Sunday, July 12, 2015
Osborne gambles on a pay rise to cushion the cuts
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

Five days on from any budget is always a bit of a challenge, particularly one that has been picked over more intensely than most. Fortunately there is still a lot to say on George Osborne’s first budget of the new parliament.

Let me first give thanks for a measure that was not in the budget. Three weeks ago I wrote that a cut in the very top 45% tax rate alongside welfare cuts would send out the worst possible signals. The chancellor was being urged to do it by some senior Tories but fortunately resisted the temptation.

The other omission, which was much less welcome, was sensible tax reform. There was nothing about merging income tax and National Insurance but instead a continuation of the coalition policy of lifting the personal income tax allowance, combined this time with raising the higher rate threshold. Merging tax and NI would help the lower-paid more, while messy aspects of the income tax system remain, including the 60% marginal rate that kicks in at £100,000.

The tax changes that were in the budget, including the new £1m inheritance tax threshold for couples on homes (though not until 2020) and restricting mortgage interest relief for buy-to-let landlords to the basic rate, added to the complexity of the tax system rather than reduced it. Neither the Institute for Fiscal Studies’ Paul Johnson nor me are champions of buy to let, but he is right when he points out that owner-occupation has tax advantages over being a landlord, and will have even more now.

So what was the budget all about? Three things. The budget, rightly, got rid of the roller coaster that the chancellor found himself with after his March budget, because ahead of the election he wanted to rid himself of the silly charge that he planned to cut spending to its lowest since the 1930s.

Though the Treasury was keen to keep that as a surprise, it should not really have come as a surprise that we now have a more measured pace of deficit reduction. I wrote as much on the Sunday after the March budget.

The planned budget surplus, of £10bn, does not arrive until 2019-20, rather than 2018-19, and spending is significantly higher in three years – 2016-17, 2017-18 and 2018-19 – than set out in March. But this is overwhelmingly a story of smoothing rather than largesse. At the end of the parliament overall government spending is just £7.1bn, or 0.8%, higher than under the previous “savage cuts” scenario.

The second thing of note was that, for a government that said fiscal adjustment would come through spending restraint, there were some significant tax increases in the budget. Overall, according to the Office for Budget Responsibility tax policy changes will be raising a net £6.5bn a year more by the end of the parliament.

The new dividends tax will eventually raise more than £2 billion a year, vehicle excise duty reforms nearly £1 billion and increasing insurance premium tax from 6% to 9.5% £1.5 billion. Most of the burden of adjustment will still be on spending, together with the clampdown on tax evasion and avoidance, but these are big revenue raisers and rather stealthily done. If he could bring himself to admire anything Osborne does, Gordon Brown would be proud.

I have left the biggest budget change until last. With his reduction in tax credits and the new national living wage - £7.20 from April, rising to more than £9 (£9.35) by 2020 – Osborne has given us a variation on traditional Tory philosophy: reduce the size of the state, not by assuming the private sector will move into the gap, but intervening to make sure they do so.

The new national living wage is a kind of super minimum wage. I remember when Labour introduced the minimum wage alongside tax credits in the late 1990s Ed Balls telling me that it was essential to have a wage floor so employers could not exploit the new system. Osborne has just raised that floor.

Just as the BBC is taking on some of the welfare bill by funding free TV licences for the over-75s, so business will take on some of the costs of welfare, particularly tax credits, by paying its workers more.

What should we think of this? It is a fair question for people to ask what the response to this might have been if it had been introduced by an Ed Miliband Labour government. It would probably have been dismissed, including by me, as an anti-business, job-destroying intervention by a party that does not understand how the economy works.

This, indeed, is the response of some in business, including the low-wage sectors that will bear the brunt of this, such as care homes and catering. The minimum wage has not been a destroyer of jobs, but only because its level has been carefully calibrated each year by the Low Pay Commission.

Labour, on the other hand, would not have accompanied a proposal to force wages up with welfare cuts on the £12bn scale Osborne announced. Politically, and perhaps economically, the pill needed to be sweetened.

The IFS is perfectly correct when it says that the national living wage will not, on its own, compensate for welfarte cuts. The numbers, £4bn extra from the living wage versus £12bn of welfare cuts, demonstrate that clearly. Some welfare losers will not gain from the living wage.

There will be losers from the welfare cuts, whatever happens to wages and employment. That is inevitable, as is the fact that most of the losses will be for households on lower incomes. What the Treasury has in mind, however, is a more dynamic process than that implied by the raw numbers, in which the living pushes up pay at higher levels and employment grows even more strongly than the 1m over the next five years expected by the OBR. Osborne expects 2m. More, in other words, could be lifted off welfare.

I am still not sure this was the best way of doing it. One of the consequences of the welfare cuts will be that the “why work?” syndrome gets worse. Some people on low incomes will face marginal tax/benefit withdrawal rates of nearly 80%. The issue I have touched on in recent weeks, that what needs to be freed up are the restrictions on the hours people are willing to work under current welfare arrangements, has not obviously been tackled. The new national living wage may make employers less willing to offer more hours. It is in danger of being seen as a sledgehammer to crack a nut

What we are seeing, to use a word that appeared frequently in Osborne’s speech, is a bold experiment. It is intended, not just to raise wages at the bottom but to have knock-on effects right up the pay scale. The aim is indeed to give Britain a pay rise.

Whether this forces the rise in productivity that will justify higher pay is one aspect of the experiment. Whether it leads to bigger job losses than the 60,000 assumed by the OBR – hugely offset by the 1m net new jobs it expects over the next five years – is another. Let us hope so. Boldness is good. But fortune does not always favour the brave.