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Irish troubles do not bode well

Ireland is held out by George Osborne as the country with the right approach, but its GDP sank by 1.

Congratulations to Ed Miliband on becoming the new leader of the Labour Party at the last gasp - but there is no time to celebrate. He must get stuck in to sorting out a serious economic strategy to counter the cuts that are about to be imposed on the British people. David Cameron believes he will be able to persuade the public of the necessity of the cuts. I think not, old chap, once they realise what you are up to.

The economic data is again looking bad. The Confederation of British Industry has lowered its growth forecast because of the impending cuts. The minutes of the latest meeting of the Bank of England's Monetary Policy Committee - like those of the Federal Open Market Committee in the US, where jobless claims have jumped again - point to worries of further slowing. According to the Bank, the flow of net lending to UK businesses remained negative in July. Contacts of the Bank's regional agents noted that, while credit conditions were easing somewhat for larger businesses, they remained tight for smaller firms.

Mortgage lending fell again in August, suggesting that house prices are heading back down. The drop in the number of home loans approved during the month - down to 31,767 from 34,219 in July - marked a 16-month low, according to the British Bankers' Association. This confirmed the report from the Council of Mortgage Lenders that mortgage lending fell by 14 per cent, from £13.3bn in July to £11.4bn, the lowest August total in a decade.

Euro millions

The latest Markit UK Household Finance Index gave further cause for concern, showing that the finances of roughly 27 per cent of households worsened in the past month, while only 7 per cent improved. And UK households remain pessimistic about the future: 41 per cent expect a deterioration in their finances, compared to 23 per cent that believe things will improve. Continuing the trend over recent months, private-sector workers were less downbeat than those in the public sector, but at 40.7 the index for all households in September was well below the 50.0 "no change" level.

Markit data

More troubles loom across the eurozone. The new, flash Purchasing Managers' Indices (PMIs) for the region suggest that growth is slowing, especially in Germany. Then there is Ireland, held out by George Osborne as the country that had the right approach: slash public spending and all will be well. That's not exactly how it has turned out. A big shock to the deficit hawks was the news that Irish GDP fell by 1.2 per cent in the second quarter of 2010, after an increase of 2.2 per cent in the previous quarter. Output was still 14.2 per cent down since the beginning of 2008 - more than twice as large as the drop in UK output - and tax receipts are now only 65 per cent of what they were at the beginning of 2007. Yet the governor of the Bank of Ireland is demanding even deeper cuts.

It prompted me to consult Ireland's Central Statistics Office for data on how the cuts have hit ordinary people. Unemployment rose from 4 per cent in the fourth quarter of 2006 to 13.6 per cent in the second quarter of this year, and long-term unemployment is rising sharply. It is presumably not unrelated that, from 2008-2009, burglary (not aggravated) and theft from shops increased by 9 per cent and 3 per cent, respectively. A quarter of a million jobs have been lost, half of them in construction. It is unclear where any new jobs are going to come from.

The Irish government's borrowing costs have increased, not fallen, as a result of the austerity measures. On 24 September, the spread on Ireland's ten-year bonds over benchmark German bunds widened 12 basis points to 430 basis points, having risen 112 basis points over the past month. Spain, by contrast, has plans to cut much more slowly than the Irish and the spread on its debt now stands at 157 points.

In a speech in Dublin in November 2009, I warned that "moves to cut public spending or public-sector wages or employment deep in a recession are a mistake and may turn a recession into a depression", and that "my advice is to wait until you're out". Ireland is a very bad precedent for Osborne, who is ignoring the same advice. The IMF, which in the past week announced its support for the coalition's cuts, encouraged Ireland's slashing spree, too - and look what's happened there.

Brain drain

A good example of the threats posed by the cuts is in the funding for universities and scientific research. On 16 September, the Times Higher Education (THE) magazine produced its world university rankings, which heavily weight the quality of research and staff citations - the better you are, the more you are cited. Research by Dan Hamermesh at the University of Texas found the most important determinant of faculty salaries, and hence their quality, was the number of citations. All of the top five universities in the THE list (Harvard, CalTech, MIT, Stanford, Princeton), and 15 of the top 20, are in the US. Only three UK universities were in the top 20: Oxford and Cambridge were joint sixth and Imperial ninth. So Britain isn't doing well, even before the cuts.

University heads and the president of the Royal Society, Martin Rees, have warned of an academic brain drain. John Krebs, chair of the House of Lords science and technology committee, has written to the universities and science minister, David Willetts, to tell him that "there is a significant risk that a worsening differential in funding between the UK and other countries will damage the ability of UK universities to attract and retain high-quality researchers". But who cares that the best researchers leave and the quality of Britain's universities drops? Actually, we all should. Less scientific funding is likely to lower the country's economic competitiveness. I was among those who left the UK in the 1980s because of low academic salaries and poor research funding. Here we go again.

There will be many more stories like this over the coming months. Maybe Osborne will be for turning as the stark truth about the cuts starts to hit the voters. But I doubt it. Ed Miliband may be prime minister before you know it. Nice one.

David Blanchflower is a labour economist and a professor at Dartmouth College, New Hampshire, and the University of Stirling

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

This article first appeared in the 04 October 2010 issue of the New Statesman, Licence to cut

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Q&A: What are tax credits and how do they work?

All you need to know about the government's plan to cut tax credits.

What are tax credits?

Tax credits are payments made regularly by the state into bank accounts to support families with children, or those who are in low-paid jobs. There are two types of tax credit: the working tax credit and the child tax credit.

What are they for?

To redistribute income to those less able to get by, or to provide for their children, on what they earn.

Are they similar to tax relief?

No. They don’t have much to do with tax. They’re more of a welfare thing. You don’t need to be a taxpayer to receive tax credits. It’s just that, unlike other benefits, they are based on the tax year and paid via the tax office.

Who is eligible?

Anyone aged over 16 (for child tax credits) and over 25 (for working tax credits) who normally lives in the UK can apply for them, depending on their income, the hours they work, whether they have a disability, and whether they pay for childcare.

What are their circumstances?

The more you earn, the less you are likely to receive. Single claimants must work at least 16 hours a week. Let’s take a full-time worker: if you work at least 30 hours a week, you are generally eligible for working tax credits if you earn less than £13,253 a year (if you’re single and don’t have children), or less than £18,023 (jointly as part of a couple without children but working at least 30 hours a week).

And for families?

A family with children and an income below about £32,200 can claim child tax credit. It used to be that the more children you have, the more you are eligible to receive – but George Osborne in his most recent Budget has limited child tax credit to two children.

How much money do you receive?

Again, this depends on your circumstances. The basic payment for a single claimant, or a joint claim by a couple, of working tax credits is £1,940 for the tax year. You can then receive extra, depending on your circumstances. For example, single parents can receive up to an additional £2,010, on top of the basic £1,940 payment; people who work more than 30 hours a week can receive up to an extra £810; and disabled workers up to £2,970. The average award of tax credit is £6,340 per year. Child tax credit claimants get £545 per year as a flat payment, plus £2,780 per child.

How many people claim tax credits?

About 4.5m people – the vast majority of these people (around 4m) have children.

How much does it cost the taxpayer?

The estimation is that they will cost the government £30bn in April 2015/16. That’s around 14 per cent of the £220bn welfare budget, which the Tories have pledged to cut by £12bn.

Who introduced this system?

New Labour. Gordon Brown, when he was Chancellor, developed tax credits in his first term. The system as we know it was established in April 2003.

Why did they do this?

To lift working people out of poverty, and to remove the disincentives to work believed to have been inculcated by welfare. The tax credit system made it more attractive for people depending on benefits to work, and gave those in low-paid jobs a helping hand.

Did it work?

Yes. Tax credits’ biggest achievement was lifting a record number of children out of poverty since the war. The proportion of children living below the poverty line fell from 35 per cent in 1998/9 to 19 per cent in 2012/13.

So what’s the problem?

Well, it’s a bit of a weird system in that it lets companies pay wages that are too low to live on without the state supplementing them. Many also criticise tax credits for allowing the minimum wage – also brought in by New Labour – to stagnate (ie. not keep up with the rate of inflation). David Cameron has called the system of taxing low earners and then handing them some money back via tax credits a “ridiculous merry-go-round”.

Then it’s a good thing to scrap them?

It would be fine if all those low earners and families struggling to get by would be given support in place of tax credits – a living wage, for example.

And that’s why the Tories are introducing a living wage...

That’s what they call it. But it’s not. The Chancellor announced in his most recent Budget a new minimum wage of £7.20 an hour for over-25s, rising to £9 by 2020. He called this the “national living wage” – it’s not, because the current living wage (which is calculated by the Living Wage Foundation, and currently non-compulsory) is already £9.15 in London and £7.85 in the rest of the country.

Will people be better off?

No. Quite the reverse. The IFS has said this slightly higher national minimum wage will not compensate working families who will be subjected to tax credit cuts; it is arithmetically impossible. The IFS director, Paul Johnson, commented: “Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.” It has been calculated that 3.2m low-paid workers will have their pay packets cut by an average of £1,350 a year.

Could the government change its policy to avoid this?

The Prime Minister and his frontbenchers have been pretty stubborn about pushing on with the plan. In spite of criticism from all angles – the IFS, campaigners, Labour, The Sun – Cameron has ruled out a review of the policy in the Autumn Statement, which is on 25 November. But there is an alternative. The chair of parliament’s Work & Pensions Select Committee and Labour MP Frank Field has proposed what he calls a “cost neutral” tweak to the tax credit cuts.

How would this alternative work?

Currently, if your income is less than £6,420, you will receive the maximum amount of tax credits. That threshold is called the gross income threshold. Field wants to introduce a second gross income threshold of £13,100 (what you earn if you work 35 hours a week on minimum wage). Those earning a salary between those two thresholds would have their tax credits reduced at a slower rate on whatever they earn above £6,420 up to £13,100. The percentage of what you earn above the basic threshold that is deducted from your tax credits is called the taper rate, and it is currently at 41 per cent. In contrast to this plan, the Tories want to halve the income threshold to £3,850 a year and increase the taper rate to 48 per cent once you hit that threshold, which basically means you lose more tax credits, faster, the more you earn.

When will the tax credit cuts come in?

They will be imposed from April next year, barring a u-turn.

Anoosh Chakelian is deputy web editor at the New Statesman.