Don’t mis-sell tax cuts to millions of working families, urges Resolution Foundation

Politicians weighing up tax cuts in the approach to the next general election are at risk of mis-selling their policies by failing to disclose how little of any proposed giveaway in the next Parliament will actually benefit millions of working households on universal credit.

Analysis by the Resolution Foundation reveals for the first time how many households are likely to lose out from the collision between income tax cuts and universal credit (UC) and by how much.

All three main parties have proposals for new tax giveaways from 2015 – this problem applies equally to each of the parties. But when UC is introduced in 2017 the gains offered under any tax cuts will be dramatically reduced – by about two-thirds. This has not been well understood and none of the parties are making this clear when they talk about their favoured tax-cuts.

The reduced gain from tax cuts for people in universal credit would apply to any future giveaways including:

· Rises in the personal tax allowance (a Coalition policy driven mainly by Lib Dems, as well as Conservatives);

· The introduction of a married tax allowance (Coalition policy driven by the Conservatives);

· The introduction of a 10p tax band (Labour policy)

The reason for the reduced gain is that the amount of money you receive under UC is calculated on post-tax income. This is different to the current system of tax credits which is based on pre-tax income. Therefore, if income rises from a more generous tax regime, a household’s UC award falls in response. Most of the benefit of the tax giveaway – 65 pence in every £1 – is immediately clawed back by UC.

Around three million individual taxpayers will be eligible for UC, spread between 2.1 million families which will be affected by the UC “claw back”. Most of these households will have children.

Tax-cuts are often presented as if they are targeted at ‘hard-pressed working families’ yet these are precisely the households who are most likely to miss out on most of the gains arising from tax cuts in the next Parliament. The collision between tax cuts and universal credit can be fixed by adjusting the size of the ‘work allowance’ within universal credit to ensure that the full amount of the tax cut actually reaches those who most need it. No party has yet said it would adopt this approach.

Here the Resolution Foundation sets out in detail, and for the first time, the effect of UC on each of these three tax giveaways:

1 Personal tax allowance

This is the amount you are allowed to earn annually before your income begins to be taxed. The current threshold will rise to £10,000 in April 2014.

However senior Liberal Democrats say they’d like to raise the threshold further – to £12,500. By way of illustration, we can consider the impact of raising the allowance to this level by April 2017. This would increase by around 1.8 million the number of lower earners paying no income tax at all (though many would continue to be liable for National Insurance Contributions).

For each £1,000 by which the allowance is raised, the post-tax income of almost all taxpayers rises by £200. A rise from the expected default tax allowance level in 2017 of £10,650 (if it is uprated with inflation) to £12,500 would therefore benefit most taxpayers by £370. A dual earning couple could benefit by more than £700. (If the allowance were to rise to £13,500, this would benefit most taxpayers by £570. A dual earning couple could benefit by more than £1,000). But with any rise, families receiving Universal Credit would lose around two-thirds of any gains through the UC claw-back. About 2.1 million families would be affected, three-quarters of whom have children.

As it stands, the gains from an increase in the personal tax allowance overwhelmingly benefit people in the top half of the income distribution. This will be accentuated by the introduction of Universal Credit.

Because families with children are more likely to be eligible for UC, parents stand to gain the least from any such tax cut. On average, a couple without children would gain £510 a year (or 1.2 per cent of their annual income). In contrast, a single parent would gain just £80 (or 0.3 per cent of their income) and a couple with children would gain £430 (or 0.9 per cent).

The estimated cost to the Exchequer of raising the PTA to £12,500 in April 2017 is in the region of £10 billion a year, with the UC claw-back reducing the cost by around £500 million.

2 The 10p tax band

The effects of a 10p tax band are very similar. Setting a 10p tax band for the first £1,000 of income in April 2017 would make nearly every taxpayer £100 better off. Again, dual earning couples stand to benefit by up to twice as much.

Once again however, around 2.1 million families would face some reduction in the UC entitlement as the result of such a move, thereby reducing the benefit of the tax cut to them. All of these families would be in work and three-quarters would have children. On average, households in the richest 10 per cent would benefit by just over £150 each, while those at the bottom would experience little or no gain.

The estimated cost of introducing a 10p tax band for the first £1,000 of earnings in April 2017 is in the region of £3 billion a year. The interaction with UC would reduce this cost by around £150 million.

3 Married tax allowance

About 3.9 million of the country’s 12.4 million married or civil partnership couples stand to benefit from the married tax allowance which the Government will introduce from 2015. The allowance is restricted to basic rate taxpayers, either in a household with a single earner or where the second earner earns too little to pay income tax. Initially, a couple will be able to transfer up to £1,000 of allowance, meaning that those who are eligible can benefit by up to £200 a year.

The level of the allowance will rise in line with the personal tax allowance, and so is set to reach £1,065 by April 2017, lifting the potential benefit to £213 a year. Once more, the interaction with UC will reduce the gains made by many from this point however.

Around 1.2 million couples will see most of the allowance clawed back under Universal Credit, reducing their gains to around £75 a year. Of these families who fail to receive just one-third of the benefit, four-fifths will have children.

Of an approximate £750 million annual cost in 2017-18, this UC interaction will save around £170 million.

Gavin Kelly, chief executive of the Resolution Foundation, said: “Given the size of the deficit that the next government will inherit many will query whether proposing tax cuts in the next few years of the next Parliament is the right priority. But if all parties are going to promise them, they should be up front about who will benefit in full and who will miss out on most of the gains.”

“As it stands millions of families in universal credit, especially those with children, will lose the major part of any future tax giveaways but most people probably don’t realise this yet. Tax cuts are going to become a far less effective way of lifting the incomes of hard-pressed working families than has previously been the case but nothing about the current Westminster debate would tell you that.”

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