Labour's challenge is to show that it has the best plan to control welfare spending

The party needs a "social investment" strategy to reduce the subsidisation of private landlords, low-paying employers and long-term worklessness.

When George Osborne used his new year political message to raise the prospect of a further £12bn of cuts to working age benefits, it confirmed that the Conservatives will put welfare at the centre of their re-election strategy. In a speech at the IPPR today, Rachel Reeves will set out her first response to this challenge as part of a series of interventions from the Labour frontbench to connect their arguments about the "cost of living crisis" to the need for longer term social and economic reform.

Having signed up to the principle of a cap on structural welfare spending, the priority for Labour is to contest the debate about which party has the best strategy for sustainably controlling rises in the benefits bill and squeezing the greatest value from taxpayers' money. This requires a "social investment" strategy to reduce the subsidisation of private landlords, low-paying employers and long-term worklessness. The goal should be, over time, to shift spending from cash transfers and into housebuilding, childcare, apprenticeships and back to work support. As Ed Miliband argued last week, Britain has to earn its way to higher living standards.

A political direction of this kind can also be connected to Labour’s stated interest in reviving the contributory principle within the welfare system. In most of continental Europe, a distinction remains between social insurance (protection from cyclical risks for those who have contributed) and social assistance (means-tested support to those on the lowest incomes). However, over a number of decades, these two functions have been almost entirely conflated in this country. Restoring the distinction would mean aiming to reduce reliance on the state for permanent income replacement wherever possible, while strengthening temporary protection at key moments when earned income drops, like losing a job and having a child.

Marrying social investment and the contributory principle in this way would require a significant re-engineering of social policy, re-orientating of public spending, plus institutional innovation to revive the currently moribund National Insurance system. As part of IPPR’s Condition of Britain programme, we are exploring how such a strategy could be advanced, within the constraints of plausible fiscal scenarios for the next Parliament.

One option is to expand the role of income-contingent loans in providing much more substantial support to those who have contributed into the system if and when they face a drop income due to job loss, on a temporary and repayable basis. Our proposal for National Salary Insurance is one variant on this idea. Another is to provide a higher rate of short-term benefit for those who lose their job after having paid into the system, funded by increasing the number of years of contribution required before this entitlement kicks in. This could be modelled on Statutory Maternity Pay, which pays a much higher rate for the first six weeks – and is only available to those women who worked before having a child.

In the coming months, we will be analysing ideas such as these with a view to setting out practical, costed proposals for shifting to social investment and restoring the contributory principle. This will also include looking at how drawing a clearer distinction between the "social insurance" and "social assistance" tracks could affect the back to work support people receive and their interactions with the welfare system. We also want to explore how the institutional architecture of the National Insurance Fund – which evokes a tradition of mutual protection in this country – could be revived to help this task.

It is clear that the debate about benefits will be at the forefront of the political battleground over the coming year. It is vital that those of us committed to a resilient and effective welfare system advance feasible reforms that can chime with popular values, as well as defending against the worst attacks on vulnerable people.

Graeme Cooke is Research Director at IPPR

Members of the public in north London walk past a poster informing of changes to the benefits and tax system that came into effect in April 2013. Photograph: Getty Images.

Graeme Cooke is Associate Director at IPPR

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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.