Blog Post

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

In a speech on22 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 about event More on this topic

Upcoming Event

Mar
3
12:30

The Brussels effect: How the European Union rules the world

This event will challenge the narrative that Europe is in decline, by asking whether Europe does in fact rule the world.

Speakers: Bente Angell-Hansen, Anu Bradford and Giuseppe Porcaro Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Opinion

Realpolitik of the day after Brexit

Compromises hammered out in the next 11 months, by both British and European negotiators, will dictate the UK’s economic landscape for decades to come

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: January 31, 2020
Read article More on this topic More by this author

Opinion

Britain faces a triple contradiction

If Boris Johnson can negotiate agreements that are better than the EU system, it would be a serious challenge for the 27

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: January 30, 2020
Read about event

Upcoming Event

Mar
31
12:30

How adequate is the European toolbox to deal with financial stability risks in a low rate environment?

Bruegel is delighted to welcome the governor of the Central Bank of Ireland, Gabriel Makhlouf. He will deliver a keynote address about how adequate the European toolbox is to tackle financial stability risks in a low rate environment. Following his speech, a panel of experts will further discuss the topic.

Speakers: Gabriel Makhlouf, Guntram B. Wolff and Agnès Bénassy-Quéré Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Podcast

Podcast

The science of Brexit

On Saturday morning, the United Kingdom will wake up outside the European Union. After 37 years of collaboration, how will Brexit affect research and innovation in Europe and in the UK? What should be the next steps undertaken by both in order to maintain the same level of cooperation? This week, Nicholas Barrett is joined by Maria Demertzis, Guntram Wolff and Michael Leigh, Senior Adjunct Professor of European Studies at the Johns Hopkins University, to discuss a post-Brexit agreement for research and innovation.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: January 29, 2020
Read about event More on this topic

Past Event

Past Event

Take a chance on me: Sweden considers the Banking Union

This event will discuss if Sweden should join the European banking union and the general state of the union.

Speakers: Fredrik Bystedt, Elena Carletti, Maria Demertzis and Pawel Gąsiorowski Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 29, 2020
Read article Download PDF

Book/Special report

A post-Brexit agreement for research and innovation

This report sets out what the Wellcome Trust and Bruegel have learned from a project to simulate a negotiation process between the UK and EU to create a post-Brexit research and innovation agreement. Our negotiating scenario assumed that the UK had left the EU with a withdrawal agreement, and that the negotiation was taking place during a ‘standstill’ transition period.

By: Michael Leigh, Beth Thompson and Reinhilde Veugelers Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: January 28, 2020
Read about event

Past Event

Past Event

A post-Brexit agreement for research and innovation

What is the future of EU's and UK's relationship on research and innovation?

Speakers: Gina Dowding, Philippe Lamberts, Michael Leigh, Adrian Hayday, Clare Moody, Martin Muller, Joe Owen, Jaroslaw Pietras, Uta Staiger, André Sapir, Beth Thompson and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 28, 2020
Read article More on this topic

Blog Post

A European anti-money laundering supervisor: From vision to legislation

In fighting anti-money laundering, the European Commission should act fast toward creating a central supervisory authority.

By: Joshua Kirschenbaum and Nicolas Véron Topic: European Macroeconomics & Governance Date: January 24, 2020
Read article More on this topic More by this author

Blog Post

How could net balances change in the next EU budget?

The gap between payments into the EU budget and EU spending in a particular country has importance when EU spending does not constitute European public goods, or there are risks for their improper use. I estimate that the Juncker Commission’s proposal for the next seven-year budget would lead to big reductions (as a share of GNI) in the net payments to most central European countries, while the changes for other countries seem small

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: January 23, 2020
Read about event

Past Event

Past Event

The state of health in the EU and the digitalisation of health promotion

The panellists at this event reviewed the general state of health as well as the digitalisation in the industry.

Speakers: Stefania Boccia, Caroline Costongs, Katarzyna Czabanowska, Zsolt Darvas, Guillaume Dedet, Martin Dorazil, Josep Figueras, Joanna Kokot, Martin Seychell and Michael Strübin Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 22, 2020
Read about event More on this topic

Past Event

Past Event

Partnering with Europe on responsible AI: a conversation with Sundar Pichai, CEO Google and Alphabet

At this event, Google's and Alphabet's CEO Sundar Pichai will elaborate on his views on Artificial Intelligence.

Speakers: Sundar Pichai and Guntram B. Wolff Topic: Innovation & Competition Policy Location: SQUARE, Mont des Arts, 1000 Brussels Date: January 20, 2020
Load more posts