Head of right-leaning Institute of Economic Affairs suggests tax credit reform can be done in way that encourages full-time work

David Cameron’s plans to focus £12bn of welfare cuts on slashing tax credits and other working-age benefits look set to be “extremely unfair” on the families who will lose money, the right-leaning Institute of Economic Affairs thinktank has said.

The prime minister argued on Monday in a speech delivered in Runcorn, Cheshire, that the UK should pay out less in tax credits – which top up the wages of low-earners – suggesting companies should offer workers higher salaries instead.

But his remarks provoked criticism from across the political spectrum about the potential impact.

Mark Littlewood, director general of the IEA, supported the need for making savings in the welfare budget but said the composition of the cuts “looks set to be extremely unfair on the working-age population”.

He added: “Whilst important for getting cash to relatively poor families, tax credits discourage people from earning more money by creating high effective marginal tax rates, leading to bunching around part-time work hours. They could be reformed in a way which encourages full-time work. But simply salami-slicing the value of tax credits will hit certain households hard without creating this positive dynamic.”

Ministers have refused to spell out exactly how they plan to save £12bn in the welfare bill, but previous statements made by Cameron to rule out cuts to pensioner benefits and child benefit have shifted the focus of expected cuts onto child tax credits for those in work as well as housing benefit and some disability benefits.

One of the options that has been mooted is cutting child tax credit back to its 2003 level, which the Institute for Fiscal Studies has calculated would reduce entitlements for about 3.7 million low-income families with children by an average of £1,400 a year, and overall spending by about £5bn.



Questioned about his plans for tax credits, Cameron said: “We have a system at the moment where basically we give people the minimum wage, we have tax taken from people on minimum wage and then we recycle it back to them.



“What I want to see is this move towards an economy with higher pay, lower welfare and lower taxes rather than low pay, high taxes and high welfare. That’s what we should be aiming for. We did well in the last parliament: more than two million people in work, we lifted many people out of income tax altogether, but we need to continue with that approach.”

Facebook Twitter Pinterest Excerpt of Cameron’s speech in Runcorn.

However, the prime minister made no commitments to asking companies to introduce the living wage, simply pointing out the minimum wage was predicted to rise to £8 by 2020.



Iain Duncan Smith, the work and pensions secretary, later told the Commons: “We want companies to pay better salaries, which means less tax credits from us.”

In a sign the government is planning to dismantle the system put in place by Gordon Brown, the cabinet minister also accused Labour of having repeatedly increased tax credits “as a way of trying to buy votes”.

Labour warned before the last election that tax credits would be in the line of fire if Cameron returned to power. Following the prime minister’s speech, Ed Miliband, the former Labour leader, used Twitter to point out that he looks set to have been proved right, saying: “The PM’s one-nation speech feels like a weak attempt to explain why it is OK to cut tax credits and say you stand for working people.”

Andrew Harrop, general secretary of the left-leaning Fabian Society, also pointed out that tax credits were often there to compensate low earners who had more responsibilities than the average worker. “This isn’t ‘one nation’, it is nasty politics and terrible policy,” he said. “The prime minister ... hopes to improve life chances for all, but singles out children as the main targets for cuts, once again.”

As well as having inflamed the left, Cameron’s suggestion that tax credits should be replaced by higher wages could set him on a collision course with employers. The prime minister is unlikely to force companies to pay the living wage but has not yet set out how he would encourage companies to pay higher salaries to replace lost tax credits, beyond modest expected increases in the minimum wage.

It is possible he could adopt an idea from Labour, who have previously floated the idea of offering tax breaks to those who pay the living wage.

