Blog Post

Will a UK welfare reform ease the UK’s EU negotiation?

In a speech on 22 June 2015, UK David Cameron pointed at a number of possible changes that could be made to the UK's tax credit system. Why is the UK government suddenly thinking of reforming their tax system? One reason is that the UK government’s official aim of cutting public spending. Also, the Conservative Party wants to negotiate new rules with the EU, so that people will have to be earning for a set number of years before they can claim benefits, including the tax credits that top up low wages.

By: Date: June 23, 2015 Topic: European Macroeconomics & Governance

In a speech on 22 June 2015, UK Prime Minister David Cameron pointed at a number of possible changes that could be made to the UK’s tax credit system. The UK’s tax credit system is an arrangement whereby some taxpayers (families and individuals on low income) can deduct a certain amount of money from the tax they owe to the state (although you do not have to actually pay any tax to receive the tax credit: the name is misleading). The Labour government introduced tax credits in the 1990s.

Why is the UK government suddenly thinking of reforming this system? The first immediate reason is the UK government’s official aim of cutting public spending. In an article in the Sunday Times on 21 June 2015, Chancellor of the Exchequer George Osborne and Secretary of State for Work and Pensions Iain Duncan Smith outlined a plan to reduce welfare spending by £12 billion a year. A quick look at UK welfare spending shows that tax credits (most importantly Child Tax Credit and Working Tax Credit) are an obvious area for attention, since cuts to state pensions have been ruled out.

Source: Department for Work and Pensions (DWP)

Incidentally, tax credits are regularly the subject of criticism, especially from the Conservative Party since the system was introduced under a Labour government.

David Cameron purported in his speech that the current UK welfare system amounted to a ‘merry-go-round’: “People working on the minimum wage having that money taxed by the government and then the government giving them that money back – and more – in welfare.” He hinted at three measures in particular:

  • Increasing the minimum wage: “The minimum wage is rising to £6.70 per hour from October 2015 – the largest real-terms increase since the financial crash and is forecasted to rise to £8 by 2020 on current projections.”
  • Increasing the tax-free amount of wages: “It is why we have increased the amount you can earn without paying tax, saving a typical taxpayer £825 a year, and it’s why we will take 1 million out of tax by increasing the tax free threshold to £12,500.”
  •  Free childcare: “Add the 30 hours of free childcare we will introduce for working families, and rewards from work, will be even stronger.”

What David Cameron does not say explicitly is what would happen to the tax credits in their present form. The media clearly expects an attack on the current system, but specifics are lacking: The Guardian reported an ‘assault’ on tax credits; the BBC pointed at Cameron’s ambition to “end welfare merry-go-round.” The UK prime minister is clearly signalling profound changes to the tax credit system, but it is unclear how far he is ready to go in reforming it or perhaps more radically removing it altogether.

But this reform could also have important implications for the UK’s EU renegotiation and impending referendum – and this could be the second motivation for reform.

The most contentious issue among the otherwise vague list of demands for EU reform formulated by the UK government is that concerning EU freedom of movement rules. Tellingly, this demand was included in the chapter “Controlled immigration that benefits Britain” in the Conservative Party’s 2015 Manifesto, but not in the chapter “Real change in our relationship with the European Union.” The Conservative Party’s demands read: “We will negotiate new rules with the EU, so that people will have to be earning here for a number of years before they can claim benefits, including the tax credits that top up low wages. Instead of something-for-nothing, we will build a system based on the principle of something-for-something.”

The ability of non-UK citizens to access tax credits that top up low wages was therefore most clearly spelled out. In the event of a profound reform of the UK’s tax credit system – in particular if the UK government decides to completely dispose of the tax credit principle – this would de facto remove the most contentious demand on the EU negotiation table. In November 2014 and again in January this year, German chancellor Angela Merkel for instance most clearly voiced her opposition to any change to the current rules on the freedom of movement, even at the expense of an eventual Brexit. But if people living in the UK, regardless of their citizenship, were no longer in principle to claim tax credits, why would the UK government ask for a change in the EU freedom of movement’s rules? The list of the UK’s negotiations demands would be easier to deal with, if very vague.

In that sense, side-stepping the free movement issue via tax credit reform would bring today’s negotiation much closer to that in 1975, the year of the UK’s previous EU membership referendum (analysed in a recent Bruegel Policy Contribution). In 1975, British Prime Minister Harold Wilson formulated a list of demands – including changes to the common agricultural policy, retention by UK Parliament of some powers and fairer methods of financing the EU budget – that avoided going into the specifics. The UK renegotiations of 1975 brought mostly cosmetic changes, but the vagueness of the original demands allowed these cosmetic changes to be presented as successes during the referendum campaign. The situation could take a similar path today: removing the UK’s original request for EU Treaty changes on the freedom of movement would leave only a few vague items on the UK’s list of demands (see 2015 Conservative Party Manifesto): ‘reform the workings of the EU’, ‘reclaim power from Brussels’ and ‘safeguard British interests in the Single Market’. David Cameron’s plans to reform the UK’s tax credit system will therefore be an unexpected critical domestic component of the UK government’s EU negotiation stance.

[1]  I would like to thank Stephen Gardner for his help in conceiving this blog and Thomas Walsh for compiling the chart’s data.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic

Blog Post

Does the European Parliament miss an opportunity to reform after Brexit?

While Brexit negotiations are beginning to progress, the European Parliament is preparing to vote on the possible reallocation of seats following the UK's departure. With many of the current proposals reflecting Member States' concerns about losing seats, this paper advocates for options that could better achieve equality of representation even within the constraints of the EU treaties.

By: Robert Kalcik, Nicolas Moës and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: January 10, 2018
Read about event More on this topic

Upcoming Event

Feb
27
12:30

Bruegel - Financial Times Forum: The future of euro-area governance

The third event in the Bruegel - Financial Times Forum series will look into the future of euro-area governance.

Speakers: Maria Demertzis, Gideon Rachman, Manfred Weber and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Opportunities and risks in Europe in 2018

The new year could very well see the positive story of 2017 continue in Europe – but a number of looming policy and political problems cannot be ignored.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: December 30, 2017
Read article More on this topic More by this author

Blog Post

The growing presence of robots in EU industries

While it is always tempting to try to predict future patterns in the automation of European industries, it is also insightful to assess key dimensions of their robotisation so far, starting from the pre-AI era. This article presents evidence on the use of industrial robots by European industries from 1993 and onwards.

By: Georgios Petropoulos Topic: Innovation & Competition Policy Date: December 20, 2017
Read article Download PDF

External Publication

European Parliament

The Impact of Brexit on the EU Energy System

What will be the impact of Brexit on the EU energy system? With or without the UK, the EU will be able to complete its market, to achieve its climate and energy targets with feasible readjustments, and to maintain supply security

By: Gustav Fredriksson, Alexander Roth, Simone Tagliapietra and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, European Parliament, Testimonies Date: December 19, 2017
Read article More on this topic More by this author

Blog Post

Optimistic UK business confidence indicators predict smooth Brexit

UK business confidence indicators hardly fell after the Brexit vote in 2016 and have been increasing steadily since. The most likely reason is an expectation of smooth Brexit deal, especially for industry, while there is more uncertainty for services.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 19, 2017
Read article More on this topic

Blog Post

Brexit, phase two (and beyond): The future of the EU-UK relationship

Whether it looks more like ‘CETA-plus’ or ‘EEA-minus’, the trade deal that emerges from phase two of the Brexit negotiations should not be the limit of ambition for future partnership between the EU and the UK

By: Maria Demertzis and André Sapir Topic: European Macroeconomics & Governance Date: December 13, 2017
Read about event More on this topic

Past Event

Past Event

The impact of Brexit for Research & Innovation in Europe

This event featured a new and interactive format, with a restricted and high-level on-site audience and in parallel, it has been livestreamed on our website to remain public and attract the widest participation.

Speakers: Alastair Buchan, Matt Dann, David Earnshaw, Kurt Deketelaere, Maryline Fiaschi, Martin Muller, Christian Naczinsky and Reinhilde Veugelers Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: December 12, 2017
Read article More by this author

Blog Post

Latest data shows developing trends in the European Central Bank’s refinancing operations

The stock of liquidity supplied through the ECB’s open market operations has remained relatively stable, though there is a clearer change in the country composition.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: December 12, 2017
Read about event More on this topic

Past Event

Past Event

Health care and macro-economics in Europe

What are the strengths and challenges of health care systems in each EU country? What are the common policy priorities and opportunities for EU value added?What role do healthcare systems play in public finances and macroeconomic developments? What are the economic values of investing in healthcare?

Speakers: Zsolt Darvas, Caroline Costongs, Per Eckefeldt, Sylvain Giraud, Petra Laux, Xavier Prats Monné and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: December 7, 2017
Read article More on this topic More by this author

Blog Post

The eurozone medley: a collection of recent papers on the future of euro-area governance

Our scholars Grégory Claeys, André Sapir, Dirk Schoenmaker, Nicolas Veron and Guntram B. Wolff, explore the next steps needed to create a more functional and coherent economic governance framework.

By: Bruegel Topic: European Macroeconomics & Governance Date: December 6, 2017
Read article More on this topic More by this author

Blog Post

How the EU has become an immigration area

Natural change of EU28 population (the balance of live births and deaths) has fallen from high positive values in the 1960s to essentially zero recently, while the previous close-to-zero net immigration has turned positive and, since the early 1990s, become a more important source of population growth than natural increase

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 6, 2017
Load more posts