Fair pay matters, but so do tax credits
With today’s labour market statistics showing that inflation is still rising around twice as fast as average weekly earnings the UK’s household budgets remain tightly squeezed. While stronger pay growth should start to emerge in the months ahead, the real pay gap that has opened up looks set to take years to close.
But although wages matter (as the FT sets out, for businesses reliant on consumer spending as well as for families looking to make ends meet), they only make up part of many households’ spending power. For many on low pay even generous wage rises would leave their households in need of additional support via tax credits (or, presuming it ever happens for working families, Universal Credit) to keep them anywhere close to above the poverty line.
TUC research published last week (based on new analysis from Landman Economics’ Howard Reed) shows just how important this support is for working families with children. The study features a range of fictional households to show how taxes and in-work benefit entitlements change as pay goes up.
There are a few key points that I take from the case studies.
Firstly, decent incomes for low earning families with children depend significantly on in-work support via cash transfers. Even when households see their pay go up from the NMW to the Living Wage, the childcare costs they face, along with the wider expenses of looking after children, mean that relying on wages alone would leave these households in deep hardship.
Because of this, measures that increase earnings (higher wages and/or tax cuts) provide a far greater overall income boost for adults without kids than they do for low earning families with children. That’s because if families with children are to avoid severe poverty they need higher incomes than single adults or couple households without kids, and because the tax credits and benefits which provide that support taper off as pay goes up. Pay rises still matter for the former group, and of course it’s right that employers who can afford to pay better wages don’t outsource their responsibilities to the state. But that doesn’t mean that higher pay alone will be enough to meet the needs of low income working families. For many, in particular single parents with high childcare costs, the support they get via tax credits and benefits will continue to be as important as their wages, even as their earnings start to rise.
Another important group of beneficiaries from higher take home pay are low earners living with higher earning partners. Again, this group will not be receiving in-work benefits and tax credits, so see a larger income rise from lower tax/higher pay than low earning families. There’s nothing wrong with this as an outcome. But it does raise questions about how well thought through the arguments of those advocating continual tax cuts are. If the main beneficiaries of rising take home incomes are higher income families or families without children, while those at highest risk of working poverty are low-income families with kids, how effectively targeted are billions of pounds of income tax cuts? And can advocates of this policy really claim to be helping the low earners in the greatest need?
Pay definitely matters, and while increasing the personal allowance is a very expensive way to help those with low earnings, it does improve take home incomes for those outside of tax credit support. But for those whose household needs mean that meeting basic living costs requires both fair pay and state support, tax credits are the most important game in town. This is a particular concern as over recent years government has supported £9 billion in personal allowance cuts, while implementing significant and ongoing tax credit cuts.
The case studies from our research are summarised below, and can be read in full here (where complete breakdowns are provided of how taxes, benefits and take home incomes are affected by pay rises for each family). They show that with more than half of benefit cuts hitting working people, any real programme to enable those on low pay to share in the recovery needs to recognise the role of in-work credits along with stronger pay growth, and focus on reversing tax credit cuts rather than on delivering further poorly targeted personal allowance giveaways.
- Jean lives in Manchester and is a single parent with two children. She works 40 hours a week in a minimum wage cleaning job, and pays £100 a week in rent. Jean has a pay boost when her employer decides to pay the living wage, receiving an extra £45.60 a week. As her pay goes up, she pays an extra £9.12 in income tax and an additional £5.47 in national insurance each week, but her benefits also change as a result of her pay rise and she loses £18.70 a week in working tax credit. This means she gets a welcome £12.31 extra a week in her pocket, but her earnings are still too little to cover her rent and her family’s living costs. That’s why even after the pay rise, it is vital that Jean is still entitled to £166.53 a week she was getting in child benefit and tax credits.
- Mark and Heather live in Stratford, East London and have two young children. They own their terraced house, and spend £200 a week on their mortgage and £120 a week in childcare. Mark works 40 hours a week as a security guard, earning £8 an hour. Heather works part-time as a shop assistant for 24 hours a week. Both Mark’s and Heather’s employers decide to pay the London living wage. This means that Mark’s earnings increase by £22 a week and Heather gets a £53.70 a week pay rise. In total, their earnings go up by £75.76 a week, although as a result their income tax and national insurance contributions also rise, while their benefits and tax credits reduce slightly. In total, their pay rise means that they are £22.08 better off a week. The pay rises help Mark and Heather out a little but without extra help their income is still too low to cover their living costs, and they still need £148.36 a week in benefits and tax credits. Without this help their income would fall substantially as Heather would not be able to cover the childcare costs that allow her to work.
- Jessica lives in Margate with her two children and works 24 hours a week as a care assistant on the minimum wage. Her rent is £110 a week, which pays for a two bedroom flat and her childcare costs are £170 a week. Jessica’s employer increases her hourly pay to the living wage, which raises her earnings by £27.36 a week. Because of the higher pay her national insurance contributions rise by £3.29 a week, but her housing benefit falls by £8.36 and her working tax credit entitlement declines by £11.21 a week. Her original pay rise is valuable and as a result Jessica has £4.50 a week more to spend (£234 a year). But at the same time, benefits and tax credits still make a bigger contribution to her household income than her earnings, and she continues to receive £170.78 a week in working tax credit – in addition to child tax credit and child benefit to help with the costs of clothes, nappies and food.
- Fatima and Ali live in Glasgow with their children. Ali works 40 hours a week in a restaurant, earning just above the minimum wage, while Fatima looks after their children. Ali’s employer starts to pay the living wage, which means that Ali’s earnings rise by £38 a week. As a result his income tax also goes up (by £7.60 a week), as do his national insurance contributions (by £4.56). Higher earnings also mean that some of the benefits and tax credits his family receive are reduced, with their housing benefit falling £6.67 a week and their working tax credit by £15.58. Overall, the pay rise is worth an extra £3.59 a week to Ali and his family (£186.68 a year) but Ali and Fatima continue to receive £217.68 a week in benefits and credits. This allows them to cover their £125 a-week rent as well as school uniform and food costs.