Giving credit where tax credit's due

When Gordon Brown talks of 'targeted tax cuts', what he means is tax credits. And this week's Budget will be awash with them. Like many of Brown's policies, they form part of the American public policy lexicon. Al Gore's presidential campaign repeatedly referred to his plans for tax credits as targeted tax cuts.

Tax credits are on offer for children, childcare, pensioners, and working families, as well as communities that invest, businesses that research, and pharmaceuticals companies that develop cheap drugs for the third world.

It's the policy tool of choice for the Chancellor of the Exchequer.

Want to coax the big pharmaceuticals companies to produce that malaria drug? Trying to persuade the poor to become 'deserving' by seeking work? Tax credits will 'incentivise' the promotion of virtue and the avoidance of sloth.

Simultaneously, tax credits can target state support to approved groups, and promote socially desirable economic behaviour. And credits can even make the public finances look more creditable.

But who gains? By and large, you need to be paying tax to benefit. This suggests you are not among the very poorest of society. Within households, benefits that used to go to mothers now increasingly become a credit on the tax bill of the father. Similarly, only profitable companies pay tax, so how do the loss-making startups benefit?

And here is the twist. Not all tax credits are actually credits, says independent think tank, the Institute for Fiscal Studies. Some, such as the Working Families' Tax Credit, are rebadged as benefit handouts. For businesses the credits are subsidies by another name - and this invites the attention of the EU.

But there is a flipside. The corollary of tax breaks for target groups and desirable business behaviour is the need for identification and proof of qualification. For individuals this means more complex forms and a massive expansion of means testing.

The fiendish complexity of claiming the credits may be putting people off. Nearly 2 million eligible parents failed to claim the existing children's tax credit by last week's deadline, despite an expensive and memorably annoying ad campaign featuring SuperDad.

The proposed integrated child credit will extend such testing from 2.5 million to 6 million families in 2003, says the Institute for Fiscal Studies. For businesses the need for identification means more dreaded red tape as the Government seeks to ensure credits are given only where they are due. Last week's National Association of Citizen's Advice Bureaux report on the Working Families Tax Credit showed that some people were losing jobs because small employers couldn't bear the regulatory burden.

This poses a conundrum for businesses leaders wanting to take advantage of, for example, the Research and Development tax credit.

As a tool for redistribution, tax credits are already having an effect. But their role as the primary means to address market failure - in inner cities, in medicines for the Third World, and in promoting technology investment - is unproven.

Take the credit announced by Gordon Brown last week to encourage pharmaceuticals companies to invest more in drugs for developing countries. There are problems of companies relabelling inappropriate drugs, claiming the credit for labs used for existing drugs, and whether the credit should apply for the total volume of research done, or the extra encouraged by the existence of the credit.

Ed Mayo is executive director of the New Economics Foundation, a think tank which helped formulate the Community Investment Tax Credit now being considered by the Treasury.

'Tax credits are an astute approach that effectively provide an interest rate subsidy for investing in inner cities,' he says. 'The real advantage is that they avoid the bureaucracy and centralisation of public spending - they don't pre-specify what the money is for.'

The childcare credit can be seen in a similar way. In the past, governments may have created state run nurseries; now they subsidise demand and leave the supply to the private sector.

But the real growth area is the use of tax credits to promote social and environmental responsibility, says Mayo. Tax credits for environmentally useful business activity are the carrot approach to incentives rather than the 'stick' of measures such as the climate change levy. In the Netherlands, tax credits are on offer for certain green projects. In the US there is, among others, the Historic Preservation and the Low-income Housing tax credits. Many are offered and voted for within regions or states. Bill Clinton even named a tax credit for further education after his home town.

Presentationally they are a godsend. A £1bn tax credit for urban regeneration will cost the Exchequer just 5 per cent of that - £50m. It doesn't even count as public spending. They offer unbeatable political value for money. They allow governments to state baldly the good things they wish to promote, without addressing the pithy issue of paying much for them.

But will they work? Perhaps there should be a tax credit for that.

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