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Ian Brinkley
Economic Advisor
Ian Brinkley

The strange world of low pay policy today

Authors: Ian Brinkley

18 November 2015

We live in an odd world where an unprecedented rise in the National Minimum Wage means that many low income households in work are worse off. A major public focus on the forthcoming Autumn Statement will be whether the Chancellor will find some way to moderate the impact of the planned cuts in tax credits. So how did we get here?

An important reason is that there is a growing consensus from both Left and Right that tax credits subsidise low pay. There are important differences on prescription – some mainly from the Right favoured reducing tax credits and increasing pay to compensate, while others mainly from the Left favoured keeping current entitlements while increasing pay so that overall welfare bills reduced as working families become better off through higher wages.

Nonetheless, the idea that the State was providing a subsidy for low pay employers has become an accepted fact on both sides of the political debate and has been taken up with enthusiasm by campaign groups. Citizen’s UK1  have recently estimated the public subsidy for low pay at £11 billion, although the calculation seems a little confused as it includes child benefit, a universal benefit; housing benefit, which can be claimed by people not in work; as well as in-work benefits.

The subsidy argument has been an important part of the underpinning to the Government’s case that in the future it is employers who should pay through higher wages rather than the State through tax credits. The big cuts in spending on in-work benefits thought necessary to achieve the strategic objectives on the public finances could therefore be achieved without making working families worse off. The policy only ran into serious trouble once it was realised that for many working families this was not true.

Concerns that tax credits subsidise low pay were raised at the time they were under consideration by the then Labour Government. The argument that won the day was that the introduction of the NMW would ensure that employers did not use tax credits to force wages down. It was also argued that employers would be unaware who was claiming tax credits.

In 2012 the Resolution Foundation2   published an assessment that could not be clearer: tax credits were not responsible for holding down pay.

Broader trends also do not support the subsidy argument. If tax credits were subsidising low pay, we might expect to see the share of low pay jobs in the economy increase, as typically if you subsidise something you get more of it and low wage employers would have had a significant incentive to expand employment. However, according to the latest OECD Employment Outlook, the share of low paid jobs in the UK was virtually the same in both 2003 and 2013 (20.6 per cent and 20.5 per cent respectively).

We might also expect wage inequality to increase, as tax credits would tend to depress the wages of those towards the bottom of the wages distribution the most. However, the OECD found little change in wage inequalities over the same period 2003 to 2013. The Resolution Foundation’s more fine-grained work, quoted above, found that wages increased at much the same rate for those who got the credit and those who did not.

In today’s highly politicised and passionate public debate some might see the questioning of the idea that tax credits subsidise low pay as unhelpful or unacceptable. It is possible that I have missed the evidence for the UK, it which case I can only recant and through myself on the mercy of the court.

But just possibly the Resolution Foundation’s original analysis is still correct: tax credits do not subsidise low pay. There are lots of reasons why we have so many low paid jobs that have little to do with in-work benefits – for example, lack of bargaining power in the workplace, insufficient provision for progression and development, low productivity, and poor educational attainment. The dysfunctional housing market and the consequent rise in housing costs has been a major source of pressure on both low income households and welfare budgets. Tackling these underlying issues alongside robust increases in the National Minimum Wage is the way forward, not misguided cuts in tax credits.