Nick Timothy is Director of the New Schools Network and a former Chief of Staff to Theresa May.
Do you believe that tax credits are a crucial way of supporting working people on low wages, or are they a legacy of Gordon Brown’s big state that must be abolished? Do you believe that the House of Lords was right to throw out George Osborne’s plans, or were its actions an affront to the Government’s democratic mandate?
If you tried to answer those questions as you read them, you’ve fallen into the trap of the political dividing line. And political dividing lines – with the binary choices they force upon Parliament, the public and, often, political opponents – are the key to understanding how the changes to tax credits have gone wrong.
From November 2008, when the Conservatives decided to drop their support for Labour’s spending plans, the dividing lines have been set. Conservative fiscal discipline versus Labour fiscal incontinence. Lower taxes versus higher taxes. Welfare reform versus welfare addiction. The party of the workers versus the party of the shirkers.
These dividing lines have served the Party well. They played their part in turning around the economy, put the Conservatives on the same side as the public, and helped to win the general election. They have also – in the infamous case of John McDonnell’s flip-flopping on the Charter for Budget Responsibility – thrown the Labour Party into turmoil. But, as a path dependence theorist might explain, George Osborne now finds himself trapped by the decisions he has already taken and the dividing lines he himself created.
To promote its own dividing lines, the Government’s plans include a balanced budget by 2017/18, a surplus each year after that, and no overall increases in tax. To nullify Labour’s dividing lines, it has promised to make no changes to pensions and benefits for older people. It has promised to protect spending on health, defence and schools. And in the last Parliament it legislated to guarantee more spending on aid. The Conservative manifesto promised a specific ratio of savings and cuts: £5 billion from tackling tax evasion, £13 billion from departmental spending cuts, and £12 billion from welfare spending cuts.
These decisions meant that when it came to George Osborne’s post-election Budget in July, he opted to cut spending on tax credits. Unfortunately, during the election campaign just a couple of months earlier, Labour and the Institute for Fiscal Studies had predicted that this was what the Conservatives would have to do. In response, ministers either stonewalled or were forced to say that “we are not going to cut them”.
But if that is a problem of presentation, there is a much bigger problem of substance. While there are significant difficulties with the way tax credits work – their cost has risen hugely and there is evidence that they have become a subsidy for companies paying low wages – tax credits have arguments in their favour. Instead of encouraging people to avoid work and live off benefits, they top up pay for people who have a job. In doing so, they mitigate against what the Conservatives used to call the “work penalty” – the steep marginal tax rates for people leaving benefits and entering employment.
This is the nub of the problem the Government now faces. Recipients of tax credits are not feckless benefits cheats, but millions of low-paid, hard-working people who are trying to do the right thing. And the Treasury realises this, which is why the Chancellor sought to offset the tax credit cuts with further reductions in income tax and the introduction of a National Living Wage in the Budget.
Unfortunately, these policies do not compensate everybody who loses from the withdrawal of tax credits. As Fraser Nelson revealed last week, they will offset the tax credit reduction for only one in three claimants, while people who try to make up for the loss by working more hours will face marginal tax rates of 93 per cent. The Institute for Fiscal Studies calculates that three million working people will lose £1,000 per year. These people are not the “shirkers” on the wrong side of the Tory dividing line, but the workers on whose side the Government is supposed to be.
So what does the Government need to do from here? Already, the options have been presented as another binary choice. Is this George Osborne’s “no turning back” moment that proves him to be the heir to Mrs Thatcher? Or is this his “10p tax” moment, showing him vulnerable to the sort of errors made by Gordon Brown? And the same binary choices are presented to MPs, peers and the public. Do you support the changes to tax credits, or do you lack the stomach to reduce the deficit?
But the options before us are not binary. It is perfectly possible to support the elimination of the deficit by 2017/18 – as the Chancellor plans – and still believe that the tax credit cuts are wrong. As Lord Lawson of Blaby – hardly fiscally incontinent himself – argued in the House of Lords, tax credits “rise surprisingly high up the income scale, but here the great harm…is at the lowest end. That is what needs to be looked at again.”
So one option available to the Chancellor is to redistribute the pain caused by the proposed changes. He might also find a way of phasing in the cuts, so people do not face a cliff-edge fall in their income. But any significant changes to his plans are made difficult by decisions and dividing lines that have already been set.
For example, he could change the profile of the cuts so departmental budgets take more of the burden than welfare. But with so many protected areas of spending – health, defence, schools and aid – cuts for non-protected departments are already incredibly steep. He could redistribute the welfare cuts to take the pressure off low-paid, working people. But the obvious alternative is already off the table: pensioner benefits are protected and so is the “triple lock”, which means that the state pension goes up by the highest out of the growth of wages, inflation or 2.5 per cent. Another option – to demonstrate that the Government really does value hard work above all else – is to stop the inheritance tax cut for estates valued between £650,000 and £1 million. But that policy is not only a manifesto promise but a totem for the Conservative Party.
The obvious truth is that there is more than one way to cut the deficit, but the Government finds itself boxed in. The Conservatives’ dividing lines – fuelled by a mistaken belief that “you can’t be tough enough on welfare” and a scepticism about state subsidies even when they promote work – led them to want to cut tax credits in the way they proposed in the Budget. As the Government changes course in the next few weeks – as we know it will – it needs to realise that while its own decisions and dividing lines have got it into this mess, there is one dividing line that must not be put at risk – and that is the one that puts the Conservatives on the side of low-paid working families.