Taxes, tax credits and welfare spending

In his budget speech today, Chancellor George Osborne, claimed that 'we will make work pay'. This blog evaluates that claim. We examine the impact of the changes to income tax thresholds and tax credits together with the introduction of a National Living Wage (NLW).

The government has announced the following changes to the tax and tax credit system:

  • Increase the income tax threshold from £10,600 to £11,000
  • Increase the higher rate (40p) threshold from £42,385 to £43,000
  • Restrict eligibility for child tax credit to the first two children
  • Decrease the threshold income at which tax credits are withdrawn from £6420 to £3850
  • Increase the 'taper', the rate at which tax credits are withdrawn for income exceeding the threshold from 41% to 48%

The main impacts of this package of changes are:

1) The changes to tax credits intensify the disincentives to work for all tax credit claimants earning more than the new threshold of £3,850, except for those earning in the very narrow range between £10,600 and £11,000.

2) The following types of families will be worse off in 2017/18 after the changes:

  • Childless and non-disabled individuals currently working 30 hours on the national minimum wage (NMW)
  • Lone parents and couples with children currently working 30 hours on the NMW
  • Lone parents and couples with children currently working 40 hours on the NMW
  • The average lone parent on in-work tax credits, who works 26 hours at an hourly wage of £8.53
  • The average single-earner family on in-work tax credits, working 37 hours at £8.78 an hour

All of these families will lose more in tax credits than they will gain from the changes to income tax and the new living wage.

3) The following types of family will be better off in 2017/18 after the changes:

  • Childless and non-disabled individuals currently working 40 hours on the national minimum wage (NMW)

Work disincentives

We believe that the measures announced are inconsistent. While the changes in income tax thresholds should modestly strengthen the incentives to enter or stay in work, the government has  worsened the work disincentives embedded in the tax credit system.  Increasing the taper from 41% to 48% increases the effective tax rate faced by families claiming tax credits to 48% for incomes between £3,850 and the NI threshold, to 59% for families paying NI but with annual incomes below £11,000 (£12,500 in 2020/21), and to a whopping 79% for families earning in excess of £11,000 (£12,500 in 2020/21) but still in receipt of in-work tax credits.

Moreover, the changes to tax credit worsen the work disincentives faced by 2nd earners in couples receiving tax credits. Currently, the first £1 that these (usually) mothers earn is taxed at the rate of 41%, the rate at which their additional income reduces their family's tax credits. Increasing the taper to 48% also increases the entry rate of income tax for this group to 48%.

Impact by family type

The tables below show the combined impact of the change from the NMW to the NLW, the reduction in income tax thresholds and the reduction in tax credit thresholds for a range of family types.

Table 1a: 30 hours at NMW to 30 hours at NLW, childless non-disabled individual

 

Minimum wage

Living wage 2017/18

Living wage 2020/21

Hours

30

30

30

Wage

6.50

7.20

9.00

Weekly

195

216

270

Annual Gross

10,140

11,232

14,040

Income tax

0

46

308

NI

250

381

718

Annual Net

9890

10805

12765

Tax credits

1245

0

0

Annual Net + tax credits

11135

10805

12765

Outcome for government

 

1422

2021

Outcome for individual

 

-330

1630

 

Table 1b: 30 hours at NMW to 30 hours at NLW, one-earner family with one child[1]

 

Minimum

wage

Living wage

2017/18

Living wage 2020/21

Hours

30

30

30

Wage

6.50

7.20

9.00

Weekly

195

216

270

Annual Gross

10,140

11,232

14,040

Income tax

0

46

308

NI

250

381

718

Annual Net

9,890

10,805

12,765

Tax credits

6,580

4,562

3,214

Outcome for government

 

2,196

4,142

Outcome for family

-1,104

-492

         

* Assumes that the thresholds for child tax credit only will shift in line with the working tax credit thresholds.

 

Table 1c: 30 hours at NMW to 30 hours at NLW,single-earner family with two children[2]

 

Minimum wage

Living wage 2017/18

Living wage 2020/21

Hours

30

30

30

Wage

6.5

7.2

9

Weekly

195

216

270

Annual Gross

10,140

11,232

14,040

Income tax

0

46

308

NI

250

381

718

Annual Net

9,890

10,805

12,765

Tax credits

9,360

7,342

5,994

Annual Net + tax credits

19,250

18,147

18,759

Outcome for government

2,196

4,142

Outcome for family

-1,104

-492

* Assumes that the thresholds for child tax credit only will shift in line with the working tax credit thresholds.

 

Table 2a: 40 hours at NMW to 40 hours at NLW, childless non-disabled individual

 

Minimum wage

Living wage 2017/18

Living wage

2020/21

Hours

40

40

40

Wage

6.50

7.20

9.00

Weekly

260

288

360

Annual Gross

13,520

14,976

18,720

Income tax

504

795

1,244

NI

655

830

1,279

Annual Net

12,361

13,351

15,542

Tax credits

0

0

0

Annual Net + tax credits

12,361

13,351

15,542

Outcome for government

 

466

1,364

Outcome for individual

 

990

3,181

 

Table 2b: 40 hours at NMW to 40 hours at NLW, single-earner family with one child[3]

 

Minimum

wage

Living wage

2017/18

Living wage 2020/21

Hours

40

40

40

Wage

6.50

7.20

9.00

Weekly

260

288

360

Annual Gross

13,520

14,976

18,720

Income tax

504

795

1,244

NI

250

381

718

Annual Net

12,766

13,800

16,509

Tax credits

5,194

2,765

967

Annual Net + tax credits

17,960

16,565*

17,476*

Outcome for government

 

2,852

5,435

Outcome for family

-1,396

-484

* Assumes that the thresholds for child tax credit only will shift in line with the working tax credit thresholds.

 

Table 2c: 40 hours at NMW to 40 hours at NLW, single-earner family with two children[4]

 

Minimum wage

Living wage 2017/18

Living wage

2020/21

Hours

40

40

40

Wage

6.50

7.20

9.00

Weekly

260

288

360

Annual Gross

13,520

14,976

18,720

Income tax

504

795

1,244

NI

250

381

718

Annual Net

12,766

13,800

16,509

Tax credits

7,974

5,545*

3,747*

Annual Net + tax credits

20,740

19,345

20,256

Outcome for government

2,852

5,435

Outcome for family

-1,396

-484

* Assumes that the thresholds for child tax credit only will shift in line with the working tax credit thresholds.

 

Table 3: Average lone parent recipient of tax credits with one child

 

Current

Living wage 2017/18

Living wage 2020/21

Hours

26

26

26

Wage

8.53

8.53

9.00

Weekly

222

222

234

Annual Gross

11,533

11,533

12,168

Income tax

187

107

0

NI

417

417

493

Annual Net

10,929

11,009

11,675

Tax credits

5,199

3,607

3,302

Annual Net + tax credits

16,128

14,617

14,977*

Outcome for government

 

1,511

1,786

Outcome for family

 

-1,511

-1,151

* Assumes that the thresholds for child tax credit only will shift in line with the working tax credit thresholds.

 

Table 4: Average couple family recipient of tax credits with one child, assuming one-earner

 

Current

Living wage 2017/18

Living wage

2020/21

Hours

36.7

36.7

36.7

Wage

8.78

8.78

9.00

Weekly

322

322

330

Annual Gross

16,756

16,756

17,176

Income tax

1,231

1,151

935

NI

1,044

1,044

1,094

Annual Net

14,481

14,561

15,147

Tax credits

3,867

1,910

1,709

Annual Net + tax credits

18,348

16,471*

16,855*

Outcome for government

 

1,877

1,913

Outcome for family

 

-1,877

-1,493

* Assumes that the thresholds for child tax credit only will shift in line with the working tax credit thresholds.

 

[1] The examples hold both for lone parents and one-earner couples with one child.

[2] The examples hold both for lone parents and one-earner couples with two children.

[3] The examples hold both for lone parents and one-earner couples with one child.

[4] The examples hold both for lone parents and one-earner couples with two children.

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