A US perspective on tax credits and the politics of reform


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By Daniel Gitterman, Associate Professor of Public Policy, University of North Carolina-Chapel Hill, and the author of “Boosting Pay Checks: The Politics of Supporting America’s Working Poor”

Full-time work remains central to individual and family economic well-being, with earnings representing the primary income source for most working-age adults, but the ability of low-wage individuals to move up and out of poverty through work alone is much less clear than the UK prime minister suggested this week in his speech on welfare reform.

In the US, tax credits emerged as the core means of boosting the pay packets of low, moderate and middle earners and their children from the early-1990s onwards.

The chart below highlights federal spending on the refundable Earned Income Tax Credit (EITC), the Child Tax Credit (CTC) and traditional cash assistance benefits (Aid to Families with Dependent Children/Transitional Aid to Needy Families).

real-federal-spending

Faced with similar problems, policymakers in the UK looked at developments across the Atlantic with great interest. Although income supplements had been around in the UK since 1971, their scope was very limited.

Gordon Brown changed all that, with the development and significant expansion of family-based tax credits over the late-1990s and 2000s coming to represent one of the foundations of New Labour’s approach to social policy.

However, things are changing once more, as highlighted in a new report from the Resolution Foundation. The introduction of Universal Credit will merge tax credits with other benefits, significantly reducing the distinction between in-work and out-of-work support and targeting assistance more narrowly on lower income families.

The new payments should continue to play their part in tackling child poverty and in supporting low income in-work families, but the role tax credits have played in recognising the family in the tax system – by providing a tax rebate for low to middle income families – is in decline.

As a policy-oriented political scientist, I worry about the politics of reform. In the end, designing an income tax credit is as much a political choice as an exercise in policy analysis.

The prevailing wisdom among many US-based political analysts suggests that narrowly-targeted income transfers, such as direct cash assistance to low-income families, enjoy only sporadic political support, as they tend to be enacted in periods of partisan imbalance and to be vulnerable to retrenchment when elections shift the balance of power. For example, Clinton joined a Republican Congress in “ending welfare as we knew it”.

The EITC, as a targeted individual credit with employment incentives and distributional impacts, is a notable counterexample to the conventional wisdom. For example, Chris Howard argues that the meteoric rise of the EITC over its first two decades indicated that it is possible to build a durable political coalition on behalf of means-tested programs that support low-to-moderate income families.

 


See also:

Cameron’s “back of a fag packet” welfare speech brings back Labour policies he’d scrapped 26 Jun 2012

Council tax benefit reforms will hit working-age adults in poverty 1 Jun 2012

£25bn welfare cuts? Hilton’s plan is absolute nonsense 17 May 2012


 

Similarly, Bob Greenstein concludes political strength can be sustained among targeted means-tested programs if the public considers benefits to be earned, or strongly approves of the services being provided.

Most universal and uniform credit proposals reflect the principle of “targeting within universalism:” that is, they provide benefits to most low-to-middle income working families but target more support at the lower end of the income distribution.

According to proponents of this approach, it can reinforce political support for assistance to low-income working families by linking it to policies that also benefit moderate and middle-income families. In this way, policymakers can broaden and strengthen the coalition in favour of income support for all working families.

If, as recent political history suggests, the income tax code is an instrument of choice for providing income support, creating a tax credit to serve as a child or family “allowance” for all working families would represent one promising approach. One US pathway to achieving this would be to merge the child tax credit and the EITC and offer it to all eligible families with children aged 18 and under.

An “Earned Income Child Credit” (EICC) would offer tax benefits similar to the current EITC and CTC, although it would provide more relief at the bottom of the income distribution, by increasing the maximum credit in the EITC portion and boosting the refundability of the CTC portion.

UK reformers should similarly push for a “targeted within universal” credit and pay careful attention to the proposed Universal Credit parameters. Maintaining or even extending some level of benefits to more moderate-to-middle-income earners with children could address any concern that current tax benefits are smaller in the middle of the income distribution than they are at the low and high ends.

In summary, any UK reform must connect the fate of low-to-moderate to middle-income working families as worthy beneficiaries during these difficult economic times.

 


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