Assessing the proposal to cut £5 billion from Child Tax Credit

Last week, the BBC reported that the government was contemplating a major reduction in Child Tax Credit, in order to go part way towards meeting the £12 billion in working age welfare benefit cuts that it has committed to finding by 2017/18.

The report suggested that the government was considering reducing the value of the ’child element’ of the Child Tax Credit (CTC) back to its 2003-04 level in real terms. This proposal would cut the near £30 billion total annual tax credit budget by up to £5 billion.

In this briefing the Resolution Foundation shows what such a cut could mean for different families, and how the losses would be distributed across households.

It shows that:

* over two-thirds of the families affected would be in-work;

* families with two children would lose up £1,690 a year;

* almost two-thirds of the cut would be borne by the poorest 30 per cent of households; and

* almost none of the cut would fall upon the richest 40 per cent of households

The child element of the CTC is paid to a total of 4 million families (with 5 million children). Over two-thirds of these families (2.7 million in total) are in work.

The annual value of the child element for each child in a family is £2,780 in 2015-16. Reducing it back to its 2003-04 level in real-terms would cut support by £845 a year per child – a cut of 30 per cent.

Working families with two children could therefore lose up to £1,690 a year as a result of this reduction in CTC. Not all families would lose this much – around 800,000 working families receive less than the full value of the CTC entitlement because some of it is tapered away from those households who aren’t on the lowest incomes. Others would also lose less than the full amount because of interactions between CTC and Housing Benefit and Council Tax Support.

Cutting CTC to this extent would weigh very heavily on low-income families. Almost two-thirds of the £5bn cut would be borne by the poorest 30 per cent of households. In contrast, the most affluent 40 per cent of households would remain almost completely unscathed (bearing just 1 per cent of the cut).

As well as reducing support for the poorest, it would also remove some families from CTC eligibility all together. Currently, entitlement to CTC for a family with one to three children is fully exhausted when gross household earnings reach between around £26,000 and £40,000 a year respectively. A £5 billion cut to CTC would reduce those figures by between £2,000 and £6,000.

Work incentives would be improved for some, but only because families are made financially worse off: out-of-work benefits would be far less generous; those in work (also facing a cut in income) would see their CTC entitlement run out at a lower level of household earnings, thereby cutting the marginal effective tax rates some working families face.

The following table gives stylised examples of how the cut would impact on different types of household.