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As Taxmageddon approaches, Romney and Obama prepare for war

The danger of falling off a “fiscal cliff” is real.

To understand US politics in the past couple of years, it is useful to have a working knowledge of the stormy relationship between Charles I and his parliaments. In 1628, John Eliot, leader of the British parliamentarians, extorted from Charles I the Petition of Right, making parliament the sole body that could legally levy taxes. Without taxes approved by parliament, Charles could not wage war. Today, without taxes
approved by Congress, Barack Obama cannot stimulate the somnolent economy.

In 2010, when the Democrats lost their majority in the House of Representatives, Obama lost his power to legislate without doing deals with his Republican rivals. Many of the Republicans in Congress have become rubber stamps, solemnly pledging to Tea Party members not to raise taxes under any circumstances. In practice, this has meant government by fudge and mudge, short-term fixes at the eleventh hour and kicking the can down the track. But mostly it has meant no government at all.

To get by, in the summer of 2011, Obama negotiated the raising of the government borrowing limit, so that the administration could collect money to pay for all the things Congress had already approved. The price for the deal was high: tax increases and deep public spending cuts that will automatically come into force if another deferment cannot be arranged by 31 December this year. There is more. On 1 January, the deep cuts to personal taxes that George W Bush introduced will lapse unless Obama can make a deal.

Cuts and bruises

This confluence of two unbreakable deadlines, vast automatic cuts in public spending and income taxes hiked across the board has led
to a good deal of fervid talk about 2012 ending with an economic Armageddon, or “Taxma­geddon”, that will tip the US back into recession. The danger of falling off a “fiscal cliff” is real. The Congressional Budget Office estimates that if no deals are done, the tax hikes and automatic cuts will cause the country’s gross domestic product to drop by 4 per cent and average households will pay a further $1,750 a year in tax. Could such a disaster be allowed to happen?

Nothing is going to be fixed before the election in November. The fiscal cliff, therefore, provides an ominous, Wagnerian backdrop to all the arguments about the economy between Obama and Mitt Romney. It suits both sides to be able to point to a reasonable way forward. It lets Obama portray himself as a moderate, willing to extend the Bush tax cuts that put a maximum of 30 per cent on income tax and 15 per cent on capital gains but only for those earning $250,000 or less. According to polling, reducing income taxes for almost everyone is popular, as is taxing the super-rich more. The threat of Armageddon, meanwhile, offers Romney a simple shtick: vote for me and the Bush tax cuts continue.

What about the automatic spending cuts? So far, the Republicans’ small government arguments are making all the running. It is their low-tax, low-borrowing, low-spending agenda that is the battleground on which the main political battles are fought. How successful they will be after November depends on how many Tea Party candidates win seats in the House and how determined they will be to impose their will on the rest of Congress. Would they want to launch straight into a rancorous battle over the budget?

It would depend on who is president. If Obama is re-elected, the number of Democrats in the House will be the key to whether the tax-raising logjam will be broken or whether the Republicans will be able to continue, from time to time, to bring matters to a dramatic halt. If Romney rides in on a wave of Tea Party Republicans, he will lead an assault on the deficit, on taxes, on business regulation, and all the other means by which conservatives believe governments paralyse a business economy. How soon would he act?

Romney, whose work as a venture capitalist has left him open to the accusation that he put people out of work and outsourced jobs, has listed a range of government programmes to cut, including repeal of universal health care and privatisation of the state railroad, Amtrak. Yet he would be in no rush to implement them. When asked recently about how deep he would cut in his first year, Romney responded, “If you take a trillion dollars, for instance, out of the first year of the federal budget, that would shrink GDP over 5 per cent. That is by definition throwing us into recession or depression. So I’m not going to do that, of course. I don’t want to have us go into a recession in order to balance the budget.”

So the fiscal diehards in Congress may not have it all their way, whoever is in the White House. Romney has said that he agrees with the fiscal continence plan laid out by Congressman Paul Ryan, who would find deep savings in Medicare, the state health system for pensioners, by issuing tax vouchers instead of providing a service. Romney would not want to find himself, like Obama, presiding over a sinking economy with no means to stimulate it.

Fiscal storm

The crowded timetable at the end of the year will ensure a perfect fiscal storm. Although the presidential election is on 6 November, the new president will not be inaugurated until 20 January 2013. So, even if Obama loses, he will have to preside over the fiscal cliff talks. And if he wins, he must wait until the new Congress to see, like Charles I, whether he has a House he can do business with.

We have seen this movie many times before. Urgent-looking, grey-haired men and women are interviewed on their way in and out of important meetings and they declare that no one can reach agreement, that the distance between the two sides is wider than ever, and that all is lost. That mantra is repeated for a few days until, just before the final deadline, with the negotiators up to their necks in water and with the roof slowly lowering itself upon them, with one bound the captives are free. Government spending can resume for a little longer. And the can is booted way down the track to mark where the next Armageddon talks will begin.

Nicholas Wapshott’s Keynes Hayek: the Clash That Defined Modern Economics is published by W W Norton (£12.99)

This article first appeared in the 23 July 2012 issue of the New Statesman, Israel: the future

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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.