,000 job losses and the Low Pay Commission going further to suggest that this estimate is conservative.
If you are someone who believes that embracing the free market is the best means through which worldwide prosperity and overall living standards are raised, as I do, you should be uncomfortable with Osborne’s apparent distrust of it.
Should Conservatives not be the advocate of the worker – the individual who gets up to work instead of concluding that state dependence would afford them a better life? No market-trusting Conservative should be in favour of the current policy direction. Reducing the state is of course important, as transferring more to the private sector with its subsequent efficiency gains and reducing dependency, over time. But cutting tax credits is a strange move – an odd priority for a new majority government with the capacity to cut in any other areas. And judging by the sentiment expressed by many across the political spectrum, including fellow Conservatives increasingly voicing their concerns, the tide is turning against recent erroneous political calculations. Hopefully, for the sake of working people, George Osborne will reconsider his priorities, deviate from his antiquated brand of Conservatism and listen to the Friedman.