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The Rt Hon Lord Willetts on tax credits and the future of in-work benefits

The Chancellor did the right thing in deciding not to pursue his cuts to tax credits. The scale of the proposed losses for low income working families was just too much for them. That was the pragmatic political argument and it was very persuasive.

But it leaves open another and deeper question. What do Conservatives think of tax credits in principle? Do they fit in to our picture of the world even if not on the scale to which Brown grew them? I went through this fundamental issue with Margaret Thatcher in the mid eighties when I helped to persuade her of the case for the family credit, the simpler and more modest precursor of what became tax credits. How we saw the issue then, offers insight into how we consider the future of in-work support.

We were trying to liberalise the British job market. But some people were not commanding very high wages. Indeed, as The Resolution Foundation has shown, in the mid-late 1980s around 1 in 5 workers were low paid (a proportion that hasn’t changed much in the last 30 years), and 1 in 20 were extremely low paid (earning less than half the typical hourly wage). We might hope that over time better skills and greater demand for them would boost their earnings but meanwhile one has to deal with the world as it is.

One solution is to require employers to pay more. That used to be thought completely unacceptable and Conservatives campaigned against Labour’s minimum wage because we feared it would cost a million jobs. But that did not happen. Now a minimum wage is part of the British labour market. Indeed George Osborne took the bold move to set a new, higher national living wage which we at The Resolution Foundation warmly welcome.

But even this does not fully resolve the problem which exercised us back in the 1980s. We may feel an obligation to help someone whose wage is the lifeline keeping a family afloat but there are other workers in very different circumstances – from pensioners working to get out of the house to students boosting their maintenance grants and loans. The case for tax credits alongside labour market regulation is that there comes a point when it is better to help that worker with young kids via a top-up to their earnings than by regulating everyone’s wages to the same high level.

One way to design this top-up payment – and the way we designed the Family Credit – is to reflect the design of the benefit system so the extra help that an unemployed family gets per child is reflected in in-work top-up payments per child too. This also ensures you are always better off working rather than on benefits.

However, the critics come back with the objection that employers are exploiting this system to get away with paying lower wages than they otherwise would. This argument draws support from both the left and the right – indeed some dismiss tax credits as a form of  ‘corporate welfare’. But there is no evidence to support this assertion. Recent Resolution Foundation research into the possible wage effects of in-work support found no evidence of lower earnings growth among those most likely to receive tax credits.

The economists will argue that the macro-economic impact does not depend on employers having such specific knowledge – it shows up in an aggregate effect on wage pressure in the job market. But one of the main macro-impacts of tax credits has beenstrong employment growth, particularly among single parents.

Above all we should look to see which countries have earnings topups – the leaders are the US and the UK. Earning top-ups are part of the deal when you have a particularly open diverse labour market employing people with a range of needs and on a range of terms. In that case, an earnings top-up is surely a price worth paying.

Critics of in-work support must explain the labour market effects of making employers foot the entire bill for supporting the incomes of low-paid working families. They should also recognise that – with employment now at an historic high – worklessness is no longer the pressing labour market challenge it was 20 years ago.

But working poverty is. And with the majority of children in poor families now living in working households, a complete withdrawal of in-work support would lead to rapidly rising poverty – an outcome all of us should want to avoid.

We need a mixture of in-work benefits and a national living wage. They both have a job to do.

The Rt Hon Lord (David) Willetts is Executive Chair of the Resolution Foundation. He originally wrote this piece for The future of work edition of Bright Blue’s Centre Write Magazine.