Poorer families left “running uphill” as Universal Credit penalty holds them back from recovery

Some families will need to earn an extra £1,000 a year just to stand still

Millions of poorer working families will find it harder for their incomes to keep up with inflation, even after recovery kicks in, because of changes to Universal Credit which will shrink the amount of earnings they can keep, shows new analysis from the Resolution Foundation.

More than 3 million families will be affected by a government-imposed freeze on the level of the work allowance – the amount they can earn before their payment under Universal Credit (UC) starts to be withdrawn.

This means that even if their wages rise at the same pace as the cost of living, their income will fall in real terms because the work allowance does not keep up with inflation. In 2017, a couple with children and qualifying for UC would need to see their combined earnings rise by almost £1,000 just to cancel out the loss in income resulting from this change.

The three-year cash freeze of the work allowance, which was set out in the small print of this month’s Autumn Statement, imposes an additional cash hit on many UC recipients and basic-rate taxpayers who already face a marginal tax rate of 76 per cent once UC is introduced in 2017. That is, for every £1 extra of gross earnings, they will lose 76p 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 under today’s tax credit system as they will under UC. However the additional penalty from the frozen work allowance means that even as wage growth is predicted to start outpacing inflation, millions of poorer working families will continue to find their income squeezed, finding it far harder than would have otherwise been the case to earn their way back to higher living standards.

The work allowance is a crucial feature of UC as it helps to make sure that work pay. A large number of low and modest income families will receive UC although this varies according to the circumstances of a household, including the number of children and a family’s housing arrangements.

The size of the loss arising from freeze in the work allowance varies according to household circumstance – from £62 for those without children to as much as £420 for a single parent. In order to make up these after-tax losses families will have to secure significant pay increases. The effects of the change will vary for different families:

· A couple with children would face a £234 hit in 2017 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 £985 just to stand still

· For a single parent, annual earnings would need to rise by £1,770 in order to stand still given the £421 loss associated with the work allowance freeze

· Single people without children are less affected. Those who qualify for UC are unlikely to be earning enough to pay income tax or NICs and therefore face a lower marginal tax rate. Avoiding the £62 loss implied by the work allowance change therefore requires a pay increase of just £179 in 2017

These figures relate entirely to the extra earnings required in 2017 just to offset the decision not to uprate the size of the work allowance. They don’t take account of the impact of inflation between now and 2017 and therefore how earnings will have to rise to take account of this. Official projections suggest that CPI inflation will increase by 8.7 per cent between 2013 and 2017.

The decision to freeze the work allowance will save the government £385m a year by 2018-19. The allowance will now be maintained at its current cash level for three years from April 2014.

Separate analysis from the Resolution Foundation has shown that household incomes need to rise to sustain extra consumption needed as the key motor of GDP growth as forecast by the Office for Budget Responsibility. Yet on current trends a general revival in consumption beyond 2014 looks unlikely without sustained income growth.

Donald Hirsch, director of the Centre for Research in Social Policy at Loughborough University and associate fellow of the Resolution Foundation , said: “This is not just another ‘cut’ but something more fundamental which will systematically make it harder for low income households to benefit from recovery. And it should be remembered that this comes on top of any cuts in the overall level of Universal Credit if it is not increased in line with inflation.”

Gavin Kelly, chief executive of the Resolution Foundation, said: “The ground is being further tilted against the lowest-earning families who will have to run uphill if they want to get on. Those families who have the most yards to make up in the recovery will find each one harder to cover than those who are better off – this is unfair and it also undermines the initial laudable goal of UC which was to make a decisive shift towards work being more effective.”

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