Janet Daley misfires on tax credits.

Janet Daley is one of the Sunday Telegraph’s more robust commentators and often has interesting things to say, but yesterday she completely screwed up over the arguments for reforming tax credits. You can find her article here, but the most offending passage reads as follows:-

“What was missing from the Osborne defence was a very persuasive moral argument against government topping up low wages and thus creating a low-pay trap. The economist Arthur Laffer has said: ‘If you pay people to be poor, you will get more and more poor people.’ He was referring specifically to the benefit-dependent underclass held in permanent poverty by the welfare system that created perverse disincentives to work. But the same principle applies to tax credits: if you pay people to be low-paid, you will get more and more low-paid people. Instead of low-wage jobs simply being an entry point to employment, or a temporary stop-gap at particular stages of life, they become the permanent condition of a whole tranche of the population. Because low rates of pay automatically trigger the government tax credit system – raising the total income to an acceptable level – there is no pressure on the employer to offer more or the worker to seek anything better.”

NO, Janet, tax credits do NOT cause employers to pay low wages. Only one thing does that and that is the balance of supply and demand for labour. Wages are low partly because we are still in recession and partly because of high levels of immigration. Have you ever met anyone who does not wish to be better off? Even millionaires want to be billionaires! It depends on their negotiating position and on what employers can afford.

Where you are right is that there is indeed a strong moral case for reform. Reform to deal with structure and perverse incentives rather than to reduce the cost per se. The cost is cyclical and will come down as unemployment comes down. Unfortunately unemployment is now more likely to rise again due to a combination of austerity at the wrong phase of the economic cycle, high rates of immigration and the government’s interventionist intention to increase the minimum wage.

Tax credits are a duplicate welfare system which were originally introduced as a way of overcoming the poverty trap (‘making work pay’ in modern parlance). A much better, cheaper and more efficient way of doing that is to increase the earnings disregards under the old system, now aka Universal Credits. Yet Osborne has done precisely the opposite by reducing them. As so often with this government and the coalition before it the rhetoric says one thing and the action says completely the opposite. Work pays less now than it did before!

Osborne is not an intellectual. He runs for the hills at the slightest challenge. We saw it in 2012 and we are seeing it again now. That is why he cannot make the case. For a more detailed review see my previous post here.

PS. Since posting this on the Telegraph’s page I received there a couple of interesting comments concerning the Iron Law of Wages and the Speenhamland system. I responded as follows:-

“I don’t know what the unemployment rate was in 1834, but I suspect it was quite high. Hence the downwards pressure on wages.

One point that does come out of this discussion though is how comparatively rare it is that governments manage to get unemployment down to the sorts of levels that would produce sustained wage increases. It seems to boil down to how we manage inflation.

Back in the 70s and 80s any wage inflation quickly developed into a comparative wage-price spiral, forcing the government to slam on the economic brakes. With union reform that may no longer be the case, but now we have property price inflation instead.

It seems to me that there are at least four different types of inflation that require quite different policy responses: wage inflation, import inflation, property inflation and general inflation. I would welcome both wage and import inflation at a moderate and constant level; the latter because we need a much more competitive exchange rate to stop jobs being exported. These are both cost-push types of inflation and so not particularly volatile. That means measuring each separately and managing property inflation by restricting mortgage availability and only general inflation by increasing interest rates. Wage and import inflation could then be given much more leeway.

I would also welcome a change in the way we determine public sector wages, which are invariably reduced to a political football much to the detriment of our public services. No successful private sector employer would underpay his staff because otherwise he would lose them, and all the investment he has made in recruitment, training, team and experience building would be written off. The general approach is to look at staff turnover rates and increase wages when they are getting too high. We should do the same in the public sector, permitting any local HR manager to appeal for an increase on the basis of auditable high staff turnover rates.

I maintain that the rate for any job has nothing to do with comparatives but is determined by the balance of supply and demand for that particular skill in that particular location and at that particular level of seniority. And maybe some other factors as well. An appeals process would enable public sector wages to be increased when and where it became necessary.”


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