Householders who get the new means-tested benefit called Universal Credit could keep just 19p of every pound extra they earn – an effective tax rate of 81%. In some parts of England it could be more - losing 83p in every pound that is earned, leaving them with 17p for every extra pound they earn. Those losses are similar to many under the present system and could undermine the work incentives which the new system is designed to create.
Universal credit
Universal Credit will be rolled out from October 2013 to replace six means-tested benefits and tax credits. It will be paid to people on low incomes who cannot work, are looking for work, or work on very low pay.
It is supposed to let people keep more of what they earn and thus boost incentives both to return to work and to earn more once in work. For every £1 extra earned the credit will be reduced by 65p allowing the claimant to keep 35p. This so called ‘withdrawal rate’ of 65p in the pound is said to be much lower than rates under the present system and allowing them to keep 35p of what they earn is seen as an incentive to work. The Government says that is a big improvement on the current system where a combination of different rules and tapers can lead to individuals losing more than more than 90p in the pound if they pay tax and their means-tested benefits are cut.
However, that figure of 65p withdrawal rate is only accurate for people who earn less than £146 a week and are not householders.
Taxpayers
Universal Credit is worked out after tax and National Insurance have been deducted. In 2012/13 anyone earning more than £146 a week will pay National Insurance and once they earn £177 a week income tax begins. Someone paying National Insurance will lose 12p in the pound before their Universal Credit is worked out. The total loss from NI and reduction in Universal Credit is 69p from each £1 they earn. So they keep 31p. If they pay income tax as well they lose just over 76p of each pound and keep just under 24p. Those figures were confirmed by Pensions Minister Steve Webb in Parliament just last week. (Hansard, House of Commons, 11 September 2012, col.196).
But that is only part of the picture.
Householders
Universal Credit, despite its name, does not replace all means-tested benefits. It does not include the means-tested reduction in council tax called Council Tax Benefit. From April 2013 that benefit will be replaced by a very similar scheme called Council Tax Support which will be operated by local councils. Like all means-tested benefits Council Tax Support will be withdrawn as income rises. The standard taper is 20p for each £1 rise in net income (after tax, NI and Universal Credit). In other words for each extra pound of net income help with council tax is reduced by 20p. The result is that for each £1 earned a total of 81p disappears in tax, NI, reduced Universal Credit, and reduced Council Tax Support. The calculation is at the foot of this blogpost.
Localism
In some areas of England and Wales the reduction in income earned may be even higher. As part of the transfer to local councils the Government will cut the money it currently pays to support help with council tax. From April 2013 councils will get 90% of the money they currently get to pay Council Tax Benefit. The Government has already said that out of that reduced budget they will have to pay exactly the same benefit to anyone over pension age. Nearly half of all Council Tax Benefit recipients are pensioners so the other half – working age people who can claim Universal Credit – will bear the whole of the funding cut. That will mean a reduction for them of between 19% and 33% according to the Institute for Fiscal Studies (www.ifs.org.uk/comms/comm123.pdf chapter 5).
Councils are currently consulting on the changes they will make in the scheme to save money. Most of the plans are still unpublished. Of those that are published most are keeping the taper at 20%. But six so far have decided to save money by increasing the taper from 20%. Four do not say how much – though the minimum rise worth implementing is likely to be 25%. One, Milton Keynes, is looking at a figure between 20% and 30%. And Trafford in Manchester is proposing to raise the taper to 30%. Only one, Brentwood in Essex, is proposing to cut the taper to 15%. (See Localising Council Tax Support by Peter Kenway, New Policy Institute www.npi.org.uk/files/New%20Policy%20Institute/LocalisingCouncilTaxSupport.pdf
In areas which raise the Council Tax Support taper to 25% householders on Universal Credit who pay tax will find that 82p of each pound earned disappears in deductions. In areas with a 30% taper they will lose 83p and keep just 17p for each pound earned. The rest will go in income tax, National Insurance, reduced Universal Credit and reduced Council Tax Support.
Conclusion
Losing more than 80% of each extra pound you earn is hardly an incentive to work or to work harder.
You can read the 11 September parliamentary debate on Universal Credit here
CALCULATION OF TOTAL DEDUCTIONS FOR A TAXPAYER HOUSEHOLDER
FOR EACH £1 OF EXTRA INCOME
| EARNS EXTRA | £1.00 | |
| Tax | 20% | -£0.20 |
| NI | 12% | -£0.12 |
| Net after tax | £0.68 | |
| UC reduction | 65% | -£0.44 |
| Net after UC | £0.24 | |
| CTS reduction | 20% | -£0.05 |
| NET GAIN | £0.19 | |
| Effective 'tax' | 81% |
An earlier version of this blog post contained an error in the calculation. My apologies.
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