The devil is in the detail: most tax credit cuts rolled back, but cuts to Universal Credit going ahead

Many of the tax credit cuts announced by Chancellor George Osborne in the 2015 Budget were rolled back today. This is a welcome move. However, the Chancellor is going ahead with pre-announced plans to  cut Universal Credit. These cuts will not affect households which are currently receiving tax credits, as they will benefit from transitional protection. The cuts to Universal Credit (UC) will, however, apply to new claimants as UC is rolled out across the country.

So while current tax credit claimants are protected, future claimants of Universal Credit will still be facing cuts of a similar size to those which had been announced in July 2015. In this sense, the cuts have been delayed, but not fully undone.

Bulk of tax credit cuts rolled back

Regarding tax credits, the Chancellor announced his intention to retain the threshold income of £6,420, so that households can earn up to this level without reducing their tax credit claims. The Summer Budget 2015 had included a reduction in this threshold to £3,850, which will now not be implemented. This measure alone will reverse most of the losses in tax credits that lower income families were facing.

In addition, the Chancellor announced that the taper – the rate at which tax credits are withdrawn on additional earnings above the threshold income – would remain at 41%. That is, for every pound earned above £6,420, the tax credit claim is reduced by 41p. The Government’s original plans were to increase the taper to 48% from April 2016.

Universal credit cuts going ahead

However, the devil is in the detail. The Chancellor appears to be sticking to very similar cuts to Universal Credit, although households currently claiming tax credits will benefit from “transitional protection”. This means that the cuts to Universal Credit will not affect households which currently receive tax credits. The cuts will be rolled out to new claimants of UC, as UC continues to be rolled out between now and 2017.

For new claimants, the cuts to “work allowances” in Universal Credit will be quite similar to the rolled back cuts in tax credits. In the Summer Budget 2015, cuts in the UC work allowances to £4,764 for non-renting households, and to £2,304 for renting households were announced.  Work allowances play the same role in UC as income thresholds do in tax credits. Combined with the taper  of 65%, this means substantial reductions in entitlements for working households on UC.

Tables 1 and 2 below compare the current tax credit entitlement to the universal credit entitlement for lone parents. The comparisons are made on the basis of ‘no housing costs’ (i.e. no receipt of housing benefit), to allow us to focus on the changes to UC work allowances rather. For the new claimants starting on UC, the cuts compared to the old tax credit system are of a similar size as the cuts to tax credits which have now been rolled back. The first column gives the tax credit claim and net income for the current system. The second column gives the tax credit claim and net income for the changes which had been announced in the Summer Budget 2015, but were today rolled back, which would have resulted in a loss of £2,615 for the model lone parent with one child, and in a loss of £2,002 for the model lone parent with two children. The third column gives the situation for new claimants under Universal Credit: now the model lone parent with one child loses £2,811 relative to current system, while the model lone parent with two children loses £2,357.

So while current tax credit claimants are protected, future claimants will be losing out. The losses to the future UC claimants are actually somewhat larger compared to the current system for our model lone parent households.

Some tax credit cuts going ahead

In addition, two tax credit cuts do seem to be going ahead. First, the family element worth £545 annually will be withdrawn from families after April 2017. Second, the two-child cap for both tax credits and Universal Credit will go ahead from April 2017. The two-child cap is set to apply to children born after April 2017 for tax credits, and for new Universal Credit claims from April 2017.

Making work pay

The aim of tax credits should be to support households which face particular challenges in earning enough for a decent standard of living for themselves and their children, and to make work pay, even at low wages. Although the tax credit cuts have been rolled back, the planned cuts to Universal Credit are still problematic. If Universal Credit aims to “make work pay”, then cuts should be focused on those types of households which have some capacity to respond by increasing their labour supply, be it by increasing hours of someone already in the labour force, or by sending a second household member into the labour force. Indiscriminate cuts, on the other hand, simply cut from all types of households, regardless of whether they are already working as much as they can reasonably be expected to or not.

To be clear: we are not making the argument that Universal Credit should be cut. There is some evidence that tax credits (which have a broadly similar structure to Universal Credit for those working on low wages) have helped to increase participation in the labour market among some groups, especially lone parents. There is also some evidence that tax credits might depress the incentives to work for some second earners, usually mothers. Much more careful empirical work needs to be done to understand how tax credits and Universal Credit work: how and by how much they affect the incentives to work for different groups, and who ultimately benefits from them. 

But if tax credits ARE to be cut, then the fairest and most effective way would be to focus the cuts on those households which are able to compensate for lost income by working more. Those which face the greatest challenges in working more – most lone parents and the disabled – should be spared from cuts to their tax credit and Universal credit entitlements. Households which already are working as much as they can, given their caring obligations and/or their disabilities, cannot respond to cuts in their tax credits by working more. Cutting their entitlements does not seem to be in line with the goal to “make work pay”.

Conversely, some groups might be more able to respond to cuts in their Universal Credit entitlements. These are primarily childless single earner couples, or single earner couple households with children of school-age or older. It is well-understood that the old tax credit system and the new Universal Credit system could do more to promote work among these groups.  

Table 1: Model lone parent with one child

Table 2: Model lone parent with two children