Latest cut in universal credit will hold back the recovery for millions of low income working families

Millions of lower income working families will find it harder to keep up with the cost of living because changes to Universal Credit (UC) will shrink the amount of earnings they can keep and erode the incentive to work, according to new analysis published today (Friday) from the independent think-tank Resolution Foundation.

In his recent Autumn Statement, the Chancellor extended the freeze on work allowances – the amount people on UC can earn before their in-work support starts to be withdrawn – by another year so that the original 2013-14 cash levels will remain in place until April 2018.  This four-year freeze affects 3.3 million working families. All parties are in principle signed up to UC and none of them have pledged to reverse this cut.

In 2018, the first year work allowances are set to be increased since their introduction, an eligible couple with children would need to see their combined earnings rise by over £1,300 just to cancel out the loss in income due to the sustained freeze.

For a couple with a single earner working full time on the minimum wage, this £1,300 shortfall is the equivalent of their earnings rising around 10 per cent over and above that forecast by the OBR by 2018. It is likely therefore that couples in this situation will now be worse off year after year on Universal Credit, even if their wages rise in real terms over the next four years.

The size of the loss arising from freezing work allowances varies according to household circumstance – from £65 for those without children to as much as £430 for a single parent who owns her own home. The effects of the change will vary for different families:

• A couple with children would face a £315 hit in 2018 as a result of the work allowance changes. But because they only get to keep 24p of every £1 of any pay rise, they would need to see their combined earnings rise by £1,325 just to stand still, or by around 10 per cent more than the OBR pay forecast if working full-time at the minimum wage.
• A single parent would lose £430 as a result of the freeze. Their annual earnings would need to rise by £1,815 in order to stand still, or by 13 per cent more than expected if working full-time at the minimum wage.
• Single people without children are less affected. Those who qualify for UC receive a lower work allowance and are unlikely to be earning enough to pay income tax or NICs and therefore face a lower marginal tax rate. Avoiding the £65 loss implied by the work allowance change therefore requires a pay increase of £186, or 3 per cent over and above wage projections (for a part-time worker on the minimum wage).

Freezing work allowances imposes a cash penalty on UC recipients who already face high marginal tax rates. UC recipients earning above the personal tax allowance will lose 76p of every £1 extra of gross earnings in income tax, National Insurance Contributions and reduced UC entitlement. Such steep marginal tax rates are a common feature of in-work support mechanisms and apply at least as much (often more so) under today’s tax credit system as they will under UC.

However under UC, millions of households will also miss out on most of the gains from the income tax cuts proposed by the main parties, such as raising the personal allowance and introducing a new 10p tax band. Families will lose 65p of every £1 gained from these policies. RF has proposed that UC should be refined to ensure that the full value of tax-cuts are passed on to all working households.

Work allowances are a vital and widely supported part of UC that improve work incentives as they allow families to keep more of their initial earnings before their entitlement to UC is withdrawn. Failing to uprate the allowances since they were set in 2013 will impact on that incentive to enter work:

• A single parent who rents and earns at the minimum wage could have worked for 10 hours before having their benefits withdrawn, but the freeze in the work allowance means that by 2018 this will fall to 8 hours.
• A single parent who owns their own home and earns at the minimum wage could have worked for 27 hours before having benefits withdrawn, but this will fall to 23 hours by 2018.
• A couple with children who own their own home would findthe number of hours they could work at the minimum wage before their benefits were withdrawn would fall from 20 hours under 2013 values to 17 hours by 2018.
• There is little change for couples with children who rent or families without children as their work allowances are of lower value.

David Finch, Senior Economic Analyst at the Resolution Foundation, said:
“The ongoing freeze to the work allowance in Universal Credit is eroding one of the most desirable features of the policy before it even comes into existence. It’s poorly understood but it matters greatly and will make a major difference to the prospects of millions of hard-pressed households. They will be running just to stand still.

“It will be hard to convince low income families that Universal Credit really is making work pay if they see their disposable incomes fall year after year when moved onto the new system, even if they are receiving real terms earnings increases.

“No political party has pledged to reverse these cuts to the work allowance. And as things stand the tax cuts proposed by the main parties will do little to offset these losses as the majority of any gains are immediately withdrawn through lower benefits. As yet no leader has admitted that their tax-cuts won’t deliver for millions of working families on universal credit.”

Impact of freezing work allowances in each year from start of 2014/15 to end of 2017/18

*the single person is working 16 hours at NMW as they are likely to be working part-time if on UC