Source: WPA Pool

Osborne Faces Fight to Regain Reputation After Tax-Credit Defeat

  • Chancellor pledges transitional help, no letup on budget goal
  • Labour calls for `less excessive' budget-surplus target

Chancellor of the Exchequer George Osborne lost a gamble on Monday on how far he could push welfare cuts in his bid to balance Britain’s books by 2020. Now he faces a battle to win back his reputation for both political acumen and economic competence.

By voting to delay tax-credit reductions -- a reform worth 4.4 billion ($6.7 billion) in welfare savings and central to Osborne’s deficit-cutting plan -- the House of Lords forced the chancellor to promise he’ll soften the impact of the reductions in his Autumn Statement on Nov. 25. It also sparked a constitutional dispute, being the first time in more than a century the unelected chamber of Parliament has voted against the government on a fiscal matter.

"We will listen on the transition but we are determined to deliver on controlled welfare and economic security for the people of this country," Osborne told lawmakers on Tuesday. "Working people need controlled welfare and a country that lives within its means."

While the government pledged a review of the Lords aimed at fostering "respect" for House of Commons decisions on fiscal matters, the rebellion will still force Osborne to adjust cuts to tax credits that have caused consternation even within his own party. Tory lawmaker David Davis, who voted against the proposals, branded as “harmful” the reductions to tax credits, a benefit introduced by the last Labour government to help low-paid families, while former Tory Chancellor Nigel Lawson urged Osborne to reconsider.

Osborne Options

Osborne may seek to smooth the transition, for instance, by reducing the speed at which tax credits cuts are applied. Under current proposals, the income threshold at which working tax credits are reduced will be cut to 3,850 pounds from 6,420 pounds, starting in April, with letters informing families of the change due to be send out around Christmas.

The rate at which those payments are cut -- the so-called taper rate -- is also going to accelerate. Claimants will lose 48 pence for every 1 pound earned above the threshold, up from the current 41 pence.

"It’s tricky to see the other areas in which he can really make cuts," said Sam Hill, senior U.K. economist at RBC Capital Markets in London. "The emphasis here seems to be on the transition, on perhaps finding a distribution that is more palatable to politicians."

Hill said the Treasury could also shift the bulk of the cuts to those at the higher end of the income threshold, lessening the impact of the reforms on the worse off. The changes in their current form are set to affect 3.3 million families, and are set to cost low-paid households an average of 1,300 pounds.

Judgment Error

Having guaranteed payments to pensioners and ruled out raising taxes on personal income and sales, the government is relying on cutting the cost of tax credits to turn a budget deficit of 5 percent of gross domestic product into a surplus by 2019-20, the final fiscal year of the current Parliament, and maintain surpluses during “normal” years thereafter.

Amid noisy exchanges in the House of Commons, John McDonnell, treasury spokesman for the opposition Labour Party, called on Osborne to reverse tax breaks for “the wealthiest few” and set a “less excessive” surplus target. The chancellor vowed to deliver on the welfare savings promised.

"The package is not as well designed as the government claims, but it’s mainly an error of political judgment," said Wyn Grant, a professor of politics at Warwick University. "On the fiscal front, some way will be found of rearranging the money, though reductions may not be achieved as quickly as Osborne had hoped."

Before it's here, it's on the Bloomberg Terminal.