Professor Ashwin Kumar
Once it is fully rolled out, two in five Universal Credit recipients will face deduction rates of more than 55 per cent as their earnings rise. The perfect storm of overlapping Income Tax, National Insurance contributions and benefit withdrawal means that for these claimants, the effective hourly pay rate on the minimum wage is often as low as £3.71.
With such a low return on work, it is unreasonable to force claimants to work additional hours. The Department for Work and Pensions should abandon the previous government’s focus on requiring low-paid claimants to increase their hours and should instead work on giving low-paid workers the skills, confidence and childcare support to increase their hourly pay rate.
When Iain Duncan-Smith introduced Universal Credit in 2010, it was supposed to be a major simplification of work incentives in the tax and benefit system. In reality, however, it will leave us with an immensely complex system where few people face the headline ‘taper rate’ of 55 per cent. Because of interactions with Income Tax, National Insurance and Council Tax Reduction, effective withdrawal rates for many people will be higher and incentives will remain extremely confusing.
The taper rate – the speed with which benefit is withdrawn as incomes rise – was 63 per cent when Universal Credit was first introduced and was reduced over time by the Conservatives to 55 per cent. In replacing six previous benefits, the idea was that this single taper rate would simplify incentives and make it easier for claimants to understand how much of each extra pound of earnings would be kept. In reality, only a quarter of Universal Credit recipients actually face a deduction rate of 55 per cent.
The previous government had a policy to try to get very low-paid workers on Universal Credit to work more hours. Yet the reality is that most low-paid workers are also within the scope of Income Tax and National Insurance and so their effective deduction rate is 68 per cent. Forcing someone in this position to work more hours at the minimum wage means requiring them to work for an effective pay rate of £3.71 per hour. Supporting low-paid workers to increase their earnings must focus on helping people to increase their hourly rate of pay, not just their hours.
It would be pie-in-the-sky to suggest the new government undertake a redesign of the tax and benefit system – they’re still implementing the last one. But there are a number of more limited changes they can and should make. Given desperately poor effective pay rates, they should remove the power to sanction people already in work for not working enough hours. Compulsory student loan repayments should be deducted from income before calculating benefit entitlement to stop extremely high deduction rates for some graduates. The Scottish Government should redesign the Scottish Child Payment to remove the ‘cliff edge’ for people just above entitlement to Universal Credit. Finally, the Higher Income Child Benefit Charge should be replaced with a slightly higher top rate of tax so that parents don’t face higher effective tax rates than others.
Given the complexity that will remain with incentives in the tax and benefit system, it is inconceivable that most people will understand the actual incentives they face. Nor is it realistic to expect wholesale redesign of the system. But many smaller measures can improve the system we have.
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Once it is fully rolled out, two in five Universal Credit recipients will face deduction rates of more than 55 per cent as their earnings rise. The perfect storm of overlapping Income Tax, National Insurance contributions and benefit withdrawal means that for these claimants, the effective hourly pay rate on the minimum wage is often as low as £3.71.
With such a low return on work, it is unreasonable to force claimants to work additional hours. The Department for Work and Pensions should abandon the previous government’s focus on requiring low-paid claimants to increase their hours and should instead work on giving low-paid workers the skills, confidence and childcare support to increase their hourly pay rate.
When Iain Duncan-Smith introduced Universal Credit in 2010, it was supposed to be a major simplification of work incentives in the tax and benefit system. In reality, however, it will leave us with an immensely complex system where few people face the headline ‘taper rate’ of 55 per cent. Because of interactions with Income Tax, National Insurance and Council Tax Reduction, effective withdrawal rates for many people will be higher and incentives will remain extremely confusing.
The taper rate – the speed with which benefit is withdrawn as incomes rise – was 63 per cent when Universal Credit was first introduced and was reduced over time by the Conservatives to 55 per cent. In replacing six previous benefits, the idea was that this single taper rate would simplify incentives and make it easier for claimants to understand how much of each extra pound of earnings would be kept. In reality, only a quarter of Universal Credit recipients actually face a deduction rate of 55 per cent.
The previous government had a policy to try to get very low-paid workers on Universal Credit to work more hours. Yet the reality is that most low-paid workers are also within the scope of Income Tax and National Insurance and so their effective deduction rate is 68 per cent. Forcing someone in this position to work more hours at the minimum wage means requiring them to work for an effective pay rate of £3.71 per hour. Supporting low-paid workers to increase their earnings must focus on helping people to increase their hourly rate of pay, not just their hours.
It would be pie-in-the-sky to suggest the new government undertake a redesign of the tax and benefit system – they’re still implementing the last one. But there are a number of more limited changes they can and should make. Given desperately poor effective pay rates, they should remove the power to sanction people already in work for not working enough hours. Compulsory student loan repayments should be deducted from income before calculating benefit entitlement to stop extremely high deduction rates for some graduates. The Scottish Government should redesign the Scottish Child Payment to remove the ‘cliff edge’ for people just above entitlement to Universal Credit. Finally, the Higher Income Child Benefit Charge should be replaced with a slightly higher top rate of tax so that parents don’t face higher effective tax rates than others.
Given the complexity that will remain with incentives in the tax and benefit system, it is inconceivable that most people will understand the actual incentives they face. Nor is it realistic to expect wholesale redesign of the system. But many smaller measures can improve the system we have.
Read more