At Prime Minister's Questions the other day, Jeremy Corbyn produced a case study of a working single mother who would suffer a substantial real fall in income due to tax credit cuts despite the NLW and tax threshold rise. In response, David Cameron claimed the new National Living Wage and tax threshold rises would mean that working people on low incomes would be better off by 2020. Who is right?
The National Living Wage will improve earned income for a high proportion of families. The Resolution Foundation estimated that:
- 4.5 million employees will see their hourly wage rise as a result of introduction of the NLW in 2016. Of those, 1.9 million earning less than the NLW are set to be brought up to at least that level, with a further 2.6 million gaining from spillovers.
- By 2020, a total of 6 million employees – 23 per cent of all employees in Britain – are likely to have received some increase in their pay as a result, with 3.2 million being brought up to at least the NLW and another 2.8 million moved onto higher wages through spillovers.
- By 2020, the average gross gain to employees directly benefiting is expected be £1,210 while for those who only benefit from spillovers, it is estimated to be £240 (in 2016 prices). Clearly however, the precise size of the pay rises experienced by individuals will vary depending on their previous pay levels and the hours they work.
The distribution of the NLW looks pretty good, too, with over 50% going to workers in the bottom half of the income distribution.
But for a significant proportion of people, particularly those with children, earned income is topped up with benefits. So what is the effect of the NLW on total income?
Here's the Resolution Foundation's chart showing the effect of the NLW on net household incomes across the income distribution:
Clearly, the NLW most benefits those around the lower middle of the earnings distribution. The greatest improvement in net income is experienced by those in the 4th decile. But the improvement is tiny, only half a percentage point. And for other deciles the improvement is much less. The effect of the NLW on household net income is distinctly underwhelming.
Although those in the 3rd and 4th deciles benefit most from the NLW, there is a substantial wedge between the earned income gain from the NLW and the effect on net income. As the Resolution Foundation explains, this is because for these households, what they gain from the NLW is to a considerable extent wiped out by taxation (my emphasis):
The requirement to pay tax and National Insurance (NI) on these additional earnings explains part of this shift. In addition, members of this middle group of households are more likely than others to be eligible for Universal Credit (UC). Crucially, entitlement to UC reduces as earnings increase – for each pound earned above around £5,000 a year by a household, 65 pence of UC entitlement is deducted. This means a worker gaining the full £1.10 hourly boost implied by a NLW of £9.35 in 2020 (using the OBR projection) would only be 39p an hour better off, falling to 26p if they also pay tax and NI.
Overall, only 60 per cent of the gross wage gains are translated into net income gains with the situation more acute for those in the lower-middle part of the distribution; only around half (53 per cent) of the £220 gross gain in decile 4 finds its way through to household incomes. As such, the share of the total gain flowing to the bottom half of households falls from 52 per cent when calculated on a gross basis to 45 per cent on a net basis.So workers in the 3rd and 4th deciles - hardly the richest people in society - may experience marginal tax rates as high as 76.4% as a direct consequence of the NLW. Lovely.
But even though that is a shockingly high marginal tax rate, it isn't a fall in income. It's an increase, though a small one. Single parents will keep less of the NLW gains than any other group, because they are more likely to be on Universal Credit. But even single parents won't suffer marginal tax rates of over 100%. So why is Jeremy Corbyn's single mother apparently facing a fall in income?
The problem is not the NLW itself, it is the government's measures to reduce working-age benefits by a total of £13bn by 2020. The most significant of these measures are:
- Freezing working age benefits for four years from April 2016;
- Reducing the point at which tax credits or UC entitlements start to be reduced as earnings rise (the "taper");
- Removing entitlement to the family element for new claims or new families entitled to UC or tax credits from April 2017;
- Limiting support from Child Tax Credit or the child element of UC to two children for new claims or births from April 2017, meaning that families with three or more children only receive support for two.
In his Budget speech, the Chancellor claimed that “taken together with all the welfare savings and the tax cuts in this Budget, it means that a typical family where someone is working full time on the minimum wage will be better off.” But the Resolution Foundation disputes this:
However, with the NLW expected to increase the nationwide wage bill by £4.5 billion in 2020, and only around 60 per cent of this gain expected to translate to gains in income, the policy clearly cannot fully offset the losses to income from the £13 billion cuts to welfare.In short, the Chancellor's figures do not add up. Again.
The extent of the shortfall for the poorest in society is graphically illustrated by this chart:
There are two things that stand out from this chart. The first is how regressive the Budget changes are. The welfare cuts fall disproportionately on the poorest in society, and the NLW does not offset them. Wages make up very little of the income of those in the 1st decile, so increasing the NLW has little or no effect on them, as the chart shows. These people therefore face real income cuts without the prospect of compensatory wage rises.
But Jeremy Corbyn's single mother is working, apparently. We don't know what her circumstances are, but it seems unlikely that she is in the very poorest group. However, the chart shows that there is a net income loss from the Budget changes for families in the bottom half of the income distribution, while those in the top half - except for the very rich - experience a net gain because they benefit from the NLW. So Jeremy's single mother could be in the 2nd or 3rd decile and still face a significant cut in her net income.
And this brings me to the BBC Question Time audience member who challenged Amber Rudd over cuts to tax credits. BBC News reported that Michelle Dorrell is a self-employed beautician running a nail bar from her home. Clearly she's no slacker. She's a hard-working woman trying to do her best to keep her family through her own efforts. The sort of person, in fact, whom the Conservatives said they wanted to help.
It's worth noting that as Ms. Dorrell is self-employed, the NLW will not apply to her, and it is unlikely that she would be able to increase prices to NLW level. She is therefore among those facing real cuts in income, due to tax credit changes, with little prospect of earnings increase to compensate. , No doubt there will be those who say that running a nail bar isn't really work and she should get a proper job mopping floors.
Self-employment incomes have fallen by 22% since 2008-9: median incomes for the self-employed are now half those of the employed, and their take-up of tax credits is much higher. One in seven people is self employed: their exclusion from national statistics is thus a serious distortion. The invisibility of the self employed in policy making is a national disgrace.
The response of David Cameron's adviser to Ms. Dorrell is frankly incredible:
The point the prime minister and government is trying to get across is that it’s important you see the changes we are making in tax credits are part of an overall package of changes, designed to ensure we push wages up.”She's being fobbed off. Raising tax credits might push wages down, but there is absolutely no reason to assume the effect is symmetrical. Employers like wages to fall. They aren't nearly so keen on increasing them. The NLW will increase them, a bit, but that has absolutely nothing to do with tax credit cuts.
In fact this is entirely political spin. The changes are about reducing the welfare bill, not raising wages.
There was always a very large hole in the Conservatives' spending plans, which would inevitably have to be filled with cuts to in-work benefits. But despite this, the Conservatives somehow managed to persuade the working poor that in-work benefits were not at risk.
Like Chris Dillow, I suspect this was primarily managed through subtle redefinition of "welfare" to mean out-of-work benefits. Working people on low incomes don't see tax credits as "welfare". Welfare is what scroungers get, not hard-working people. So the Conservatives could trumpet "welfare" cuts while still promising to support "hard-working families".
The strategy worked. People like Michelle Dorrell believed them. It never occurred to her that in voting Conservative, she was voting for a party that would slash her own income. Turkeys do vote for Christmas, if they are led to believe that people eat goose for Christmas dinner.
So Jeremy Corbyn was right. The single mother in his case study does indeed face real cuts to her income. As does Ms. Dorrell. She will pay a high price for her gullibility.