House of Lords demand delay to Chancellor’s tax credit changes

12 Nov 2015

A tough decision awaits George Osborne as a defeat in the House of Lords imposes a delay to £4.4bn worth of tax credit cuts.

On 26th October the House of Lords voted to delay the tax credit reforms expressing unease with the impact of the cuts on low income working families. The Lords have asked that the Government provide full transitional protection from the cuts for at least 3 years and for the cuts to be put on hold pending an independent analysis report on the expected impact of the cuts.

The biggest cuts since 1945, the tax credit reform announced by the Chancellor in the Summer Budget was set to effect more than 3 million working families. The proposal would have seen an average loss for a family on tax credits lose £1,350 a year.

What is Tax Credit?

Tax credit is a means tested benefit designed for people on low-incomes.  There are two elements: Working Tax Credit and Child Tax Credit

  • Working Tax Credit: It tops up the wages of workers on low-income
  • Child Tax Credit: These are benefits payable to parents with a child under 18; or 20 if they are in education

What are the proposed changes to tax credit?

Working Tax Credit

  • From April 2016 the income threshold for working tax credits will go down from £6,420 to £3,850
  • The taper rates will increase from 41% to 48%, meaning once your tax credits would be reduced by 48 percent of any earnings above £3850

Child Tax Credit

  • The Family element, worth £545 per year, will be removed for new claimants from 2017
  • Families will only be able to claim for two children from April 2017, currently the child element is worth up to £2,780 a year per child

These changes are part of the government’s economic strategy and vision for the country as a ‘high wage, low tax, low welfare state’. The government stated that any losses experienced as a result of the tax credit reform would be offset by other measures.  These include: increases in the Personal Allowance (which will increase to £11,000 by 2017), higher wages from the introduction of a National Living Wage (rising to £9 by 2020), and a rise in free childcare for 3-4 year olds (rising from 15 to 30 hours) in families where all families work.

Detailed analysis from the Resolution Foundation, however, finds that any gains made from the Personal Allowance and National Living Wage would only reduce the average loss from £1300 to £1100.  The Institute for Fiscal Studies calculated that only around 13% (£150 per year) of losses will be offset by the NLW on average.  The households that would gain the most from the NLW are not the households losing the most from tax and benefit changes.  In other words, there is little overlap between the tax credit population and those that stand to gain from these other reforms. If looking at it in terms of winners and losers, a single parent working part-time on minimum wage (which makes up the majority of tax credit recipients) could expect to lose at least £1000 a year.  These recipients are also more likely to be lone parents and female.  A Couple with no children, working full-time, and on higher wages will be £350 better off on average as they currently have no Tax Credit entitlement and gain in full from the NLW and personal allowance increases

Tax credit changes coupled with other welfare reforms announced in the Summer Budget, such as the reduction in Universal Credit’s work allowance, create perverse work incentives, especially for lone parents.  The Resolution Foundation calculated that before the summer budget, a lone-parent earning minimum wage would increase their earnings by £89 if they were to increase their work from 10 to 22 hours a week.  In the post-summer budget however, the same circumstances would only see additional earnings of £36 a week.  When Universal Credit eventually replaces tax credits, some recipients may find little incentive to earn beyond the work allowance.

What are the alternatives?

In their analysis of the tax credit changes, the Resolution Foundation also explored a number of remedies for alleviating some of the impact of the cuts. They explored a number of options which included:

  • Restoring the income threshold to £6,420
  • Offset the costs to households by bringing forward minimum wage rises and tax cuts to their full 2020 amount
  • Apply cuts to new claimants only
  • Restoring the taper rate to 41%
  • Offset costs from within Universal credit by increasing the taper applied to Work Allowance

These suggestions, however, would only mitigate losses in the short term, and in the long term 2.7 million recipients would still face a £1,000 drop in income by 2020.  Equally, these suggestions would not restore any of the lost incentives to work or progress while in work.  The Summer Budget cuts suggest a bias towards cutting the deficit at the expense of supporting incomes and boosting work incentives.

The Resolution Foundation proposes 5 ways to reduce the deficit without making the cuts:

  • Restoring tax reliefs to their 2010-2011 levels – this would raise £10 billion
  • Recovering over-indexation of pension – this would raise £6 billion
  • Reversing £12.5k Personal Tax Allowance pledge – this would raise £4.9 billion
  • Reversing the increase in the inheritance tax threshold and cuts to corporation tax will save £3.4 billion
  • Reversing the pledge to raise higher rate tax threshold from £41,900 to £50,000 will save £1.3 billion.

The Chancellor has said ‘I believe we can achieve the same goal of reforming tax credits, saving the money we need to save to secure our economy, while at the same time helping in the transition.. I’m determined to deliver that lower welfare economy the British people want to see.”

The ambition of reducing the welfare budget by £4.4billion leaves only very narrow room for the Chancellor to manoeuvre.  All eyes are on George Osbourne to see whether he listens to the concerns raised by Peers and is able to reverse the damage to hard working families.