Tax Credits (Income Thresholds and Determination of Rates) Amendment Regulations Monday, 26 th October 2015

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1 Tax Credits (Income Thresholds and Determination of Rates) Amendment Regulations Monday, 26 th October 2015 About these regulations These regulations, introduce major reductions in support for low income working families. The regulations do three things: reduce the income thresholds in tax credits; increases the tax credit taper rate from 41% to 48%; and reduce the income rise disregard in tax credits. The regulations have been debated and passed in the House of Commons, they are expected to shortly be debated in the House of Lords. This briefing explores the impact of these measures on low income working families and their incentives to work. 1. Reducing the income thresholds in tax credits Income thresholds specify the amount of (gross) income that a household can keep before additional earnings begin to affect their tax credit entitlement. These thresholds are crucial in ensuring that work pays for low and middle income families. The income threshold for tax credits for working families is currently set at 6,420 per year, with earnings over this threshold deducted at a rate of 41p for each 1 earned above this threshold. In future, this threshold will be reduced to 3,850 per year a reduction of over 40%. Currently with the deduction of 41p in the 1, this reduced threshold will cost low income working families 1,054 per year. However, the Government also intends to increase the taper rate for tax credits, meaning that the cost of this reduction in the income threshold will be higher still. These measures will only affect working families, and will significantly reduce the incentive to work. Sally s family: Sally is a single parent with 2 children who is working and earning 10,000 per year. Currently she has an excess income of 3,580 over the level of her income threshold which is counted as income for the purposes of tax credits. At a withdrawal rate of 41%, this means she faces a deduction of 1,468 from her maximum tax credit entitlement. Following the introduction of the reduced threshold Sally s income will exceed her income threshold by 6,150, at an increased taper rate of 48%, she will now face a 2,952 deduction from her maximum tax credit entitlement. This is a reduction in entitlement of 1,484 per year as a consequence of the reduction in the tax credit income thresholds and increases in taper rates. Since these measures only affect working families, this measure will reduce the financial incentive for Sally to work by up to 1,484 per year. childrenssociety.org.uk Sam Royston October

2 2. Increases the Tax Credit taper rate from 41% to 48% Taper rates are the rate at which any additional earnings (over the level of income thresholds) reduce benefit entitlements. Currently increases in earnings over the income threshold reduce tax credit entitlements by 41p in every 1. These changes will increase this to 48p in every 1. Sally s case above indicates the impact of this on work incentives for tax credit recipients. Tax Credits are often received in combination with receipt of other benefits, and most working recipients also pay income tax. The combination of these deductions from earnings can lead to working recipients being left with very little money from each extra 1 they earn. Steve and Muna s family: Steve and Muna have 2 children, rent of 400 per month, and council tax of 110 per month. Steve works and earns 11,000 per year. Currently, for each additional 1 he earns: 32p would be lost through additional income tax and national insurance payments 41p would be deducted from their tax credit entitlement Of the remaining 27p, 85% would be deducted from housing benefit and council tax reduction entitlements. Muna and Steve keep 4p in the 1. Following the increased tax credit taper rates: 32p would still be lost through additional income tax and national insurance payments 48p would be deducted from their tax credit entitlement Of the remaining 20p, 85% would be deducted from Housing Benefit and Council Tax Benefit entitlements. Muna and Steve now keep just 3p in each extra 1 earned. If Muna and Steve do not receive Housing Benefit or Council Tax Reduction, their gains from additional earnings reduce from 27p in the 1, to 20p in the 1. Both reductions in income disregards and increases in taper rates for tax credits undermine the additional financial work incentives offered by the increase in the national minimum wage. For example, if a tax credit, housing benefit claimant moves from 30 hours per week on the current national minimum wage of 6.50 per hour, to the proposed higher rate of 9 per hour, then their gross earnings will increase from 195 per week to 270 per week (an increase of 75). However, from this, they may face the following deductions (assuming they remain below the relevant tax thresholds): Tax credits: 36 Housing benefit and council tax reduction: This leaves a remainder of just 5.85 per week that the family keep as a result of the pay increase - about 305 per year. While we welcome the increase in the national minimum wage, in order to make sure that low income families keep the additional pay received, the Government needs to increase income disregards in tax credits and work allowances in universal credit. These regulations, however, do the exact opposite, substantially reducing non-means tested earnings within the tax credits system. childrenssociety.org.uk Sam Royston October

3 3. Reducing the income rise disregard in tax credits When incomes for tax credit purposes rise from one year to the next, currently up to 5,000 of the increase is ignored for the purposes of calculating tax credit entitlements. So for example, if a claimant household has an income of 11,000 in 2011/12 and 13,000 in 2012/13, their income for tax credit purposes in 2012/13 will be 11,000. Assuming it remains at 13,000 in 2013/14, their income for tax credit purposes will rise of 13,000 that year. The principle purpose of this is to avoid overpayments caused by estimated income for the coming year being lower than finalised income at the year end. This measure also helps to provide additional support to those returning to work at key points of financial strain such as returning to work following maternity leave or illness. Emilie s family: Emilie is returning to work following maternity leave. Her actual gross income whilst on leave in 2014/15 is 9,000. Following her return to work her income in 2015/16 is expected to be 15,000. In 2015/16 her income for tax credit purposes will be 10,000 ( 15,000 minus 5,000 income rise disregard). However, following the introduction of this measure, someone in her situation would have an income for tax credit purposes of 12,500. Based on a tax credit taper rate of 48%, this measure will cost Emilie s family up to 1,200. This would come at a time shortly after the birth of her child, where additional income would be vitally important to support her baby as she returns to work. 4. To what extent does the increase in the personal tax allowance, the increase in the national minimum wage, and the extension of the childcare offer make up for the losses incurred from these changes? The Government has introduced a number of alternative measures which would improve the incomes of families also affected by the changes introduced through the tax credit amendment regulations. These include: i. An increase in the Personal Tax Allowance to 12,500 per year by 2020 The Personal Tax Allowance will rise by 1,900 to 12,500 by 2020 (and from to 11,000 between and ). At a 20% basic rate of income tax, the cash gain from this is up to 80 per year in , and 380 ( 7 per week) per earner by However, since Housing Benefit and Council Tax Reduction entitlements are calculated on the basis of net rather than gross income, and since net income increases as a result of reduced income tax payments, the gain for lower income working households (even where earning above the personal allowance threshold) is limited, as a result of consequent reductions in HB and CTR. At a 65% withdrawal rate for Housing Benefit and a 20% withdrawal rate for Council Tax Reduction entitlements, the actual overall cash gain from the 1900 tax allowance rise is likely to be as little as 57 per year for many families (just over 1 per week). For those in receipt of Universal Credit (also calculated on the basis of net income) the gain is likely to be around 133 per year ( 2 per week). childrenssociety.org.uk Sam Royston October

4 ii. An increase in the National Minimum Wage to 9 per hour by 2020 The Government s announcement that the National Minimum Wage would rise to 9 per hour by 2020 will provide a welcome increase in earnings for many families. However, as outlined on page 2 of this note, the gains from this are limited for those in receipt of benefits and tax credits are limited because of the high levels of deductions faced from receipt of other entitlements. In addition, only earners who would otherwise earn below 9 per hour in 2020 would gain from this measure. This is likely to be only a small proportion of the working families affected by the Tax Credit changes. iii. Extending entitlement to the three and four year old childcare offer The summer budget announced an extension of the 3 and 4 year old childcare offer from 15 hours per week to 30 hours per week for working families. This will provide much needed support for low income working families. Based on an average cost of around 69 per week for 15 hours of nursery care, and additional help for 38 weeks of the year, the entitlement is worth around 2600 per entitled child. However, households in receipt of Tax Credits, Housing Benefit, Council Tax Reduction, or Universal Credit, can already receive significant childcare support (currently up to 95% of childcare costs for households in receipt of Tax Credits, Housing Benefit and Council Tax Reduction.) As a result, although many families will get additional free entitlement, they will also see reduced entitlement to help with childcare through the benefits and tax credits system. For a family receiving support through HB, CTR and Tax Credits, the additional gain from the extra 15 hours could be worth around 117 per year. Based on 85% of childcare costs being covered through Universal Credit, the gain for a family in receipt of Universal Credit would be just under 400 per year. iv. Other measures reducing support for families However, these other measures need to be considered in the context of further changes to the benefits and tax credits system which will also affect the working families affected by the Tax Credit amendment regulations. Such changes include limiting the child element of Child Tax Credit and of Universal Credit to 2 children in a household, removal of the family element of Child Tax Credit, and freezing most benefit and tax credit entitlements for the coming four years. 5. The overall impact of the reforms 1. The impact on households in receipt of Housing Benefit The impact of the reforms is less for households in receipt of Housing Benefit (HB) and/or Council Tax Reduction (CTR). This is because Tax Credit receipt counts towards household income for the purposes of calculating HB/CTR entitlement, as a result reductions in Tax Credit entitlement lead to higher HB/CTR entitlement. The following example shows the impact of the tax credit reduction on a 2 child family in receipt of Housing Benefit. In the example given, the family not only receives increased HB entitlement childrenssociety.org.uk Sam Royston October

5 following the tax credit cut, but is also brought into entitlement for CTR support. The overall reduction in support is around 9 per week. Couple 2 children, 150 rent, 20 per week council tax, one earner working 35 hours per week, earning 350 per week. Tax Credits 115 Housing Benefit 73 Net earnings 297 Total 519 Comparative incomes after the Tax Credit reductions: Tax Credits 76 Housing Benefit 97 Council Tax Reduction 4 Net earnings 299 Total The impact on families on the minimum wage (and in receipt of HB/CTR) Couple 2 children, 60 rent, 18 per week council tax, one earner working 30 hours per week, earning 201 per week (NMW of 6.70 per hour) Tax Credits 176 Housing Benefit 9 Council Tax Reduction 2 Net earnings 195 Total 417 Comparative incomes after the Tax Credit reductions and NMW rise to 7.20 ph per week (including both gains from NMW rise and from income tax threshold rise): Tax Credits 141 Housing Benefit 24 Council Tax Reduction 7 Net earnings 208 Total 414 childrenssociety.org.uk Sam Royston October

6 3. The impact on households not in receipt of Housing Benefit The impact is considerably larger on families not in receipt of HB/CTR for example, families with lower rents and/or higher earnings. In the following case the 39 per week reduction in tax credit entitlement is retained in full costing the family in excess of 2000 over the course of the year. Couple 2 children, 60 rent, 15 per week council tax, one earner working 35 hours per week, earning 350 per week Tax Credits 115 Housing Benefit 0 Net earnings 297 Total 446 Comparative incomes after the Tax Credit reductions: Tax Credits 76 Housing Benefit 0 Net earnings 299 Total 409 For more information about this briefing, please contact Sam Royston, Director of Policy and Research on sam.royston@childrenssociety.org.uk or on , childrenssociety.org.uk Sam Royston October