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1. The tax credit crunch How to limit the losses for low-income families David Finch 5 November 2015 @resfoundation @davidfinchrf 2. 2 SUMMER BUDGET IMPACT I The effect…
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  • 1. The tax credit crunch How to limit the losses for low-income families David Finch 5 November 2015 @resfoundation @davidfinchrf
  • 2. 2 SUMMER BUDGET IMPACT I The effect of changes in 2016 on incomes
  • 3. Key boosts to income • Raising the wage floor – Introduction of a ‘national living wage’ for over-24s (50p minimum wage supplement) • Tax cuts: – Personal allowance increase to £11,000 – Increase in the higher rate threshold to £43,000 Summer Budget contained good news and bad news from April 2016 3
  • 4. Key cuts to income • Tax credits – Reduction in income threshold (from £6,420 to £3,850) – Increase in taper (from 41% to 48%) • More widely: – Freeze to benefits (limited impact in April because counterfactual inflation is so low) – Benefit cap reduced (overall limited impact) Summer Budget contained good news and bad news from April 2016 4
  • 5. The gains are spread relatively evenly across the distribution In combination, raising the wage floor and cutting taxes have positive impacts across the distribution The main NLW gains are made in the middle of the distribution because low earners do not necessarily live in low income households 5 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 6. But losses from reducing the tax credit threshold are highly concentrated Of the cuts due in April, reducing the income threshold for tax credits has the biggest impact, with the effects felt most acutely among low and middle income households This produces a straight income shock for all tax credit recipients of up to £1,050 6 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 7. As are losses associated with increasing the tax credit taper Increasing the tax credit taper produces a further drag on income in the bottom half of the income distribution The reduction in the income threshold makes the taper cut more regressive as it applies to a greater span of income 7 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 8. Producing a highly regressive impact on incomes overall Overall, the even spread of gains and the concentration of cuts means that significant losses in the bottom half of the income distribution contrast with modest gains in the top half 8 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 9. Overall, around 3.3m working households will lose an average of £1,100 in April 2016 9 • 3.3 million working households will face an average drop in tax credit income of £1,300 • Including gains from the personal allowance and national living wage reduces this net average loss to £1,100 • These changes will push around 100,000 working households, and 200,000 children in working households, into poverty in 2016
  • 10. With actual impacts in 2016 varying by family circumstance 10 Source: Resolution Foundation analysis using the RF microsimulation model Notes: Full-time earners are working 37.5 hours a week, the part-time earner works 20 hours a week. The NMW is assumed to be £6.70 until October 2016 at which point it rises to £6.95, in line with OBR projections for earnings growth. Estimates shown provide an annual average. Families shown have no housing or childcare costs. Gross earnings Net earnings Net income Gross earnings Net earnings Net income Gross earnings Net earnings Net income Single parent with 1 child FT @ minwage 13,350£ 12,200£ 17,610£ £14,080 £12,740 £16,080 +£390 +£390 -£860 Single-earner couple with 2 children FT @ min wage 13,350£ £12,430 £20,290 £14,080 £12,970 £18,980 +£730 +£540 -£1,310 Dual-earner couple with 2 children One FT @ £8ph; one PT @ min wage 22,760£ £20,880 £25,610 £23,150 £21,320 £23,480 +£390 +£430 -£2,130 Dual-earner couple without children Both FT @ NMW 26,690£ £24,420 £24,420 £28,160 £25,500 £25,500 +£1,470 +£650 +£650 2016 pre-Summer Budget 2016 post-Summer BudgetSelected case studies in April 2016 before and after Summer Budget changes Change
  • 11. 11 SUMMER BUDGET IMPACT II The effect of changes in 2016 on incentives
  • 12. Existing tax credit system creates incentives and disincentives Provision of working tax credit when working specified number of hours (16 for a single parent; 24 for someone in a couple; boost at 30) incentivises working at certain points But high marginal deduction rate tends to dis- incentivise working longer 12 Source: Resolution Foundation analysis using the RF microsimulation model
  • 13. Summer Budget changes will reduce the incentive to enter or progress at work The combined cuts (taper & income threshold) reduce the gain from starting work by up to £1,250 Raising the taper to 48% increases the already high marginal deduction rate making progression less attractive – other than for those being taken out of tax credits altogether 13 Source: Resolution Foundation analysis using the RF microsimulation model
  • 14. 14 OFFSETTING THE LOSSES Can we compensate the tax credit losers outside of the benefit system?
  • 15. Options for offsetting the losses: Bringing forward minimum wage rises and tax cuts 15 The increase to the personal allowance and NLW reduce gross tax credit losses on average by £200 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 16. Options for offsetting the losses: Bringing forward minimum wage rises and tax cuts 16 The increase to the personal allowance and NLW reduce gross tax credit losses on average by £200 A higher NLW in 2016 would do little to offset losses Increasing the PTA to £12,500 (cost of ~£9bn if done straight away) still leaves working families on average £900 a year worse off Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 17. Options for offsetting the losses: Bringing forward minimum wage rises and tax cuts 17 The increase to the personal allowance and NLW reduce gross tax credit losses on average by £200 A higher NLW in 2016 would do little to offset losses Increasing the PTA to £12,500 (cost of ~£9bn if done straight away) still leaves working families on average £900 a year worse off Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 18. Options for offsetting the losses: Boosting childcare support 18 30 hours free childcare • Only helps workers with a 3 or 4 year old, with full introduction not due until September 2017 • Less than 10% of Tax Credit families have a child under 5 & claim childcare support • Tax Credit families already receive support with 70% of costs Additional support in Tax Credits • Childcare support in UC is set to be raised to cover 85% of costs (originally due in April 2016 but now delayed) • Introducing this in the Tax Credit system in 2016 would cost around £500m, help 400k families and be beneficial
  • 19. Options for offsetting the losses: Boosting childcare support 19 30 hours free childcare • Only helps workers with a 3 or 4 year old, with full introduction not due until September 2017 • Less than 10% of Tax Credit families have a child under 5 & claim childcare support • Tax Credit families already receive support with 70% of costs Additional support in Tax Credits • Childcare support in UC is set to be raised to cover 85% of costs (originally due in April 2016 but now delayed) • Introducing this in the Tax Credit system in 2016 would cost around £500m and help just 400k families
  • 20. • Making changes outside of the welfare system doesn’t work – Lack of overlap between the tax credit population and those who benefit from raising the wage floor, cutting tax or boosting childcare support – Potential ‘solutions’ can’t provide enough compensation 20 Options for offsetting the losses: Conclusion
  • 21. 21 DELAYING THE IMPACT Limiting the overnight losses
  • 22. Phasing: Slowing the pace of tax credit cuts would mitigate losses in the short-term 22 • Phasing-in the changes would provide more opportunity for recipients’ incomes to rise due to: – real-wage gains – income tax cuts – the rising wage floor • Phasing would reduce the overnight losses faced in 2016, but would also reduce cumulative government savings • And, whatever the trajectory, we expect at least 2.7m families to be worse off by an average of £1,000 in 2020 (comparing pre- and post-Budget measures in 2020 in a UC steady state)
  • 23. Phasing: Current plans imply big overnight losses in April 2016 23 3.1 million of the 3.3 million tax credit recipients are set to have their net income reduced in April 2016 Spike at relatively small level of losses, but significant numbers losing more than £1,500 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 24. Phasing: But delaying the final outcome by one year makes very little difference 24 Even after allowing for wage growth, tax cuts and a rise in the national living wage, outcomes in 2017 look little altered In part this is due to the high taper rate reducing gains from wage growth And the benefit freeze offsetting income gains Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 25. Phasing: Even a two-year delay only reduces the number of losers by 200,000 25 Very marginal improvements by 2018, with an increase in those losing more than £2,250 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 26. Phasing: Reaching the planned level of cuts in 2019 still leaves 2.8m worse off 26 The tail of big losers grows still further in 2019 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 27. Phasing: Even phasing to 2020 will not result in losses being compensated in a meaningful way 27 Delaying full implementation of the tax credit cuts to 2020 – thereby allowing four years of wage growth - would still result in 2.6 million losers, facing an average drop in income relative to their 2015 level of £1,500 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 28. Phasing: Even adding in the ambition of a £12.5k personal allowance makes little difference 28 The personal allowance is set to be around £11.8k by 2020 Raising it to £12.5k will have sizeable benefits for dual earner taxpayers, but much less (or zero) benefit for single earners and for those on the lowest earnings who don’t pay tax Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 29. Phasing: Even adding in the ambition of a £12.5k personal allowance makes little difference 29 The personal allowance is set to be around £11.8k by 2020 Raising it to £12.5k will have sizeable benefits for dual earner taxpayers, but much less (or zero) benefit for single earners and for those on the lowest earnings who don’t pay tax Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 30. 30 TRANSITIONAL PROTECTION Applying the cuts to new claimants only
  • 31. Transition: Applying only to new claims will greatly reduce the number of losers 31 Transitional protection for existing recipients can significantly limit the overall scale of losses in a given year • Only around 300,000 families a year make new claims
  • 32. Transition: But also reduces savings and therefore effects the government’s fiscal targets 32 • Savings are significantly reduced with implications for the government’s deficit and debt targets Savings to 2020 from income thresholds and the taper, £ millions, cash Source: Resolution Foundation analysis & Summer Budget policy costings document Notes: Pace of transition and number of new claims is based on the impact of restricting the family element to new claims from 2017 2016 2017 2018 2019 2020 Planned cuts 4,400 4,100 3,800 3,700 3,700 Transitional approach 400 700 900 1,100 1,400
  • 33. Transition: Work incentives in UC still weakened & creates perverse incentives stay onTax Credits 33 • Also leaves work incentives in Universal Credit much weaker than under pre-Summer Budget plans (thanks to big reduction in the work allowances) • And leads to perverse incentives for families to not change their circumstances in case they lose tax credit entitlement
  • 34. Transition: UC work incentives weakened & creates perverse incentive to stay onTax Credits 34 • Also leaves work incentives in Universal Credit much weaker than under pre-Summer Budget plans (thanks to big reduction in the work allowances) • And leads to perverse incentives for families to not change their circumstances in case they lose tax credit entitlement
  • 35. 35 REFORMING THE REFORMS Mitigating the impacts by directly amending the tax credit changes
  • 36. Options for reform need to balance three (often competing) demands Summer Budget changes are firmly skewed towards saving money at the expense of supporting incomes and boosting work incentives All other options need to be assessed against the same criteria 36
  • 37. Reforming the reforms: 1) Prioritising restoration of the income threshold Restoring the £6,420 income threshold mitigates losses, with the greatest protection flowing to lower income tax credit recipients Incentives to progress at work (or enter at higher hours) will still be damaged Savings will be reduced 37 Source: Resolution Foundation analysis using the RF microsimulation model
  • 38. Source: Resolution Foundation analysis using the RF microsimulation model Reforming the reforms: 1) Prioritising restoration of the income threshold Restoring the £6,420 income threshold mitigates losses, with the greatest protection flowing to lower income tax credit recipients Incentives to progress at work (or enter at higher hours) will still be damaged Savings will be reduced 38
  • 39. Reforming the reforms: 2) Prioritising restoration of the taper rate Restoring the 41% taper mitigates losses slightly, but with the greatest protection flowing to higher income tax credit recipients. Those on the lowest incomes will face very little difference Incentives to progress at work (or enter at higher hours) will be improved (though still weak), but short-term savings will be reduced 39 Source: Resolution Foundation analysis using the RF microsimulation model
  • 40. Source: Resolution Foundation analysis using the RF microsimulation model Reforming the reforms: 2) Prioritising restoration of the taper rate Restoring the 41% taper mitigates losses slightly, but with the greatest protection flowing to higher income tax credit recipients. Those on the lowest incomes will face very little difference Incentives to progress at work (or enter at higher hours) will be improved (though still weak), but short-term savings will be reduced 40
  • 41. Reforming the reforms: 3) Offsetting the cost within the tax credit system The threshold cut is the key driver of reducing incomes and damaging incentives to enter work But, paying for its restoration by raising the taper rate results in marginal deduction rates of close to 100% for large parts of the population And would not cover the full cost to restore the threshold 41 Source: Resolution Foundation analysis using the RF microsimulation model
  • 42. Source: Resolution Foundation analysis using the RF microsimulation model Reforming the reforms: 3) Offsetting the cost within the tax credit system The threshold cut is the key driver of reducing incomes and damaging incentives to enter work But, paying for its restoration by raising the taper rate results in marginal deduction rates of close to 100% for large parts of the population And would not cover the full cost to restore the threshold 42
  • 43. Reforming the reforms: 4) Universal Credit – work incentives are undermined by the Summer Budget measures The large reductions to the UC work allowances announced at Summer Budget significantly weaken incentives to work Single parents and second earners may become trapped at low earnings with little return to earning beyond the work allowance 43 Source: Resolution Foundation analysis using the RF microsimulation model
  • 44. Reforming the reforms: 4) Universal Credit – offsetting the cost from within Universal Credit Increasing the taper to 70% would allow around half of the work allowance cut to be restored But lead to an 80% marginal deduction rate when paying tax , reducing incentives to progress The incentive to earn no more than the work allowance would be reinforced 44 Source: Resolution Foundation analysis using the RF microsimulation model
  • 45. Reforming the reforms: 4) Universal Credit – offsetting the cost from within Universal Credit Increasing the taper to 70% would allow around half of the work allowance cut to be restored But lead to an 80% marginal deduction rate when paying tax , reducing incentives to progress The incentive to earn no more than the work allowance would be reinforced 45 Source: Resolution Foundation analysis using the RF microsimulation model
  • 46. • Efforts to restore the income threshold appear more progressive than those which focus on the taper • But, pushing the taper higher in tax credits to pay for restoring the income threshold pushes marginal deduction rates too high • More scope in UC to increase the taper but the higher overall marginal deduction rate created fundamentally damages work incentives 46 Reforming the reforms: Conclusion
  • 47. 47 REVERSING THE CUTS Options for raising equivalent funds
  • 48. Sourcing new funds to reverse the cuts can be met from within existing fiscal plans The tax credit threshold and taper savings amount to around £3.6bn in April 2016 Equivalent amounts could be achieved in any number of ways. For example, cancelling income tax pledges would raise £6.2bn The Chancellor could also choose to reduce the near- £12bn surplus in 2020 48 Source: Summer Budget policy costings, Resolution Foundation analysis using the IPPR tax-benefit model & author’s calculations
  • 49. Cancelling the proposed tax cuts reverses a very regressive policy Further cuts to income tax will see four-fifths of the gains going to the top half of the income distribution Savings over and above those needed to reverse tax credit cuts could be better utilised by increasing the NI threshold 49 Source: Resolution Foundation analysis using the IPPR tax-benefit model
  • 50. 50 DEALING WITH THE CRUNCH Some concluding thoughts
  • 51. • Policies on tax, the minimum wage and childcare will make very little difference to the typical tax credit losses faced by families next April • Phasing-in the changes will reduce the overnight income shock, but make no difference to the final outcome, with 2.6m households still worse off in 2020 relative to 2016 pre-Summer Budget • Transitioning would protect existing recipients, but results in a much slower build up of savings. It also creates a perverse incentive to remain on tax credits and fundamentally damages incentives in UC • Funding to reverse the cuts can be secured in a variety of ways. Using funds earmarked for future tax cuts to reverse the tax credit cuts would be both progressive and good for incentives There are no simple – or free – solutions to the tax credit problem 51
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