In the March Budget – and, indeed in the Conservative manifesto - we were promised budget balance by 2018-19. That magic moment has now been shifted back a year. In part, that reflects a gentler than planned path for spending cuts, including welfare spending cuts. The gentler path does not however represent a let up in the overall scale of cuts – other than for defence. Spending in unprotected departments (those other than health, overseas aid, schools and, now, defence) will still have fallen by about a third in real terms over the ten years to April 2020.
The Budget was certainly not short on measures. The scorecard shows net tax increases of £6.5 billion a year by 2020 (although whether these are all fully realised remains to be seen) but benefit cuts were at the centre of the budget strategy. The Chancellor did not manage to find the £12 billion of cuts by 2017-18 he has repeatedly promised, announcing just £7 billion worth of cuts by then. But he did announce measures which should reduce spending by £12 billion by 2019-20. The biggest cut to tax credits was the reduction to the work allowances in Universal Credit. This represents an interesting choice: to focus cuts in the tax credit/universal credit system on families in work much more than those out of work.
1. It’s a higher-taxing budget So this budget will lead to a lower welfare country as the Chancellor promised. The figures are quite clear though – this was a tax-raising budget, not quite consistent with the boast that it was aimed at a lower-tax country. We told you before the election that post election budgets tend to raise at least £5bn in tax – and this one expects to bring in a little more than that. As for a higher wage country – well, the only sure way of achieving that is to raise productivity. We still await details of how that is to be tackled. Simply forcing wage increases by government fiat by hiking the minimum wage is more of a gamble.
2. Public sector pay squeeze: An important part of the Chancellor’s chosen route to achieving these cuts is to hold public sector pay down for a further four years, raising it by just 1% a year from 2016-17. If private sector pay rises as expected we think this will take public sector pay levels well below their long term average, relative to pay in the private sector. And, indeed, well below anything seen since - we can readily make comparisons back to the early 1990s. Up to now public sector pay restraint has merely served to match changes in the private sector. We are entering a new and much tougher phase.
3. Benefits: most back behind 2008 levels The biggest single cut to welfare spending is set to come from extending the freeze in working age benefits, tax credits and local housing allowance out to 2020. That will affect 13 million families who will lose an average of £260 a year as a result of this one measure. After about 2017 this will mean that most benefit rates will have fallen back behind their 2008 levels both relative to price inflation and relative to earnings growth.
4. Universal Credit changes, which makes work incentive worse: The next biggest cut comes from the reduction to work allowances in Universal Credit. This represents a substantial shift in the design of the UC system. The work allowance is the amount that a claimant can earn before benefit starts to be withdrawn. Significant allowances were an integral part of the design of UC, intended to give claimants an incentive to move into work. This reform will cost about three million families an average of £1,000 a year each. It will reduce the incentive for the first earner in a family to enter work. The equivalent changes in the current tax credit system will have much the same effect. These are changes that will alter the effects and structure of the system quite substantially. Relative to one alternative policy which would have been simply to reduce the levels of child tax credit, the policy the government has chosen will protect those on the lowest incomes, mostly those not in work, at the expense of low earners.
5. Minimum Wage – £4bn of extra pay won’t compensate for £12bn of welfare cuts It is easy to construct examples of families which would lose overall and ones which would gain from the combined changes. There is little value in this trading of examples. In general, the more important tax credits are to someone’s income at present, the less likely they are to be compensated by the higher minimum wage. But the increase in the minimum wage simply cannot provide full compensation for the majority of losses that will be experienced by tax credit recipients. That is just arithmetically impossible. The gross increase in employment income from the higher minimum wage is about £4 billion. Welfare spending as a whole is due to fall by £12 billion and, even excluding the effects of the four year freeze tax credit spending is due to be cut by getting on for £6 billion. And of course many of the recipients of the higher minimum wage will not be tax credit recipients. Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.
6. Landlords: At present if you own a property which you let out to tenants you can set any mortgage interest costs against tax due on rent received. The Budget red book states that this means that “the current tax system supports landlords over and above ordinary homeowners” and that it “puts investing in a rental property at an advantage”. This line of argument is plain wrong. Rental property is taxed more heavily than owner occupied property. There is a big problem in the property market making it difficult for young people to buy, and pushing up rents. The problem is a lack of supply. This change will not solve that problem.
7. Smaller tax changes: little rationale: As well as an array of anti-evasion and anti-avoidance measures there are three other big tax increases: to insurance premium tax, to VED and to the Climate Change Levy. All look more or less opportunistic. The latter, which both increases tax on business consumption of energy – already taxed more heavily than household energy consumption – and reduces the relationship between tax paid and the carbon content of the energy, seems to have little coherent rationale.
Given the array of benefit cuts it is not surprising that the changes overall are regressive – ie, taking much more from poorer households than richer ones. Poorer households have done worse than those in the middle and upper middle parts of the income distribution - although it remains the case that the some of the biggest losers have been those right at the very top of the income distribution.
This was a big Budget in some respects. It was a deeply disappointing Budget for those of us who hoped the Chancellor might take the chance to improve, simplify and reform our creaking tax system. This was not the Budget of a tax reforming Chancellor.
The above is an edited extract of the speech just delivered by Paul Johnson from the IFS. The full version can be found here.