Would you work 30 hours per week for an extra £20? Sixty-seven pence per hour? Probably not. But before April 2003 that’s exactly what the tax and benefit system implicitly expected childless low-paid workers to do. Those who worry about people getting stuck on benefits in this way should therefore have welcomed the government’s decision to introduce the working tax credit for childless people in April 2003. Designed to tackle just this kind of unemployment trap, WTC has been part of a raft of radical measures since 1997 to make work pay.
So, problem solved? Well, not quite. Withdrawing WTC support as income rises creates a different set of problems. But there need not be such a simple trade-off here and the government should now consider radical ways of tackling both problems together.
With the possible exception of the Speenhamland system that operated in England at the end of the 18th century, the introduction in April 2003 of WTC represented the first time that a national wage subsidy policy for childless people had been tried in the UK. But at a cost of £700m per year those in charge of the Treasury’s cash-strapped coffers are right to ask: was the policy worth it?
A recent HM Treasury working paper, which I co-authored with Mario Pisani, showed that among the target group of childless WTC recipients there was a 2.4 percentage point increase in employment as a result of the policy. The policy was therefore successful. But assessing whether it represents a net saving to the exchequer, by reducing the benefits bill, is a more finely balanced judgement and a source of objections to the policy.
In fact the justification for wage subsidies goes beyond a narrow assessment of whether the policy was worth it from the exchequer’s point of view. Indeed, in implementing WTC the government fulfilled a duty, neglected by previous governments, to ensure that low-paid workers face good work incentives.
In a wealthy, civilised country, few would argue that the state must provide a minimum level of income to people out-of-work in order to provide housing and some money to live on. But providing out-of-work benefits poses problems when people move into work. When benefits are withdrawn quickly as income rises (such as £1 withdrawn for every £1 earned for those on income support) this reduces low-paid people’s incentives to work since they see very little of the extra money they earn.
But wage subsidies, such as WTC, are no panacea. WTC alleviates the unemployment trap, at the expense of a bigger poverty trap. The combined claims on an extra pound of income, from tax credits reduction, income tax and National Insurance contributions mean that a minimum wage earner typically only receives 30p in net income for every extra £1 earned. The inequality here is glaring. While rich people have only to pay tax on each extra pound of earnings, low-paid workers have to pay off their tax credits as well as tax and national insurance.
In the next stage of tax benefit reform this inequality of effective tax rates needs be addressed. One approach would be to provide a lump-sum out-of-work income for all working age people that would replace income support and job-seeker’s allowance but would be withdrawn much more slowly than those benefits, at the usual income tax rate of 20 pence in the pound.
Since everyone would have this allowance added to their earned income, it would replace the personal income tax allowance and any earned income would then be taxed at the usual rates from the first pound.
This kind of system is essentially the same as that recommended by Nobel laureate James Mirrlees in his seminal 1971 paper, which sketched out what an efficient and fair system of income taxation should look like. Such an approach would have the added benefit of being administratively simple by comparison with the current patchwork of support.
While WTC was a major step in the right direction, it should not be the last word on work incentives policy. The government should look to tackle the poverty trap with the same moral purpose that has underpinned its efforts to make work pay.