Lift 500,000 people out of poverty with tax cuts for working families on Universal Credit

A package of reform to Universal Credit (UC) to ensure work always pays would reduce tax rates for low earners, boost disposable incomes by £1,100 per year and lift 500,000 people out poverty, according to the New Economics Foundation (NEF). The total cost would be less than the £9bn earmarked for the flawed Job Retention Bonus, which the CEO of HMRC argued was poor value for money.

The analysis shows that those on the lowest earnings from work pay some of the highest tax rates in the economy. Cutting taxes directly for these groups is therefore likely to be far better targeted where it is most needed, compared with cutting VAT for hospitality (such as in the government’s Winter Economic Plan), or reducing employer payroll taxes through the Job Retention Bonus (such as in the government’s Summer Plan for Jobs). For example:

• A single parent on UC earning £13,600 per year as a cleaner has an effective marginal tax rate of 75%: they get to keep just 25p in every extra £1 of earnings, after taking into account income tax, national insurance and withdrawn benefits.
• An IT technician earning £35,000 per year and not receiving Universal Credit has an effective marginal tax rate of 32%: they get to keep 68p in every extra £1 of earnings, after taking into account income tax and employee national insurance.
• A person earning £200,000 per year has an effective marginal tax rate of 47%: they get to keep a minimum of 53p in every extra £1 of earnings after income tax and national insurance if they pay themselves through PAYE. If they receive income through dividends or selling shares they will likely have an even lower marginal tax rate and keep even more than 53p in every extra £1.

The ​‘taper rate’ of UC sets the rate at which benefits get withdrawn for every additional £1 in earnings from work, and the ​‘work allowances’ set a threshold for earned income, above which the taper is applied. The new modelling from NEF shows that reducing the taper rate by just three percentage points would boost incomes for the poorest 20% of working families by more than £100 per year, while increasing work allowances by the equivalent of just one additional hour on minimum wage per week would boost incomes for the same households by £70 per year. The analysis also looked increasing support for childcare for those on UC, since the costs of childcare can be key a factor in determining the amount of earnings that are effectively retained from work.

Based on the findings of the analysis, NEF sets out an illustrative package of reform to Universal Credit that allows people to keep more of what they earn, containing the following features:

• Increase all current work allowances by the equivalent of one hour per week at national living wage (NLW)
• Extend work allowances to workers without children at the equivalent of eight hours per week at NLW
• Ensure all second earners in a family also have a work allowance on the same basis as primary earners
• Reduce the taper rate from 63% to 50%
• Increase support for childcare costs from 85% to 100%.

The analysis shows that this package would reduce the earnings lost through tax and withdrawn benefits for an unemployed single parent getting a new minimum wage job on 30 hours per week (what economists call the effective ​“participation tax rate”) from 31% to 25%. The same person would also be able to keep 34p for every extra £1 in earnings, compared with 25p in the current system. Overall the package would see disposable incomes rise by £1,100 per year (or 14%) on average for working families among the poorest fifth of all households, and £1,200 per year (or 5%) among the next poorest 20%, while also lifting more than 500,000 out of poverty. In total the package would cost £8.8 billion, less than the maximum £9.4 billion earmarked for the Job Retention Bonus.

Lukasz Krebel, Economist at the New Economics Foundation, said:

“The government should be commended for supporting millions of jobs through its furlough scheme. But with the new Job Support Scheme set to do little to avert a tsunami of redundancies, the UK is now facing a severe and avoidable jobs crisis.

“Much of government support so far has come in the form of a tax cut, such as through VAT or an effective cut to employer payroll taxes through the Job Retention Bonus. But this has failed to target tax cuts where they are most needed – for the some of the lowest income families that get to keep just 25p for an extra £1 in earnings.

“Addressing these eye watering tax rates experienced precisely where increased hours, earnings and spending is needed most, should be an uncontroversial goal that both left and right can get behind. Fortunately, there are already quick and straightforward ways of achieving this, that could be pursued alongside deeper reform of Universal Credit and the establishment of a new minimum income guarantee.”

Contact

Becky Malone, becky.malone@neweconomics.org, 07925950654

Sofie Jenkinson, sofie.jenkinson@neweconomics.org, 07981023031

Notes

The New Economics Foundation is a charitable think tank. We are wholly independent of political parties and committed to being transparent about how we are funded.

NEF analysis is based on the IPPR Tax-benefit model using data from the Office for Budget Responsibility, Office for National Statistics and Department for Work and Pensions’ Family Resources Survey. All modelling is simulated in the 2021/​22 labour market, using projections for earnings, unemployment and other aggregates from the OBR’s core forecast scenario. The poverty threshold is defined as 60% of median income, after housing costs, with median incomes recalculated to take into account a given policy change. Poverty figures include adults and children and are rounded to the nearest 100,000. Costings are rounded to the nearest £100m. The National Living Wage (NLW) rate is defined at the 25+ rate for the 2021 – 22 financial year.

Upcoming work at NEF will call for a permanent replacement to Universal Credit to accompany its existing Minimum Income Guarantee policy. Together these proposals could address poverty and act as a springboard into employment. Read the report Building a Minimum Income Guarantee for the UK here: https://​newe​co​nom​ics​.org/​2​0​2​0​/​0​3​/​b​u​i​l​d​i​n​g​-​a​-​m​i​n​i​m​u​m​-​i​n​c​o​m​e​-​p​r​o​t​e​ction

In the examples given above:

• The single parent on Universal Credit has one child and receives no support for housing and works as a cleaner for 30 hours per week on minimum wage through PAYE.Their effective marginal tax rate is therefore 75%.
• The IT technician earns £35,000 per year through PAYE and does not receive Universal Credit. Their effective marginal tax rate is therefore 32% before taking into account pension contributions or any student loan repayments.
• The banker earns £200,000 per year through PAYE. Their effective marginal tax rate is therefore 47 before taking into account pension contributions or an student loan repayments.