The Employment Tax Credit and issues for the future of in-work support, by Fran Bennett and Donald Hirsch

(Joseph Rowntree Foundation, 2001, ISBN 1 84263 035 0). Currently out of print. Order this book.
This book, published by the Joseph Rowntree Foundation, begins with a quote from Samuel Brittan: “The government plans to bring together, in 2003, support for children into an integrated child credit, while in-work support for adults will be consolidated into an employment tax credit. The net result will be close to a negative income tax subject to a ‘willing to work’ test.”
The paper outlines the background and purposes of the Employment Tax Credit (ETC), analyses the proposal, sets out a range of issues raised by its introduction, and examines some general implications of trying to tackle these issues within the framework of an ETC.
The current Working Families Tax Credit (WFTC) is a tax credit for families with children, and the Disabled Person’s Tax Credit (DPTC) is a tax credit for people with disabilities. In 2003, the children’s elements in these will be combined with other payments for children to form the Child Tax Credit, and what’s left of WFTC and DPTC will be integrated with each other to create a tax credit for adults which will be extended to people without children.
As with the WFTC, the ETC will be means-tested against family income and will be withdrawn as income rises; and, like WFTC, it will be delivered through the pay-packet.
The authors suggest that to extend an employment tax credit to all working adults ( – though effectively only to low-paid working adults because of the credit’s withdrawal as income rises) might create disincentives where they do not currently exist: “It would be unfortunate if the deployment of a particular safety net discouraged behaviour that might reduce the need to use it” (p.10). Whilst recognising that the ETC will increase the incomes of some low-paid adults, the authors are concerned that wages might end up lower (because low wages will be subsidised by ETC), that means-testing might reduce people’s willingness to seek new skills, that it could deter one partner from seeking employment (because the amount paid will be based on a family means test), and that new complexities will be added to an already over-complex tax and benefits system.
A particular concern is that take-up will not be 100% (take-up of WFTC is already low, largely because employees don’t want employers to know their financial situation); another is that small employers will find administration of the system burdensome; another that the family means test will affect intra-family relationships across a broader range of family types than WFTC and DPTC do between them; and yet another is that shifting family patterns will create administrative problems.
The paper explores issues related to details which the government will need to consider: for instance, if there is a cut-off at a particular number of hours worked, then employment patterns will be changed by the tax credit. If the taper is sharp, then many people might reduce their hours to below the threshold.
The major problem, though, is that of incentives: “Whatever the structure of the ETC, it is impossible to escape entirely the effect on incentives and opportunities of encouraging people to work for earnings that need to be topped up on a means-tested basis in order to create an acceptable standard of living. Under a system of means-tested supplementation, attempts to overcome disincentives are inevitably traded off against other objectives, such as responsiveness, ease of administration and lack of intrusiveness for claimants,” (pp.21f).
The paper suggests that a major reason for ETC is the government’s desire to reduce the number of people receiving cash benefits (though the new Child Tax Credit is to be paid as a benefit to the main carer), and also suggests that the distinction between receiving money as a cash benefit and receiving it through the tax system is more important to the government than to claimants.
The authors’ conclusion is that “all the difficulties suggest that the problems thrown up by the ETC are not easy to overcome through policy design, since they represent certain dilemmas inherent to the fundamental characteristics of in-work means-tested support. Even where it is possible to solve one problem, either wholly or partially, the solution may create another” (p.27). Their solution to the problems which ETC is intended to address would be to increase the minimum wage, to encourage investment in human capital, to offer advice beyond the New Deals, to emphasise women’s working opportunities, to review treatment of part-time work, and to subsidise in-work costs such as childcare.
The conclusion points out that by 2003 two fifths of households will be on means-tested benefits or means-tested tax credits. The authors counsel against extending means-testing in this fashion: “Whilst the government’s first priority may have had to be addressing the symptoms of in-work poverty, it should now be focusing on addressing its causes. Means-tested in-work supplementation is likely, we believe, to make at best a limited contribution to these longer-term tasks,” (pp.38f).
(‘Part II’ contains ‘further evidence and arguments presented at a JRF seminar on ETC on the 14th May 2001.’ This should have been called an appendix. Donald Hirsch’s and Fran Bennett’s paper contains many of the main paper’s findings; Frank Wilkinson’s historical reflections offer useful background on wage subsidisation; and Mark Pearson and Stefano Scarpetta discuss the employment and distributional effects of ‘making work pay’ policies.)
On page 37 the ‘participation income’ suggested by Tony Atkinson gets a brief mention. What doesn’t get a mention is the fact that universal benefits such as Child Benefit don’t exhibit the problems associated with means-tested tax credits, that they cohere with the authors’ suggestion that too much means-testing is bad for incentives, and that they would contribute constructively to the authors’ preferred solution to the problems to which the government believes ETC to be a solution.
The Joseph Rowntree Foundation is to be congratulated on this accessible, interesting, well-argued and constructive paper. What would now be welcome would be a follow-up asking whether such approaches as a participation income, a negative income tax or a citizen’s income might be preferable to the current increasing reliance on means-tested tax credits.