A Budget For Working Families?

This blog originally appeared on The Huffington Post

Chancellor George Osborne says tomorrow’s budget will be a budget for working families. “The bulk of the measures in the budget are going to be targeted at working people on low and middle incomes” he told the BBC’s Andrew Marr on Sunday.

So, with budget day upon us, it’s worth asking what a budget that genuinely put working families first would look like. At its heart would be a reversal of planned cuts to the Working Tax Credit (WTC) – which, as they stand, are set to hit precisely the people Osborne claims to be trying to help.

Why prioritise WTC rather than further increases in the personal tax allowance (PTA)? After all, if rumours are to be believed, working families can count on a substantial further increase in the level at which individuals start paying income tax towards the Lib Dem’s flagship target of £10,000. This move will indeed benefit most working people on low to middle incomes – though not those earning less than the current threshold, due to rise to £8,105 in April. But raising the PTA is not a good way of targeting support at low and middle income households with relatively small benefits spread far up the income distribution, only petering out when individual earnings reach well over £100,000.

Who benefits from a £500 increase in the personal allowance for all taxpayers? (Distribution of £500 above-inflation increase in personal allowance in 2013-14 by household income decile)

Source: Resolution Foundation analysis using the IPPR tax benefit model

Of course, how well the expected increase in the PTA targets low to middle income households depends on how the move is designed and on how it is funded. The most obvious way to make the change more progressive would be to restrict the benefits to basic rate tax payers (by bringing down the threshold at which people start paying the higher 40p rate). This was the approach taken in April 2011, but the planned increase in April this year will fully benefit higher rate taxpayers. When it comes to funding, there are more and less progressive ways of raising money for the PTA. In particular, the chancellor could consider reducing the roughly £7bn currently spent on pension tax relief for higher rate tax payers. New taxes on wealth, such as the Lib Dems much vaunted Mansion Tax, would also make this a more progressive policy overall, but are unlikely to be introduced.

Whichever way you design an increase in the PTA, at a time when money is so short, it will be hard for the Chancellor to justify such poorly targeted tax cuts. And all the more so because the government is overlooking a far more efficient way of supporting working families. Working Tax Credits (WTC) are targeted at low to middle income households – yet a series of cuts are set to reduce the total WTC bill by £1.3bn in 2012/13. From April this year, couples with children will have to work 24 hours between them in order to claim WTC, up from the current 16. With under-employment at a record high, few will be in a position to negotiate increased hours with their employers, and as a result the measure is expected to save £515m in 2012/13. In addition, the government is saving £350m from the reduction (already implemented) from 80% to 70% in the amount of support that parents get towards childcare costs. Finally, the value of WTC is being frozen, despite inflation running at 3.4%, bringing in a further £480m this year alone.

Where do cuts to Working Tax Credits fall in 2012-13? (Distribution of the above three cuts to WTC by household income decile)

Source: Resolution Foundation analysis using the IPPR tax benefit model

All three changes to WTC will reduce work incentives, making it harder for parents in particular to raise their incomes through work. If George Osborne is really serious about supporting low to middle income households, his first priority should be to reverse these cuts.

Of course, if such a reversal is planned, George Osborne has been keeping very quiet about it. Could there possibly be a wild card option up his sleeve? I’d say it’s unlikely. If he wanted one, an obvious candidate would be additional support for childcare. With childcare costs continuing to rise above inflation, there is a growing consensus that something needs to be done. The government has already committed to increased support for two year olds, but there may be political appetite to go further, particularly in ways that help parents make choices about work. That could mean, for example, increasing free provision for three or four year olds from 15 to 25 hours per week, or expanding wraparound childcare for school age children – both of which would support part time parents (mainly mothers) who want to return to work or increase their hours.

With rising prices and historically low wage growth the Chancellor is right to highlight support for working families. Reversing planned cuts to WTC is clearly the most efficient way to help low and to income households. But will the Chancellor deliver?