Tax credits: government should pause reforms

11 November 2015

In a unanimous cross-party report, the Work and Pensions Committee says in the absence of any satisfactory mitigation of tax credit cuts, the Government should pause for a year and plan for a major overhaul of the tax credit system.

According to the report, the measures the Government has so far cited in mitigation of tax credit cuts will simply not reach many of those worst affected, and the benefits for those who would be helped are "dwarfed" by the cuts. As things stand the majority of families affected will still be worse off by 2020-21.

Committee findings

The Committee finds that:

  • Increases in the income tax personal allowance and the National Living Wage "should not be confused with compensation for tax credit cuts." An individual will only start to pay income tax when they earn more than £11,000, but will start to lose tax credits if their combined household earns as little as £3,850. At best, half of families facing tax credit cuts will benefit from the personal allowance increase.
  • A single earner with 2 children working 35 hours will increase their net income by £323 pounds a year under the National Living Wage, but will lose £1,701 in tax credit cuts, leaving the family £1,378 worse off overall.
  • Only about one third of those affected by the tax credit cuts would anyway benefit from the increase in the National Living Wage, even by the time of its full implementation in 2020/21.
  • By 2020-21, 78% of affected families will be on average £1,500 worse off in real terms as a consequence of the proposed cuts, the personal allowance increases and the National Living Wage combined.
  • The increased taper rate of 48% under the tax credit cuts combined with income tax, national insurance (NI) and implications for housing benefit mean that many individuals would keep just 7p of every additional £1 in earnings: a marginal deduction rate of 93%. This runs directly against the Government’s objective of making work pay.
  • A "raid" on Universal Credit as a means of covering adjustments to the tax credit plans would either just shift the burden of cuts to different low income families, or further undermine the objective of making work pay by removing a higher share of earned income.
  • The Treasury has been unacceptably evasive in failing to provide data about the effects of its Summer Budget measures on different income groups: obfuscation is not consistent with effective scrutiny or effective policy-making.
  • The Government is reaching the limits of cuts that can be made to the working-age welfare system, and particularly on the "strivers". At the same time, spending on pensioner benefits will continue to rise sharply and, arguably, unsustainably. The Committee intends to investigate the generational balance of welfare expenditure over the course of this Parliament, and consider radical reform of the welfare system in the round.

Committee comments

Frank Field MP, Chair of the Committee said:

"No one has been able to provide the Committee with a satisfactory series of mitigating policies to combat the impact of cuts in tax credits next year. My advice to the Chancellor would be to pause and use the next 18 months to bring forward a major overhaul to abolish tax credits as we know them. A new system could come in fully by 2020 when the Chancellor’s National Living Wage will be paying a wage of £16,000 per year. This would allow him to question whether a reformed tax credit system shouldn’t be remodelled to help only lower earning families with children."

Heidi Allen MP, Committee Member said:

"The Government now has an opportunity to rethink its approach to tax credits and find a solution that does not impact so severely those on low pay. To maintain the economic growth we have worked so hard to achieve, it is vital that we keep everyone working. We are at a critical point in our recovery and this would be jeopardised if we returned to the bad old days of being "better off out of work." I know there are no easy answers, but I sense the majority of people in this country would back the Chancellor if he revisited other possible areas of savings; budget surplus levels or Inheritance tax thresholds for example. We talk so often about "all being in this together": now is the time to put that mantra into action."

Further information

Image: iStockphoto

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