What Owen Jones gets wrong (part 2 of 2: tax credits, low pay and a ‘Living Wage’)

Most politicians and commentators think the ‘cost of living’ and its inverse ‘low pay’ are areas of serious concern for public policy. But for some, like the journalist Owen Jones, these challenges have simple solutions which just happen to be outside the boundaries of accepted debate at the moment.

In his new book, The Establishment: And How They Get Away With It, Jones talks at length about the concept of the Overton Window – the theory that describes the range of ideas the public will accept at any given time. Jones, for example, is certain that the cost of living crisis is caused by employers paying poverty wages and, at least in part, by greedy landlords and ‘profit-making companies’ (scare quotes deliberate) raising prices for consumers. Though it might not be currently acceptable, he believes that a state-enforced Living Wage and price controls (in particular rent controls on landlords) can be used both to improve living standards and lessen the need for state welfare in the form of housing benefit and tax credits.

As we saw in part 1 of this 2-part blog, Jones’ analysis on landlords and rent controls has two major problems: ‘greedy landlords’ are not the cause of high rents, and rent controls are not a harmless means of making rents more affordable. Far from traditional rent controls being ignored in public debate because the Establishment are all paid-up neoliberals, worshipping at the altar of Milton Friedman and Friedrich Hayek, they are dismissed because their record as a policy is disastrous.

But Jones makes similar errors when he looks to the wage side of the equation in the cost of living debate too.

According to Jones, employers are exploiting their workers by paying low wages, safe in the knowledge that the state is stepping in with tax credits to top them up. In effect, Jones believes employers are outsourcing part of their wage bill to the general taxpayer. If this is true, he asks, shouldn’t more be done to ensure that firms don’t exploit this generosity? Shouldn’t we impose the condition that employers pay their workers a Living Wage to prevent this abuse?

For this line of argument to be right, there are two assumptions which need to be shown to be true. The first is that tax credits are indeed subsidising employers. The second is that hiking the minimum wage is really a good substitute for them and can be raised easily without other negative consequences. On both counts, the evidence does not back up Jones’ narrative.

It is certainly true that tax credits to some extent act like a negative income tax. As such we might expect them to lower worker’s reservation wages, and to reduce incentives to demand higher wages or accept better-paid positions. But the set-up of the UK tax credit system and the demographics of those households trapped in low pay in the UK means that the ‘tax credits are a subsidy to employers’ argument is hugely exaggerated.

To see why, consider Child Tax Credit, by far the most important component of the tax credit regime. This does not come with any work requirements attached. In fact, 1.5 million of the total 4.6 million households in receipt of tax credits do not have any adult in paid employment. That means £8.9 billion of the total tax credit bill of £29.6 billion goes to households with nobody in work. It’s very difficult to argue that this segment of tax credit spending subsidises employers when these households are not employed!

Furthermore, many other recipients of in-work tax credits (0.9 million of the 3.1 million working) work less than 30 hours per week. In this sense, another large chunk of the tax credits bill can be considered a substitute for working longer hours, rather than as a substitute for low wages paid by employers.

Admittedly, this does leave 2.2 million households who are eligible for tax credits and work substantial hours. In regard to these households, the argument can indeed be made that taxpayers subsidise low pay.

For these groups, tax credits are in effect justified by policymakers as a social policy to supplement incomes for those who might not be able to command earnings high enough in a free-market for an acceptable standard of living. We can therefore debate whether they are effective in doing so, or whether other approaches are better.

Jones’ alternative to tax credits is to increase minimum wage rates to somewhere near the ‘Living Wage’ and have companies and their consumers bear the full cost of this social ambition. But raising the NMW as a substitute for the tax credit system would only be sensible policy if it did not have any negative impact on the employment prospects of those with the greatest difficulties in the labour market. Yet evidence shows these effects cannot be ruled out. The mainstream academic literature still believes that the level of the minimum wage matters, and that a significant rise in the rate would dampen labour demand to the detriment in particular of young and unskilled workers.

Furthermore, people who are paid low hourly rates are not necessarily in poor households – meaning that raising the minimum wage is not a direct substitute for tax credit spending. Tax credits are highly targeted towards those with low household incomes (80 per cent of spending goes to households with annual incomes below £20,000). On the other hand, 44 per cent of all UK workers earning less than the hourly living wage rate are in families in the top half of the income distribution, whilst 12 per cent are actually in the top fifth of the distribution. People who would benefit from Jones’ policy then are often second earners or young people in relatively affluent households.

So whilst Jones’ exaggerated claims that tax credits subsidise employers holds some truth, a hiking up of state-enforced wage rates is not a good substitute for them and at the same time risks eroding job opportunities for some of the lowest skilled workers. As with Jones’ rent controls proposal, he wrongly takes for granted that wage controls will have little in the way of negative consequences.

And yet…Jones does highlight an important issue. Pay is low for many households relative to the cost of essentials and welfare spending is very high. The question is: is there anything that can be done to raise living standards and lessen the need for benefit spending, without interventionist policies which have significant negative consequences? Thankfully the answer is ‘yes’, and the solution lies in a supply-side approach to bringing down the cost of living. My IEA colleague Kristian Niemietz has written extensively on this subject here, here and here, and I will write more about it in the coming weeks.

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.