Six thoughts about the tax credit cuts

  1. Working tax credits are a good idea in principle. Low pay is a big problem, and shifting the welfare system away from being a safety net towards topping up the incomes of low-skilled people who are in work is probably the right approach.
  2. It doesn’t make sense to both tax people and pay them benefits. Cutting income tax and, especially, raising the National Insurance threshold on low-income workers is less complicated than making them apply for tax credits, and probably would incentivise work by getting rid of the tax credit withdrawal ‘tax’, without removing their incentive to join the work force (as ditching tax credits alone might do).
  3. That isn’t what’s happening here, though. These cuts are meant to reduce the deficit, so they won’t be offset entirely by tax cuts. That might disincentivise work (reducing people’s incentive to enter the work force) and will clearly make some poor people worse off.
  4. Lowering the child tax credits threshold and increasing the withdrawal rate would be one of the least harmful ways to cut tax credits, because these are not tied to work and because they are paid to couples earning up to £41,000/year, which is quite high.
  5. Housing benefit and pensions would probably be better things to cut. The £26bn housing benefit bill could be reduced significantly by reforming planning to allow more houses to be built. Abolishing the pensions triple-lock and increasing pensions in line with inflation only would produce major year-on-year savings – this year, the £92 billion pensions budget would be essentially frozen.
  6. Deregulations that cut the cost of living would offset some of these cuts. Housing and, for people with children, childcare are the biggest costs for people on low incomes, and payments for childcare in particular are built in to the tax credits system. The UK has some of the harshest regulations in Europe on both of these things, driving up costs. If the government made it easier for the private sector to build more houses and relaxed regulations about staff:child ratios in crèches for children, the cost of living for poor people would fall significantly.

How Jeb Bush could get his 4% growth (for a few years, at least)

US presidential hopeful Jeb Bush says that, with the right policy reforms, the US can achieve 4% annual growth. As economic historian (and Adam Smith Institute Fellow) Anton Howes has pointed out, historically it’s very hard to sustain growth above 2% except when you’re catching up, either after a recession or as a poor country converging on rich ones.

For the US, 4% growth would mean catching up to the pre-2008 trend for a few years, and then reverting to normal. Glenn Hubbard and Kevin Warsh, two economists who are likely to advise Bush on economic issues during the campaign, suggest that investment-focused tax cuts and pro-competition deregulations might help the US to recover back to the pre-2008 trend. Well, maybe.

One thing they did not mention was liberalising planning (or urban zoning, in American English). But that could deliver a big boost to GDP. An NBER working paper by Chang-Tai Hsieh and Enrico Moretti released earlier this year argued that:

…worker productivity is increasingly different across cities. We calculate that this increased wage dispersion lowered aggregate U.S. GDP by 13.5%. Most of the loss was likely caused by increased constraints to housing supply in high productivity cities like New York, San Francisco and San Jose. Lowering regulatory constraints in these cities to the level of the median city would expand their work force and increase U.S. GDP by 9.5%.

Basically, making it easier for people to move around makes it easier to put people into the jobs where they’re most productive, and constraints on housing supplies make it much harder for people to move around.

Deregulating planning, then, could massively boost US GDP – even bringing constraints in the most productive cities down to the average level would increase it by nearly 10 percent. Spread over a few years, and combined with the standard 2% we’d expect from the US economy normally, that’s about one Presidential term’s worth of 4% growth.

This is really just a moot point – the President doesn’t have much say over local zoning laws. But who knows? This might be one time where the Presidential bully pulpit comes in handy.

Mostly, this is instructive for those of us in other cities where supply constraints make it difficult for people to move in. How much richer Britain might be if it was a little easier to build houses in the places people want to live – and work.

Five reasons to support Osborne’s budget surplus law

1. This law makes it harder for governments to run deficits when the economy is healthy. This is a sound approach to the public finances whatever you think the government should do during recessions. Both the Clinton and Blair governments ran surpluses for part of their time in power and they are usually praised for doing so. It’s hard to think of a good argument against that. Keynes said in 1937 that, “The boom, not the slump, is the right time for austerity”.

2. The law will not prevent deficit spending during recessions. The point is to make deficit spending the exception, not the rule. That also means that deficit spending is much easier if we think we need it – it’s easier to go from 0% to -5% than from -5% to -10%. According to Keynesian theory it is the change in spending that matters, not the level. Advocates of fiscal stimulus should love this rule – it makes their policies much easier to implement in busts.

3. Yes, the law can be repealed by an Act of Parliament. So can any other law, that doesn’t mean that they’re irrelevant. There is inertia in politics and a government that is seen to repeal this kind of law will need a good reason for doing so. Making the public more aware of what’s going on with government spending makes politicians more accountable.

4. Even if our models of economics told us that it was better for the government to have as much flexibility over spending as possible, our models of politics tell us that constitution-like rules are a good way of stopping abuses. This is about political economy as well as economics.

5. An honest Keynesian argument would be that the public is too ignorant and will oppose necessary deficit spending, so it’s better to keep them in the dark. In this case the argument is simply that monetary policy is clearly and demonstrably just as or more effective than fiscal policy during recessions and depressions (indeed fiscal policy probably only ‘works’ through the monetary policy channel). The US cut fiscal spending by $85bn/year in 2013 (the “Sequester”) which people like Paul Krugman warned would cost 700,000 jobs. Because monetary policy was accommodative under QE3, offsetting those cuts, this did not happen.

Thatcherism did actually make Britain richer, compared to everyone else

A new report by economists at Cambridge University’s Centre for Business Research purports to show that the post-1979 liberal reforms introduced by the Thatcher government did not boost the British economy.

In a sense, that’s true. As the report shows, trend GDP growth and productivity were slower in the thirty years after 1980 than the thirty years before that. I hadn’t realised that this was new information, but OK.

The problem with the report is that it mostly looks at the UK in isolation. What it doesn’t mention is that this slowdown in trend growth was a global phenomenon. The real question should be how the UK did relative to the rest of the developed world.

Taking the US as a benchmark – the ‘technology frontier’ – the best any major economy can hope to do, basically – I’ve compared GDP per capita, adjusted for purchasing power parity, of France, Germany, Italy and the UK (German numbers include East Germany after 1991, so I’d more or less ignore them after that point). The UK is purple:

 

rawdata

And here’s those countries’ relative performance, indexed to where they were in 1980. What we see is the UK’s position basically not changing until 1980, with (West) Germany, France and Italy all converging on the US up to that point, then stagnating or declining slightly afterwards:

 

2indexedto1980pre1980

 

In this relative picture, the UK’s economic performance looks a lot better post-1980. There is a clear inflection point in the early 1980s where the UK begins to converge on the US, with GDP per capita as a percentage of the US’s rising sixteen percentage points from 66% to 82% in 2010. In 1950 the UK GDP per capita was 69% that of the US’s. The highest it was during the pre-Thatcher period was 73%, in 1961.

France, on the other hand, falls ten percentage points from 86% in 1980 to 76% today. Germany doesn’t do much until the end of the 1980s, when political events render the data basically useless. Italy’s decline tracks France’s closely. In every case the UK improves relatively, and of course with the US at 100 the UK is improving relative to them, too.

This is probably mostly to do with labour force participation rates, not productivity. That might mask the true welfare situation: I might be much better off retiring early, but that would make me appear poorer and reduce GDP. But it still points to a large change that seems to have happened in 1980 that the report’s authors virtually ignore.

I say “virtually” because they do, actually, show this comparison in their report, it’s just hard to find. In a report with over thirty charts, all but one start during the postwar period. The only chart that doesn’t is this one – which, weirdly, starts in 1880. I cannot understand why, but it does make the UK’s relative recovery much more difficult to spot.

It is quite interesting that the Thatcher reforms don’t seem to have boosted trend productivity by very much. As Pseudoerasmus notes, there doesn’t seem to be anything the UK can do to reach US levels of GDP per capita, and the Thatcher reforms only really brought Britain up to European levels of wealth. It looks as if boosting trend growth, not just playing catch-up, is really, really hard.

Ed Miliband is right: in-work poverty is the scourge of our time

Ed Miliband has given his first Commons speech since losing the election, where he’s focused on inequality and low pay in Britain. He’s almost entirely wrong on the first of those, in my view, not least because most of the problems he identifies come from perceptions of inequality, which are not driven by reality.

But on low pay, he makes an important point. In-work poverty really does appear to be the scourge of our time, and free marketeers ignore it at their peril.

By poverty, I do not mean relative poverty, although that is the definition the government uses to define the word. (A household is defined as in poverty if it earns less than 60 percent of the median wage.) I prefer the approach of the IEA’s Kristian Niemietz and the Joseph Rowntree Foundation, which calculates the cost of a basket of goods that most people would consider essential to living a decent life in modern Britain.

This approach is in the spirit of Adam Smith’s conception of poverty:

A linen shirt … is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into without extreme bad conduct.

According to the JRF, single working-age people need to earn at least £17,100 before tax to live decently; a couple with two children need to earn £20,200 each (versus £13,900 in 2008), and a lone parent with one child now needs to earn more than £27,100 (versus £12,000 in 2008).

Because real wages have fallen across the board since 2008, and the cost of living has risen, an increasing number of people in full-time jobs are still in poverty. My fear is that this is not simply a product of the financial crisis and Great Recession, but a reflection of a longer-term trend.

Wages usually reflect worker productivity, so simply jacking up the minimum wage is no solution to this. Any worker who is less productive than the minimum wage costs will just not be able to find a job. In general, when minimum wages rise, so does unemployment. So there is no simple way to boost workers’ incomes by forcing wages up.

Changes like automation and offshoring work (to call centres in India, for instance) will raise global living standards overall, and should be welcomed for that reason, but they may hurt the incomes of low-skilled British workers by increasing competition for the jobs they have been doing and leaving only relatively unproductive work left to be done. Some people say low-skilled immigration does the same, but labour market liberalization seems to be a tidy solution to that problem.

The techno-pessimist view that machines may simply replace workers in some jobs, without creating new ones for them to move into, is not impossible or even particularly unlikely. Even if it is wrong, improvements in automation or competition from abroad may make low-skilled workers’ marginal productivity too low to earn a decent amount. Their productivity might just not be enough to earn as much as we would like them to.

As I see it, there are three possible ways we could reduce in-work poverty:

  1. Reduce the cost of living. Instead of trying to raise workers’ take-home pay, we could reduce the cost of things they want to buy. Housing and childcare are two of the most expensive things in most people’s budgets. Housing could be made much cheaper if the supply of housing was increased by liberalising planning. Britain has the tightest staff:child ratio requirements in Europe, and in a labour-intensive industry like childcare that has driven costs extremely high. Allowing as many children per staff member as they do in, say, Denmark would let costs fall considerably. However, both of these reforms, as well as most other supply-side deregulations, face considerable political opposition.
  2. Cut taxes on low-income earners. The government has already pledged to raise the income tax threshold to be close to the minimum wage level. But National Insurance payments kick in at a much lower level – £155 a week, or 23 hours of minimum wage work. Raising this threshold, ideally to kick in after forty hours of minimum wage work, should be a major priority. But the higher the threshold goes, the fewer of the poorest people it helps, because they are already earning less than the threshold amount.
  3. Just give money to poor people. Whether we do it through something like a Negative Income Tax, a Basic Income, or a significantly simplified and reformed tax credits system, direct cash transfers seem to be a good way of boosting the incomes of the poor without messing markets up in other ways. If they are only conditional on income, they can be designed to avoid severely perverted incentives that exist in the current welfare system. But paying for this would mean major changes to existing benefits system, which the Universal Credit reforms have shown are a minefield. There is also a danger that this kind of system would be implemented as a costly addition to existing welfare payments, rather than a revenue-neutral replacement.

In practice, some combination of the three is probably our best bet. There is no single political grouping that favours all three of these policies; indeed the false solution of massive minimum wage hikes is popular across the political spectrum.

This is worrying, but there is so much evidence against it that it will surely fail, and accepting that we have a problem may be the first step to solving it. So, in highlighting low pay as one of the central problems of the 21st Century, allow me to say something rarely heard on this blog: Ed Miliband is right.