Tax Credits and the Missing Argument

The debate about tax credits has been hugely frustrating to me. I am Labour, and very proud of the fact that we introduced tax credits when we were in Government- they’ve made an enormous difference in helping families, incentivising work, and tackling child poverty. I am all too aware of the enormous damage that George Osborne’s plans are going to do to families who desperately need them to get by at a time when the economy is still shaky, especially for the low-paid.

And it’s because I feel so strongly about it, that I’ve been disappointed by the debate. We should definitely be talking about the enormous hardship that households are going to face when they’re slashed- and we are. But we’re not talking about other seriously important reasons why we need tax credits.

The macroeconomic argument is simple. When households saw their incomes fall with the onset of the recession in 2008, tax credits were there to help them to see them through- they acted as automatic stabilisers. These are an important way of putting a brake on downturns, and making sure that consumption does not descend into an endless downward spiral. It’s why the bill for tax credits has increased so much, with the cost going from £16.4bn in 2006 to £31bn in 2014- because we had a recession in-between. With job losses in the steel industry-heavy North East of England, we should be talking about this more.

The microeconomic argument for them is to directly rebut the Government’s assertion that tax credits subsidising wages is wrong. It is true that tax credits can subsidise wages; because people get a top-up from the Government, they’re willing to work at wages lower than they would have otherwise. I think this has two problems- the first is that employers have considerable market power over employees at the low-wage end of the labour market, so many of those who work would have just worked for a lower wage. The second is that the evidence clearly shows that tax credits help increase employment by creating incentives to work that low-income wages would have failed to achieve by themselves. Employment has positive externalities outside of bringing home a wage; it helps create a work ethic that can be valuable, and is a necessary step before higher wages can be achieved. A positive externality means that leaving it to the free market means not enough people will be in work- and so a Labour devised tax credits- the Working Tax Credit and the Child Tax Credit- to assist those on low wages.

Tax credits aren’t always perfect, and sometimes can be a bit complicated, but it is worth remembering what we’re fighting for, and why it’s so important to our economic future to do it.

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Celebrating Lives

Three people have been in the news recently that have made their mark on economics and economic policy. I have sympathies with two of the them, less so for the other, but these are people of stature who deserve to be celebrated.

Denis Healey‘s death wasn’t totally unexpected – he was in his late-90s, after all- but it was a blow because he was a real hero of mine. A brave and brilliant person, who represented the straight-forward talk of a Yorkshireman, the fluent literary and musical skill you’d expect of a Balliol Classics Scholar, and the steely determination and grit that could only be forged as the Beachmaster at Anzio during the war. As a Chancellor of the Exchequer in the 1970s, he had a torrid time of it, but he demonstrated real steel and leadership when all around him (not least the Treasury’s forecasts) seemed uncertain.

Less than a week later,  his nemesis and foe, Geoffrey Howe passed away. The giant who made Thatcherism possible wouldn’t normally have been a natural candidate for me to write about here, but as a former Treasury man, I think that the passing away of any former Chancellor of the Exhequer is a moment to be noted. Howe fought the economic establishment, notably with the 1981 Budget, and though he claimed victory, I am less sure- but it was a politically brave move that would melted lesser men.

The news swiftly moved on to happier news, with the awarding of the Nobel Prize for Economics to Angus Deaton, a man who pioneered the use of data and information to help us understand the world around us, and in doing so, made enormous strides towards helping us understand the problems of poverty, inequality and consumption across the world. More importantly, the techniques he pioneered, wonky though they might be, have played a pivotal role in modern-day microeconomics.

I’m sure I’ll return to the work of these men in turn to discuss aspects of what they did, and why it matters to me, as a politically-inclined public policy economist. But for now, I’d just like to say thank you.

Missing Links: The Problem with the Government’s Fiscal Charter

Last week, the major political debate centred around the Government’s Fiscal Charter- and indeed, the Labour Party’s position. The actual economic debate has been disappointing, but to be expected because you won’t find many economists who do support it. My personal opinion is that it is the wrong approach for fiscal policy in the UK because:

  • the speed and extent of fiscal consolidation will cause macroeconomic instability at a time of general global vulnerability- the too far, too fast” argument
  • there is no distinction made between capital and current spending; we will be cutting investment at the very moment we need to protect and expand our potential for future economic growth

My arguments are very much in line with those of Simon Wren-Lewis.

But there’s something else that has been missed from the discussion about the Charter. The section entitled “The Government’s Fiscal Policy Framework” states

The Treasury’s objectives for fiscal policy are to:

  • ensure sustainable public finances that support confidence in the economy, promote intergenerational fairness, and ensure the effectiveness of wider government policy; and
  • support and improve the effectiveness of monetary policy in stabilising economic fluctuations.

(my emphasis)

I’ve written an article and indeed given a lecture about this before- but our overly tight fiscal policy is undermining the effectiveness of monetary policy. Interest rates are at the Zero Lower-Bound (ZLB), which means that they can’t go any lower. It also means that savers are losing out, whilst borrowers are benefiting- perhaps more than is a sensible amount. The longer tight fiscal policy goes on for, the longer interest rates will have to stay low- over the course of 2015 so far, we’ve seen the expected date for an interest rate rise move from August to December, and now to next March. When rates do finally rise, some borrowers are going to be in for a nasty shock, raising a potential threat to financial stability. And, as I’ve also previously pointed out, low interest rates have the effect of exacerbating inequality- which is already taking a massive hit because of public spending cuts.

The quality of the economic debate hasn’t been great- but surely we could aim for one that is at least complete by including some discussion of the link between fiscal policy and monetary policy?

Economic Policy Lecture from April 2015

I was invited to give this guest lecture at the University of Reading in March 2015. It was part of a series, following Joe Grice, Chief Economist of the ONS, and John Redwood MP, who presented Conservative Party policies ahead of the forthcoming general election.

Five Wasted Years

I should have published this ages ago, and have only just got round to it. Sorry. Read it, and let me know what you think!

The Time Inconsistency of George Osborne

Wednesday was Budget day, and there’s been a huge amount of comment on the measures it announced and its overall presentation. I’ve been very surprised that more hasn’t been made of George Osborne’s shifting timescales.

Its not just that he failed to meet his 2010 target of reducing the bulk of the budget deficit by 2015, or that the actual rate of deficit reduction matches that proposed by Alistair Darling when he was Chancellor of the Exchequer. Everything that George Osborne did in the run up to the election was to emphasis the dramatic scale of spending cuts- at one point it, looked like it was going to be twice the rate it had been between 2010-2015. And yet, on Wednesday, he announced,

“we should cut the deficit at the same pace as we did in the last Parliament. We should not go faster; we should not go slower.”

Having eviscerated the Labour Party’s policy to reduce the Budget deficit by 2018-19, he announced (chart 1.5, also below) that it take until then before his fiscal target was met. By extending it, Osborne will have to make real cuts of £18bn, but that’s a lot easier than the £42bn he was going to have to make. Similarly, he’s found the £12bn of welfare cuts that he promised to make, but it’ll take until 2019-20 to them to fully come into effect- i.e. that it would take 3 years rather than 2 to raise the money he had promised.

OBR_cuts

 

How does he get away with it? The fundamental problem facing Greece is about credibility- if they default on their debt, why should anyone ever lend to them again when they don’t look like they can pay it back? (I know, I know, this is a gross oversimplification which isn’t fair. I’m just trying to make a point about credibility). And the UK is not Greece, not by a long shot. But if other countries had changed their fiscal plans as often as Osborne changed his, they would be in a lot more trouble than we are now. As Duncan Weldon has pointed out Osborne has reversed the normal practise of politicians, campaigning about toughness and having a much more loose policy in Government. Shouldn’t markets have a problem with that? Is it because they think he’s got a mandate to tighten things up if necessary, or are they inherently Tory-biased? I don’t believe either of those to be true, and yet I don’t have a clear answer to why the timescales seem to change at zero-cost to the Chancellor.

I’m a Labour Party man, and there is much in this Budget that I dislike. But one of the trickiest things about dealing with George Osborne is that he is extraordinarily good at stealing our language (and sometimes the policies) like he did over the living wage. But our side had been consistently warning about the macroeconomic outlook, suggesting that spending cuts that are too deep will impact current and future growth potential- and lo, the cuts are now more spaced out, and less deep. What does a Labour Shadow Chancellor say to that?

We’re not out of the woods just yet- Karim Palant (Ed Balls’ former Head of Policy) has written incredibly well on the challenges that still face the British economy. But Osborne’s certainly made things difficult for the Labour Party.

Tomorrow- and Today (A Process Story)

2015 is a special year, because we’re going to have two Budgets*.

We had two budgets in 2010 as well (one from the Labour Government, one from the Coalition). Hell, when Denis Healey was Chancellor, he would do 4 a year- and that was when each Budget involved a massive spending round as well. At least the spending side has been separated and hived off into the Spending Review so it can be set for 4 years at a time.

Ahead of the manic news coverage that will start tomorrow, I think we should spare a thought for the Treasury officials who had hoped they would be done with the Budget back in March- not least because I used to be one of them. Damien McBride has covered a lot of the scorecard process from when he was working on Budgets here, and whilst I can’t vouch for how things might have changed since, it doesn’t seem a million miles away from how things might be run now. It was certainly shared round the Treasury new ‘uns when I was there.

What I do know about is it the Budget Brief. This is a mammoth document, more than 200 pages of one-siders on absolutely everything that is mentioned in the Budget. There’s overview sections which cover the big picture stuff, and every policy has its own brief. Key facts, figures, and everything else you might need to know if you were about to be grilled about the Budget. Its sent to all Cabinet ministers, all Treasury ministers, and is treated as a bible- not just for the immediate aftermath of interviews, but because it can be used for the rest of the year.

So putting together the mammoth document is a mammoth task. The eve of a Budget is nowhere as fraught as it used to be, because the OBR need details of policies about two weeks in advance to cost them and work out their impact on the macroeconomy, as well as public finance forecasts. All the same, in the list of things that need to be completed, the Budget brief fell way down on the Treasury Policy Advisor’s list of priorities. There was Budget document text to get right, press notices to work up, and a list of key contacts to call straight after the Chancellor sat down. The Brief was usually something done at the last minute. When I was the Budget Brief Co-Ordinator for Budget 2012 (otherwise known as the omnishambles Budget) I tried everything I could to make it more of a priority. I created a whole new part of the process, the Quality Assurance Panel, in which Deputy Directors would scrutinise briefs in the weeks beforehand and ask challenging questions of them to try and test if they were robust enough. There was some co-ordination, but the briefing document was very much an output of the Budget process- if we found a weakness, there was very little we could do to change a policy, unless a minister was already on top of it- in which case, it would never have made it that far anyway. Turns out that the Budget brief won’t save you if the politics of the day doesn’t match up to the policies.

But what does happen is that the Brief Co-ordinator will stay up late tonight and pull the whole lot together so it can be sent for printing and hit minsters’ desks by the morning. This week, the co-ordinator and their team will work 20 hour days. We shouldn’t feel sorry for them- you know what it is when you sign up for the role, and it gives you an insight into the process that few get to see. Smarter people than I build on the knowledge they gain to have a great Treasury career (less smart people do what I did, which is to skip out, go back to university for my masters, and then leave the civil service to run for Parliament in a hopeless seat). We should just be aware that when the Chancellor stands up tomorrow, there’s a lot of people who will be glad the day has arrived**.

*Almost everything I have written could equally apply to the Autumn Statement. Budgets tend to always be big events (partly because it introduces the Finance Bill, so it kicks off a legislative process- things actually happen) whereas Autumn Statements can be a big deal, or they can be relatively quiet affairs, just announcing a consultation or two, depending on the politics of the day. In any case, the process is similar, even if it is a bit lighter.

** And not just because the Ashes will have started.