The Budget and Tax Credits
One of the surprises of today’s Budget is the assault on the tax credit system – it’s much more severe than I was expecting.
These changes will exclude hard-pressed middle-income workers, increase the marginal effective tax rates faced by low paid workers, hit families with young children, penalise claimants who are late in reporting changes of circumstances and increase the uncertainty for workers in insecure jobs. Possibly the worst change of all is the reversal of a previous reform that was introduced to deal with the problems that were faced by workers whose incomes rose during the year and found themselves with huge arrears to pay back.
It’s worth listing the changes in full, together with my explanation of why they are problematic.
- From next April the second income threshold for the family element of the Child Tax Credit will be cut from £50,000 to £40,000. One of the attractive features of the CTC is the way it makes sure that most families gain something from the system – it is important for ensuring middle-class ‘buy-in’ to a programme that gives most to the poor, and we can expect to see voter support for generous tax credits decline as a result. More importantly, it recognises the fact that middle-income families can find that their children’s needs stretch the family’s budget.
- From next April the rate at which tax credits are withdrawn will rise from 37% to 41%. This will increase the marginal tax rate low paid workers will face. Everyone will face a 4 percentage point increase in their marginal effect tax rates; add this to income tax and, in some cases, Housing Benefit and Council Tax Benefit, and some people will face combined tax and tax credit withdrawal rates of well over 60%. The Budget Report acknowledges that the Budget increases the number of people facing a marginal rate of 90 per cent or more from 110,000 to 130,000 and the numbers facing a rate of 60% or more from 1,895,000 to 1,935,000.
- From next April the baby element will be removed from the Child Tax Credit and the toddler supplement promised by the last government will be withdrawn. As Nicola has pointed out, this is one of a series of tax credit and benefit changes that will cost families with babies £1,293 a year.
- From April 2012 the 50+ element will be removed from the Working Tax Credit. Nothing will be put in its place to help older people returning to the labour market.
- From April 2012, backdating of changes of circumstances will be reduced from three months to one month. This will inevitably have the worst consequences for vulnerable low paid workers, who are most likely to get into difficulty with keeping HMRC informed.
- From April 2012, a £2,500 disregard will be introduced for falls in income. The Budget Report gives no more details, but this seems to mean that low paid workers whose income falls after they have put in their claim will have to make do with the same amount of WTC. Take, for instance, someone whose firm is in difficulties because of the recession, and they lose regular overtime or have to accept shorter hours. One of the advantages of the tax credit system has been that it has been some help to workers coping with having to work reduced hours but this change will mean that tax credits become much less effective at cushioning people from changes like this.
- From April 2011, the level of in-year rises of income that will be disregarded when calculating entitlement will fall from £25,000 to £10,000. From April 2013, this will fall to £5,000. These changes were introduced with an early problem with the tax credit system: people whose income increased during the year – because they got a promotion, or a better paying job, for instance – could find that they owed HMRC thousands of pounds in arrears. At the very least, this led to huge cuts in the amount of tax credit they were entitled to, for some it also meant massive burdens of debt. At the time, the Conservatives and Liberal Democrats complained about this vociferously. The current rules have successfully eliminated this problem; we can expect the changes announced today to lead to its re-emergence.
These changes will seriously damage popular support for generous tax credits. It isn’t merely the well-off who will lose out. Conservative and Liberal Democrat MPs laughed when the Chancellor talked about people earning over £80,000 receiving tax credits. They are not typical of the losers. From the Budget Report (table A1) it is clear that families earning less than £15,000 a year will receive less from the tax credit system as a result of the changes in this Budget.
I have to admit that I’m surprised that the government has been so extreme in its assault on Working Tax Credit and Child Tax Credit. Iain Duncan Smith’s plans for a system he calls ‘Dynamic Benefits’ are essentially based on extending the tax credits to the whole working age benefit system. These reforms will undermine support for that system, return us to the days of glaring injustice and increase the marginal effective tax rates IDS rages about when he is complaining about work disincentives.