Personal allowances won’t help most low income households. How could that money be better spent on Universal Credit?

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Budget 2014

George Osborne announced today that the personal tax allowance will be raised from £10,000 to £10,500 in April 2015. Based on the cost of last year’s increase, this will cost around £1 billion.

But as Policy in Practice will argue in its upcoming report Universal Credit: Towards an effective poverty reduction strategy, low income households do not see much benefit from this policy. Only about 30% of adults receiving Universal Credit will be working and earning enough to pay income tax, meaning that 70% of adults receiving Universal Credit will not benefit at all from an increase in the personal allowance.

The withdrawal of benefits based on net earnings also means that those 30% of UC claimants who would benefit (or those who receive Housing Benefit today) will see much less benefit from the policy than other taxpayers. The £500 increase in the personal tax allowance will mean a £100 increase in annual income for taxpayers not in receipt of these benefits. On the other hand, taxpayers in receipt of Universal Credit or Housing Benefit will only see a £35 increase in their annual take home income.

How else could that £1 billion be spent to help families receiving Universal Credit?

  • For £200k, you could extend 85% childcare support to all Universal Credit households without having to cut support elsewhere
  • For £500k, you could extend Free School Meals to all Universal Credit households without having to reduce the work allowance
  • For £1 billion, you could increase the UC household work allowance by £300 per year, increasing take home incomes for working families and increasing incentives to take up work
  • For £1 billion, you could lower the UC withdrawal rate to 61.7%, allowing households to keep more of their earnings

 

You could give UC families 85% childcare support without having to withdraw support elsewhere

The Government has announced in the Budget that all Universal Credit households will be eligible to receive an 85% childcare subsidy.

This will benefit around 60% of working UC households with children – 900,000 families – that would otherwise not have qualified for the higher level of support, as their earnings were below the income tax threshold. Commentators had argued that families that depend on formal childcare would otherwise not have see much financial gain from working more or would even pay to work.

The bad news is that the Government plans to pay for this by cutting Universal Credit support elsewhere. We will not know the details of this until the Autumn Statement 2014, but it is likely that work allowances (already frozen and declining in real terms) will be cut in order to pay for this policy.

This would mean that families may receive more support for their childcare costs, but their Universal Credit award for other elements would be reduced, so they might not see much of an increase in their take home income. This could also take support away from working families who do not rely on formal childcare.

Why does childcare support for low income families have to be paid for through cuts to Universal Credit elsewhere? The DWP have estimated that extending an 85% childcare subsidy to all Universal Credit households will cost £200 million.  For just a fifth of the cost of raising the personal tax allowance, the Government could extend 85% childcare support to Universal Credit families without having to cut support to low income households elsewhere.

 

You could give all UC families eligibility for Free School Meals

Free School Meals are a passported benefit and the introduction of Universal Credit means that the current system for administering them will have to change. While the Government has announced its plan to extend FSM to all children aged 5-7, the treatment of FSM for older children under Universal Credit is yet to be decided.

Many organisations, including Policy in Practice, have campaigned for Free School Meals to be extended to all families in receipt of Universal Credit.

The full cost of extending Free School Meals to all UC households is estimated to be £500 million. In our forthcoming report on Universal Credit, Policy in Practice finds that the cost could be lowered to as little as £100 million if working families paid a portion of the school meal through a reduced work allowance.

However, at just half the cost of increasing the personal tax threshold, the Government could extend Free School Meals to all families receiving Universal Credit without having to cut their support elsewhere.

 

You could increase the work allowance for all in-work households by £300 per year

The work allowance of Universal Credit is the amount a household can earn without losing any Universal Credit. Work allowances are much higher under Universal Credit than they are under the current benefit system, but as noted above, they have been frozen and will decline in real terms.

An increase in the work allowance would not only increase the take home incomes of working households, but also improve incentives to take up work. We find in our forthcoming report that this would help households escape poverty at a lower level of earnings.

Based on an approximate 3.3 million in-work households that will receive Universal Credit, we estimate that for the £1 billion pounds being spent to increase personal tax allowances, the Government could increase the work allowance by £300 per year. Working families on Universal Credit who earn above the current work allowance would see the full benefit of this policy, with a £300 boost in annual income. This is compared to the £35 boost they see from an increase in the personal allowance.

 

You could lower the UC withdrawal rate to 61.7%

The withdrawal rate of Universal Credit determines the rate at which benefits are withdrawn as earnings increase. It is currently set at 65% of net earnings, meaning households keep 35p for each pound of income earned after tax.

Lowering the withdrawal rate would allow households to keep more of their earnings, which would both increase the take home incomes of working families (earning above the work allowance) and improve work incentives.

The Government has previously estimated that the cost of reducing the withdrawal rate by 1% would be £300 million. This means that for the £1 billion pounds being spent to increase personal tax allowances, the Government could instead reduce the withdrawal rate to 61.7%.

This would benefit the 3.3 million working households who will receive Universal Credit. We estimate that households below the tax threshold would see a £33 gain in annual income for every £1,000 of earnings, and households above the tax threshold would see a £23 gain for every £1,000.

 

In conclusion, raising the personal tax allowance will not help many low income households because they either don’t pay tax or the withdrawal of benefits will mean they don’t see much of an increase in their income. The £1 billion spent on this policy could be better spent within Universal Credit to support low income households and help to tackle poverty.

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