Universal Credit set to support more people into work – but could result in more subsidised short hours working

Universal Credit (UC) will increase financial incentives for benefit recipients to enter work but could also make it more attractive for some to work short hours, according to a new report published today by the independent think-tank the Resolution Foundation.

Credit where it’s due? – the interim report of the Resolution Foundation’s major inquiry into UC – is the first in-depth examination of how UC could affect the work choices of over eight million families as it is rolled out over the course of the next parliament.

The report argues that UC will boost work incentives for some via the introduction of ‘work allowances’ – which will allow individuals to keep their full benefit entitlement when they enter work, up to a specified earnings limit. This is in contrast to the current system in which individuals have little incentive to find a job with only a small number of hours because they lose benefits pound for pound as their earnings grow.

While work allowances should help boost employment, especially among those who want to work a small number of hours, the potential gains won’t apply evenly to all groups. And weak incentives to earn more once work allowances have been used up also bring significant new risks. The report argues that some people may opt to work fewer hours, at a substantial cost to the state.

UC recipients who get help towards their rental costs will find that their work allowance runs out at very low hours of work – no more than nine hours at the minimum wage (NMW). After this point, they will only keep a maximum of 35 pence of each extra £1 they earn, falling to 24 pence once they’re paying income tax and National Insurance. This both reduces the incentive to earn more and cushions the impact of cutting their hours of work, with up to 76 pence of every £1 of reduced earnings made up through higher benefits (and lower tax payments).

The report suggests it is possible that some groups – such as single parents, who historically have been relatively responsive to financial incentives – could reduce their working hours under UC.  Single parents currently need to work at least 16 hours a week to qualify for extra state support, with one in five (100,000) working single parents who rent doing these exact hours.

But under UC, a single parent with rental costs earning £7.50 an hour who halved their hours to eight hours a week, would only see their disposable income fall by £21 (or five per cent), as their UC support would automatically increase by £39 per week.

The report also highlights incentives for short-hours working for over one million workers without children, many of whom will be entitled to in-work benefits for the first time. Currently, those who work less than 30 hours or who are aged under 25 aren’t eligible for tax credits. Under UC they will become entitled to new support for part-time working.

For instance, a full-time worker without children on the minimum wage (NMW) and who rents, could work one fewer eight-hour shift a week and see their disposable income drop by just £12 (or five per cent) – as lower tax payments and increased UC support offset £40 of their drop in earnings.

The report estimates that around 300,000 workers without children, earning at or near the NMW, will eventually be in receipt of UC.

Given that most individuals without children have had little interaction with the in-work benefit system to date, the report argues it is very hard to gauge how they will respond. However, in an environment of severe cuts to working-age welfare (including UC), the report questions whether extending new support for part-time working to non-disabled adults without children is the best use of scarce resources.

In order to counter the potential risk of short-hours working, the government is introducing a new system of ‘in-work conditionality’ alongside UC that could include sanctions for those not taking the necessary steps to boost their earnings. But the system is untried and untested, says the Resolution Foundation, so it is unclear how much impact it will have.

The report supports the principle of integration of six benefits into one in UC. This should simplify the claims process for recipients and is likely to prove to be the greatest improvement of all the UC reforms over the current system. However, it cautions against overstating its simplicity. Crucially, the exclusion of Council Tax Support from the new system means many households will still need to make multiple benefit applications and face punitive marginal tax rates as they earn more.

The Resolution Foundation’s expert panel will set out detailed policy options for improving UC in its final report, due to be published after the election.

David Finch, Senior Economic Analyst at the Resolution Foundation, said:

“Universal Credit could have a major effect on the labour market as it’s rolled out. By letting out-of-work recipients keep their benefits as they enter work, many thousands more people are likely to be encouraged to find work.

“But this brings with it potential risks. Those brought into the labour market might find themselves stuck in low hours of work, with little financial gain to be had from increasing their hours. Similarly, many existing workers will find that over three-quarters of any fall in their earnings will be absorbed by UC, which may result in some people working fewer hours.

“As UC is rolled-out over the next parliament it is important that the strong incentives to find work are protected, but not at the cost of people reducing the hours that they work or getting stuck on short hours and low pay.”

Mike Brewer, Professor of Economics at the University of Essex and co-author of the report, said:

“The integration of six benefits into one under Universal Credit will be a major benefit to households. It should help to get more people into work and smooth the transition for those moving in and out of employment.

“But the important goal of claimants only having to make a single application is weakened by the failure to incorporate Council Tax Support, which for many low-income households will mean multiple form-filling and distorted work incentives. The monthly reporting requirements could also result in families with children and the self-employed losing vital UC support.

“More needs to be done to safeguard and strengthen the welcome simplification of the benefit system under UC.”

Notes to Editors

The benefits – and possible risks – of short-hours working for single parents with housing costs in UC

The chart below shows the net income at different hours worked for a single parent with one child aged two, earning £7.50 an hour with rent of £100 a week. There are clear financial gains for an out-of-work single parent to find low-paid work of less than 16 hours a week in UC, compared to the current system. However, whereas the current cliff-edge at 16 hours acts as a strong disincentive for existing workers to reduce their hours, under UC the fall in income from shorter-hours work is relatively small as it replaces two-thirds of their net income drop with a higher benefit entitlement.

Levels of work allowances by household type