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30 October 2015

A wage rise isn’t enough to combat poverty – you need tax credits, too

The Living Wage and tax credits aren't alternatives, but allies, in eradicating poverty.

By Donald Hirsch

Next week is Living Wage Week. Nearly 2,000 accredited Living Wage employers will reiterate their commitment to pay workers a decent minimum, as the rate undergoes its annual uprating. The UK Living Wage rate derives from research that I lead on which details what households require for a minimum acceptable living standard. The fact that the government’s new (and lower) “National Living Wage” has no reference to living costs has caused much derision among Living Wage supporters. This, I think, is misguided, and distracts from a much bigger issue that the government is getting badly wrong.

George Osborne’s Budget announcement that all employers will have to pay over-25s at least around 40 per cent more in 2020 than the 2015 minimum wage is a massive assault on low hourly pay. While it remains vital to keep comparing this rate to what households really need as a minimum, we are heading for a wage floor higher in relative pay terms than most other European countries: a decisive change for low-wage Britain. And in terms of living standards, the many low-paid workers not relying on help from the state (including most of those without children) will become a lot better off from the Budget.

What is wholly misguided, however, is for Osborne et al to link higher pay floors to cuts in tax credit entitlements – which as is now well-known – will make most low-earning families with children worse off overall. For years, there has been a debate about whether state support for working families on low incomes effectively subsidises low pay. The government has largely found the solution to this problem: make low pay illegal. For those low-wage workers who receive family top-ups, pay rises automatically reduce the subsidy and save the government a lot of money, without any cuts in entitlements. This is because tax credits fall steeply with rising family earnings.

It is not widely realised that the designers of the present tax credit system saw a close complementarity between minimum wages and state top-ups. Gordon Brown and his advisers feared that if they did not put some floor on wages, the tax credits system could be exploited by unscrupulous employers, since the system would have allowed a family to become significantly better off than not working, even with wages close to zero. It is no coincidence that the National Minimum Wage was introduced in 1999, the same year as the Working Families Tax Credit; or that the steepest rise in the rate came in 2002-04 (by 15 per cent over two years), coinciding with the current, more extensive tax credit system introduced in 2003.     

By comparison with those times, the current assault on low pay (with the important exception of younger workers’ wages) is bold and generous. Yet many working families will still need a lot of help in making ends meet, not because of very low wages but because of earnings constraints and high costs. The majority of those with children do not have two parents working full time, and for those families and for anyone with high childcare costs, no plausible wage floor will be enough to produce a minimum living standard without some state help. Better pay rates will help rebalance the burden of improving family living standards from state to employer, but the Budget’s sharp cuts in what help you get on a given level of earnings simply put a decent living standard out of reach for many families.

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Osborne’s assault on the principle of government support for working families is already a sharp turnaround from the principles of Universal Credit – his government’s own replacement of tax credits, about which we have heard little of late. A key improvement was to be that a family moving into work could keep what it got from the state up to a certain level of earnings, without having to work any minimum number of hours. Now the earnings at which support starts disappearing has been cut sharply, and we are hearing voices such as Jeremy Hunt saying that parents can reduce dependency by working long hours like the Chinese. I have worked out that, in order to end up with the same net income in 2016 as 2015 after the cuts, a lone parent working 30 hours a week on the minimum would need to work 45 hours a week even before taking any extra childcare costs into account.  

What all this boils down to is a conflict between different narratives about how working families with modest earnings potential can live a decent life in 21st century Britain. The Osborne/Hunt version simply does not add up: withdrawing an in-work safety net will mean that, even with improved wage rates, many families will face impossible choices between neglecting their children’s material needs and working so hard that they never see them (but often still not reaching a decent minimum). The Brown version risked too much emphasis on means-tested support from the state, particularly as wages stagnated over the past decade. Yet a more balanced partnership between state and employers may now be possible. With substantial wage growth, a stable level of state support could allow improved living standards for working families, driven largely through better earnings. The extent to which the Chancellor now compromises in response to the rebellion in favour of working families may indicate how far he accepts the government’s continuing role in this partnership.