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23 June 2015

David Cameron’s sums don’t add up – his cuts would hurt, not help, the working poor

Cameron's merry-go-round isn't as crazy as it sounds - and his attempts to fix it would deal real damage. 

By Spencer Thompson

Yesterday’s speech by David Cameron, while light on specifics, sets out the broader argument likely to be used by the government to justify the £12bn of welfare savings needed to meet their deficit reduction plan. The key claim in the speech is an assertion that the state currently supports living standards among the low paid through a ‘merry-go-round’ of taxing their income before handing it back in the form of in-work benefits, such as tax credits. Therefore, it follows that it is possible and desirable to reduce the tax burden on low-income households while also cutting their entitlement to tax credits.

Indeed, over this parliament the government plans to raise the personal allowance to £12,500 in order to take minimum wage workers out of tax altogether. We still don’t have much detail of which working-age benefits are expected to be cut in order to reach £12bn, outside of a few small savings such as a two-year freeze in the value benefits. One suggestion that has been discussed at some length is a potential cut in the real value of Child Tax Credit, a key working-age benefit, to its 2003-04 value. Another idea that has been floated is to restrict entitlement to Child Tax Credit to only the first two children in a family.

Comparing the impact of these changes, a generous income tax cut and a dramatic reduction in tax credits, allows us to test Cameron’s claim. The chart below shows the average change in family income in each decile of the family income distribution (from the poorest to the richest) from increasing the personal allowance to £12,500 and from restricting child tax credit to two children as well as decreasing its value to 2003-04 levels.

The chart shows that the vast majority of the gains from the income tax cut flow to those households higher up the income distribution, The child tax credit changes, on the other hand, would see those in the bottom half of the income distribution lose far more than the receive back in the form of tax cuts.

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The government may not go ahead with these specific proposals on Child Tax Credit, but it is likely whatever package of welfare reductions they settle on will have a similar impact of taking hundreds of pounds from families in the bottom half of the income distribution. The overall picture is that the planned income tax cuts will do little to compensate those families likely to be hardest hit by cuts to working-age benefits.

Spencer Thompson is Economic Analyst at IPPR