Tax

Will future tax cuts reach struggling working households?

Donald Hirsch
Donald Hirsch

This briefing looks at how exactly tax cuts interact with Universal Credit and quantifies how little low to middle income working households will keep from a higher personal allowance or a 10p tax rate under UC. It also suggests a simple way in which the Government could ensure that the benefits of tax cuts do flow through to the pockets of the three million taxpayers who claim UC. Any party proposing tax cuts that does not adopt this or an equivalent policy cannot claim to be targeting low to middle income households by cutting taxes.

 

Key findings

  • As thoughts turn to the next general election, all parties are likely to set out some tax cutting plans for the next parliament. Already plans have been mooted for further increases in the personal allowance or for the re-introduction of a starting 10p rate of tax. Whatever one makes of these proposals it is important to appreciate that, as things stand, the government’s flagship welfare reform, Universal Credit, conflicts with these plans in terms of the help they will give low to middle income families. Because UC will operate on the basis of post-tax income, the vast majority – 65 per cent in most cases – of the benefits of any tax cut for UC claimants are returned immediately to the government in the form of lower UC support.
  • Fixing this problem requires that UC be adjusted by raising disregards each time the personal allowance is raised, or when a 10p tax band is introduced. To make sure low to middle income working households receive the full benefits of a tax cut, UC disregards would need to be raised by 20% of any increase in the personal allowance and by 10% of the width of any new 10p tax band. Any party proposing tax cuts that does not adopt this or an equivalent policy cannot claim to be helping low to middle income households by cutting taxes. This approach would of course make any tax cut more expensive. But it would also prevent tax cuts from benefiting only better off families.
  • This briefing note has also stepped back to look at the relative effectiveness of different forms of support for these households. It has shown that in boosting the position of working families on low to middle incomes, measures to improve Universal Credit provide far better value for money than reducing income tax through higher allowances or the introduction of a new starting-rate band. For example, raising the income level at which UC starts to be reduced (the “disregard”) could benefit a low to middle income working family on UC by around 15 times as much as an increase in the personal tax allowance costing the Exchequer the same amount.
  • To be clear, our conclusions do not mean that improvements in UC should always be preferred to tax cuts. Too much reliance on means-tested transfers to working families can stifle incentives to raise earnings by working longer hours, seeking training or negotiating wage increases. However, at a minimum, it is clear that future tax cuts will need to run alongside reforms to UC to make sure the families who are struggling the most receive as much benefit as everyone else.

Further reading

More, more, more
Putting the Autumn Budget 2024 decisions on tax, spending and borrowing into context
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Camron Aref-Adib, Mike Brewer, Molly Broome, Tom Clark, Alex Clegg, Nye Cominetti, Adam Corlett, Emily Fry, Sophie Hale, Lindsay Judge, Zachary Leather, Jonathan Marshall, Charlie McCurdy, Louise Murphy, Felicia Odamtten, Cara Pacitti, Simon Pittaway, Hannah Slaughter, James Smith, Greg Thwaites, Lalitha Try
Revenue and reform
What tax changes could – and should – we see in Autumn Budget 2024?
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Adam Corlett
Growing for gold?
Analysing the tax and spend package of the 2024 Labour Manifesto
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Molly Broome, Nye Cominetti, Emily Fry, Tara Goatley, Charlie McCurdy, Simon Pittaway, Hannah Slaughter, James Smith, Lalitha Try
Donald Hirsch
Donald Hirsch