From the TUC

Today’s tax credit debate – what is the independent assessment going to reveal?

26 Oct 2015, by in Society & Welfare

Today the House of Lords debated regulations to cut tax credits, scheduled to be introduced next April. They voted to delay this introduction until an independent assessment of their likely impact has been carried out.

In this post I want to look at what this assessment is likely to discover and why I think the government will move heaven and hell to implement the changes regardless.

There are three changes:

  • The income threshold for working tax credit and child tax credit is cut (and equivalent cuts to Universal Credit),
  • The taper rate at which tax credits are withdrawn is increased and
  • The income rise disregard is decreased.

Last week I blogged about the overall impact these changes are going to have. Using the IPPR tax-benefits model, we estimate that working families in the poorest fifth of the country will be £560 a year – more than ten pounds a week – worse off. In the second poorest fifth the losses will be even greater: £670 a year. 11,400,000 people, in 3,500,000 households, will be worse off.

One defence of the policy that we’ve heard from Ministers and Conservative backbench MPs has been that these cuts are essential, sadly necessary to cut the deficit, but that Universal Credit will be an improvement. And it’s certainly true that the government hasn’t yet announced plans to increase the UC taper to 48 per cent, bringing it in line with the tax credits.

Unfortunately for this argument, over the next five years there’s a whole series of other changes that are going make people worse off, which will mean that people will be even worse off by 2020/21:

  • Most working age benefits will be frozen for four years and Universal Credit won’t be exempted from this freeze.
  • The UC work allowance, the equivalent of the tax credit income thresholds, will be cut just as harshly.
  • For new claims, the family element will be abolished and the number of children the system supports will be limited to two.

These are all major cuts. We estimate that, by 2020/21, the benefit freeze will be making 10.8 million households – 31.6 million people – worse off; 4 million households, with 11.6 million people, worse off cut in the UC work allowance; and the family-unfriendly cuts will hit 2.7 million people in 700,000 households. Many people will be hit by more than one of these cuts.

For working families in the poorest fifth of the population, the benefit freeze will cost them £360 a year (2015/16 prices), the cuts in the work allowance another £530 a year and the loss of the family element and 2-child limit £290 a year. The combined loss will be £1,190 a year. The average combined impact for working families across the income distribution will be to reduce their entitlement by £410 a year. (And, despite all the guff about these cuts being introduced to “make work pay”, it’s working families that will be hit hardest – the average combined reduction for non-working families will be £190, less than half as much.)

And these cuts are massively biased against the poor. Look, not at the change in pounds and pence, but the percentage loss in disposable income for working families:

  • Poorest quintile: 8.78 per cent.
  • Second quintile: 4.29 per cent.
  • Third quintile: 1.24 per cent.
  • Fourth quintile: 0.26 per cent.
  • Richest quintile: 0.03 per cent.

The other common defence of the cuts is that they don’t take into account other more positive changes. Just which beneficial reforms should be taken into account differs from one Minister to another, but the two that were emphasised by the Chancellor during the Budget were the increase in the personal allowance for income tax and the supplement to the minimum wage. These changes won’t do much to offset next year’s massive cuts because they won’t be fully implemented till 2020.

Even then, we shouldn’t expect too much of them. The increases in the personal allowance does increase incomes, by £60 a year on average for working families, but they are not a measure to help the working poor. The very poorest of the working poor already earn too little to pay any income tax and the biggest gains go to the best off as we can see if we look at the impact on working families:

  • Poorest quintile: £10 a year better off.
  • Second quintile: £30 a year better off.
  • Third quintile: £50 a year better off.
  • Fourth quintile: £70 a year better off.
  • Richest quintile: £100 a year better off.

The new minimum wage supplement will do rather more and will focus more help on the working poor, but it won’t be enough to match the scale of the losses we have seen from the tax credit and UC cuts:

  • Poorest quintile: £100 a year better off.
  • Second quintile: £110 a year better off.
  • Third quintile: £150 a year better off.
  • Fourth quintile: £80 a year better off.
  • Richest quintile: £40 a year better off.

This chart shows the impact of all these changes:

TC cuts v2

Notes: 2020/21 figures, calculated on an After Housing Costs basis) assume 100% take-up. “Combined benefit cuts” = cut in the work allowance, freeze in working age benefits, abolition of family element and limit to 2 children.

You may find that this chart seems to tilt down and to the right – that’s a visual illusion, caused by the fact that the benefit cuts are so much bigger than the positive changes and hit the poorer groups on the left hand side of the chart so much harder.

So the distributional analysis is going to come up with explosive results, even if it takes the income tax cuts and minimum wage supplement into account. This summer, research we published with the Child Poverty Action Group showing that cutting the taper and increasing the work allowance could take hundreds of thousands of children out of poverty. We can expect that doing the opposite will mean hundreds of thousands more children in poverty. And the worst-hit families will be the working poor – the people who are doing just what the government says it wants and trying to work their way to a decent life.

But I don’t believe the government are going to change their minds. That’s because it would be really expensive for them to do so – they’re banking on making substantial savings on the tax credits from the moment they come into effect. If we look at the document the treasury produced with the cost and savings expected in 2016/17 from each policy announced in the July Budget we can see that they expect these cuts to save –

  • Increasing the taper to 48 per cent: £1,475 million.
  • Cutting the income thresholds: £2,880 million.
  • Cutting the income rise disregard: £170 million.

That is, bringing in transitional protection would leave the government having to find £4,525 million in 2016/17, though this sum would gradually decrease over the following years.

Some people will be very disappointed that the Lords didn’t simply reject these changes, I know that I am. But we have to recognise that they were under tremendous pressure from the government, including a threat to create 150 new members of the Lords, if that is what it took. And what they did vote for could be even harder for the government to cope with because it looks as though they could face one of three harsh options:

  • To fight and fight to avoid publishing an independent evaluation of the likely impact of their policies.
  • Allowing that publication and then going ahead with indefensible cuts.
  • Scrapping the cuts and dealing with a £4.5 billion hole in their fiscal plans.

3 Responses to Today’s tax credit debate – what is the independent assessment going to reveal?

    Oct 27th 2015, 10:53 am

    Tax credits and other benefits are generally spent on local services, so don’t hurt the economy. Inheritance tax changes go into homes that become unaffordable, or bank accounts in New Jersey or Switzerland – itis money that essentially leaves the active economy and doesn’t create employment.

  2. 2016 Tax credit cuts will worsen regional inequality
    Nov 18th 2015, 5:59 pm

    […] to mitigate some of these impacts, but there’s a limit to what he can do. As I’ve mentioned before, he’s relying on these cuts to save a lot of money straight away – £4.5 billion in […]

  3. Just two cheers for the #spendingreview tax credit U-turn
    Nov 25th 2015, 6:18 pm

    […] calculated that 11,400,000 people, in 3,500,000 households, would be worse off, with the average loss among […]