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Laughed out of the Bank of England? You must be joking

A response.

David Smith responded to my most recent New Statesman column in not unexpected ways.

I have no wish to engage in a war of words but it is appropriate to take a look at what he says.

In my column, I simply exposed the fact that Smith's analysis, in my view, is generally biased in favour of the coalition. He has helped to establish the false narrative that Labour caused the crisis when the cause was global. He also gives the impression that everything is going along swimmingly which, of course, it isn't.

Recall that the Tories backed Labour's spending plans through 2008 and wanted more deregulation, not less. The Tories have criticised Gordon Brown and Alastair Darling's reaction to the crisis but have never told us what they would have done instead. Meanwhile, I criticised the Bank of England's MPC for missing the recession and for its hopeless forecasts of both growth and inflation.

Smith goes on to suggest that I had claimed that unemployment was going to rise to four or five million which is not true. This is what I actually said in my New Statesman column of 24 September 2009 when my forecast was a conditional statement depending on policy:

Unemployment is going to continue to rise this year and may keep on rising. If spending cuts are made too early and the monetary and fiscal stimuli are withdrawn, unemployment could easily reach four million. If large numbers of public sector workers, perhaps as many as a million, are made redundant and there are substantial cuts in public spending in 2010, as proposed by some in the Conservative Party, five million unemployed or more is not inconceivable.

I share the view of Ben Bernanke that he expressed in his 60 Minutes interview on CBS back in December 2010. Namely, that without the monetary and fiscal stimulus unemployment would have hit 25 per cent. I think this applies to the UK as much as it does to the United States.

As evidence for my assertion that Smith seems to talk up the economy and talks down any bad news, let's start with his post on 25 January 2012 responding to the dreadful fall in GDP, entitled "GDP slips, but no big deal. On 29 January he argued that "in all likelihood the 0.2 per cent fall in GDP, announced by the ONS last week will be revised away in time." How does he know that, given over the last five years the average revision has been down?

On 3 February it was "service sector at ten month high", despite the fact that the series remains at a very low level. And when there was a small rise in PMI Manufacturing his headline on 1 February 2012 was "A good start for manufacturing".

There are more examples besides. But let's put this in its proper context -- this is the longest lasting and deepest recession in a hundred years with no end in sight as Jonathan Portes NIESR pointed out last week.

On an 8 January post -- "Nice surprises so far - can they possibly last?" -- Smith claimed that "pretty well every bit of economic data we have had so far has surprised on the upside." Really? How about declining growth, falling living standards, rising unemployment, record levels of youth unemployment, lengthening waiting lists in hospitals and historically low levels of business and consumer confidence?

On 30 December it was "house prices relatively resilient" despite the fact that house prices continue to fall.

I find Smith's comments about the way I allocated quarterly growth to Darling and George Osborne illustrative of a more general problem. Given that there are time lags between implementation and outcomes it doesn't seem unreasonable to give Darling the first three quarters of 2010 and Osborne gets the data from there. This way they get five quarters each.

I was quite explicit about it and presented the data for all to see. Smith's response is to ask "why doesn't the coalition get half of Q2 2010 and the whole of Q3 2010"? The obvious answer is that it takes a while for policies to impact outcomes.

Why would anyone think that growth in the second half of May 2010 and June 2010 is due to the policies that Osborne was going to announce in his 23 June 2010 Budget, seven days before the end of the quarter?

Smith also argues that it will be astonishing if private sector jobs don't "more than outweigh losses in the public sector". I guess, therefore, he has to be astonished given that over the last year public sector job losses were bigger than private sector job gains.

As there is no plan for growth this is set to continue. It is the word "more" that I especially object to -- it seems unlikely that the private sector will respond in large order (as the OBR is predicting to the fiscal contraction) or that the MPC can expand fast enough to compensate.

Finally to his suggestion that on the basis of my analysis in the column "I would be laughed out of the building" should I show up at the Bank of England, does he mean just as I was in the spring of 2008?

He also suggests that I "may be the only economist in the country -- or, rather viewing the country from New England -- who thinks Britain's slowdown is entirely due to fiscal tightening."

I have never said such a thing and certainly don't believe such simplistic nonsense -- fiscal tightening is just part of the explanation. As I have written many times I do think that a lot of the problems that the economy now faces are the result of the leaders of the coalition talking down the economy falsely claiming it was bankrupt or like Greece.

Sorry David, the spin doesn't wash.

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

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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.