One of the most controversial policy changes being made by the Conservative government relates to the tax credit system. For many years, the tax and benefits system in the UK has come in for significant criticism. It has been described as overly complex, a system that doesn’t reward work and yet a system that doesn’t provide sufficient incentives to move off benefits and into work.
The changes that the government is proposing are wide-ranging and focused in part on reducing the deficit. With changes to tax thresholds, the introduction of the National Living Wage (NLW) and changes to the thresholds at which tax credits are available, the Treasury suggests that £4.5 billion will be saved per year. It also says that most working families will be made better off. However, the IFS suggests that some families could lose up to £1000 per year following the changes.
In addition to these changes, the amount of tax-free childcare is also set to increase, helping those households with young children
Tax credits are designed to help low income families and working tax credit, in particular, is aimed to encourage people to move into work. A key change to this tax credit will see the threshold at which the recipient’s payments of this benefit begin to decline move from £6420 to £3850. The withdrawal rate – the rate at which the benefit is withdrawn – will also be increased.
The idea is that this will help to target the benefit more tightly – make it more vertically efficient. But, the concern is that this will also mean that low-income working households are worse off, despite the introduction in April 2016 of the National Living Wage. The Chancellor suggests that anyone who is working full time will be better off following these changes and that as such the changes will actively encourage work and lead to an increase in the supply of labour. This, the government argues, is a good policy for the working population, tax payers and for the wider economy.
This policy will remain controversial, with changes set to come in from 2016 and then 2017. It is certainly difficult to assess the impact of these changes on households and part of that stems from the complexities of the existing system, which mean that some households are eligible for some benefits, whereas others are not.
The final impact, if such changes are approved, will only be known once the tax credit changes are implemented. The House of Lords will vote on whether to ‘kill’ the tax credit cuts and Mr. Osborne, despite some concerns from Conservative back-benchers has said he is ‘comfortable’ with the policy and that the House of Lords should respect the views of the other house. Until we see the results of the vote and, even then, the impact of the changes on households, both sides will continue to produce data and estimates in support of their views.
Tax credit changes: who will be the winners and losers? BBC News, Brian Milligan (20/10/14)
Tax credit cuts: Osborne ‘comfortable’ with plan despite pressure from fellow Tories The Guardian, Rowena Mason and Heather Stewart (22/10/15)
George Osborne insists he signalled tax credit cuts before the election Independent, Jon Stone (22/10/15)
George Osborne: I am “comfortable” with tax credit cuts The Telegraph, Steven Swinford (22/10/15)
Commons Speaker warns Lords not to block tax credit cuts The Guardian, Patrick Wintour (21/10/15)
Tax credits: George Osborne ‘comfortable’ with ‘judgement call’ BBC News (22/10/15)
Osborne stands firm despite tax credits unease Financial Times, George Parker and Ferdinando Giugliano (22/10/15)
Austerity was a political choice. Now it’s starting to look like a bad one The Guardian. Heather Stewart (25/10/15)
Questions
- What are tax credits?
- How do they aim to affect the supply of labour?
- Using indifference analysis, explain how the income and substitution effects will work, following a change to tax thresholds.
- What is meant by vertical efficiency and the targeting of benefits?
- Why would the changes to tax credits help those in full-time work more than those in part-time work?
- What are the main arguments for and against the changes to tax credits?
As the new tax year begins, many changes are taking place. In order to cut the large budget deficit, sacrifices have to be made by all. The tax and benefit changes could make households worse off by some £2bn this year – definitely not good news for those households already feeling the squeeze. However, the Coalition say that the poorest households will be made better off relative to the rich.
Personal allowance is increasing by £1,000, which is expected to benefit £800,000 people who will no longer pay any tax. At the same time, the 40% tax bracket is being reduced from £43,875 to £42,475, which will bring another 750,000 people into this higher tax bracket, bringing in much needed revenue for the government. Employee’s national insurance contributions will rise by 1% and according to Credit Action, this will leave households £200 worse off per year. Benefits do rise with inflation, but they are to be indexed against the CPI rather than the RPI. The RPI is usually higher and hence benefits will not increase by as much, again leaving some people worse off. Child benefit will be frozen for all and will then be removed for higher rate tax payers from 2013. According to the Treasury, it is the top 10% of households who will lose the most from these needed changes. However, as Justine Greening, the Economic Secretary to the Treasury said:
‘Labour left behind a complete mess with no plan to deal with it, apart from to run up more debts for the next generation to pay off.’
In order to cut the deficit, which stands at an estimated £146bn, spending must fall and tax revenue for the government must rise. The government argues that if cuts are not made today, even higher cuts will be necessary in the future and this will harm the poorest even more. Whilst the Treasury have accepted that there was a ‘marginal loss’ across the population, it is the highest earning households that will suffer the most.
Wednesday of woe as the taxman bites: Changes could leave you £600 worse off Daily Mail, Becky Barrow (6/4/11)
Benefit cuts: Labour warns of ‘Black Wednesday’ BBC News (6/4/11)
Tax and benefit changes: row over financial impact BBC News (6/4/11)
Black Wednesday will hig millions in tax changes and cuts Metro, John Higginson (5/4/11)
Taxman to take extra £750 from families this year Scotsman, Tom Peterkin and Jeff Salway (6/4/11)
Tax and welfare changes will hit women and children hardest, says Ed Balls Guardian, Helene Mullholland, Polly Curtis and Larry Elliott (6/4/11)
Black Wednesday for millions of British families Telegraph (6/4/11)
Majority of households ‘better off’ The Press Association (6/4/11)
Questions
- Where does the term ‘Black Wednesday’ come from?
- What is the likely impact of the 1% rise in NICs? Think about the income and substitution effects. Can you illustrate the effect using indifference analysis?
- Why are Labour arguing that women and children will be hit the hardest and the coalition arguing that it is the highest income households who will lose the most? Can both parties be right?
- What are the arguments (a) for and (b) against bringing in tax and benefit changes today rather than in a few years?
- How might these changes affect the economic recovery?
- Is it equitable that child benefit should eventually be removed from those paying the higher rates of income tax?
- Why has the government indexed benefit payments to rise in line with the CPI rather than the RPI?
One of the key issues tackled during Labour’s term was poverty. In 1997, the UK had one of the worst child poverty rates in Europe (20% of the population) and so Labour made a concerted effort to move more people out of poverty than ever before. Low income was defined as income below 60 per cent of median income. As Chapter 1 from the first “Data and reports” link below states:
Over the period 1994/95 to 2008/09, the percentage of the population below 60 per cent and 70 per cent thresholds of contemporary median income showed slight falls on both Before Housing Costs and After Housing Costs bases. …The proportion and number of the population below low-income thresholds … fell substantially over the same period – with proportions falling by around one half.
Over the period 1994/95 to 2008/09, there was a marked fall in the proportion of children below low income thresholds held constant in real terms. 2008/09 has shown a fall compared to 2007/08.
Despite these improvements, there is a high concentration of people just above the 60% of median income level. And, although poverty rates have fallen since 1997, income inequality remains stubbornly high, with a post-tax-and-benefit Gini co-efficient hovering around 0.38 since 1992, compared with around 0.30 in the late 1970s/early 1980s.
As recession set in, there were concerns about the effect it would have on poverty figures. However, according to the Department for Work and Pensions (DWP), throughout 2008 and 2009 both children and pensioners saw their position improve, as hundreds of thousands were lifted out of poverty. According to the DWP’s annual Households Below Average Income report, mean take-home incomes grew for the seventh consecutive year – by 1% in 2008/9.
Whilst the most vulnerable seem to have survived the first test, the next will come with the substantial budget cuts the UK will see, as the government attempts to reduce the budget deficit. Poverty campaigners have warned that attempts to reduce the deficit must not be detrimental to poverty figures, by taking benefits away from those who need them. As Michelle Mitchell, the charity director at Age UK said: “Clearly there are huge challenges ahead for the new government, but now is the time to renew the fight against pensioner poverty and commit to eradicating it once and for all.”
Articles
Campaigners warn Coalition not to jeopardise falling poverty rates Guardian, Katie Allen (20/5/10)
Child poverty ‘historically high’ The Press Association (20/5/10)
Labour kept poverty in check, says IFS Financial Times, Nicholas Timmins (22/5/10)
Child poverty in Scotland increases by 10,000 in year Scotsman, Gareth Rose (21/5/10)
What the poverty figures show Guardian (20/5/10)
The untold story of poverty in working households Guardian, Peter Kenway (21/5/10)
UK pledges to reduce poverty Financial Times, Daniel Pimlott (21/5/10)
Don’t scrap child benefits, charities warn Guardian (20/5/10)
Data and reports
Households Below Average Income (HBAI) 1994/95-2008/09 Department for Work and Pensions (19/5/10)
Households Below Average Income (pdf file) National Statistics, First Release (20/5/10)
Effects of taxes and benefits on household income Office for National Statistics (see also, especially Tables 26 and 27)
Poverty and inequality in the UK: 2010 Institute for Fiscal Studies
A range of poverty data The Poverty Site
Previous blog
See also The poverty of poverty reduction policies
Questions
- What are the main causes of a) poverty and b) inequality?
- What is the difference between poverty and inequality? Can you think of any policies that might improve one of these objectives, but worsen the other?
- Explain how and why the recessions of the early 1980s, the early 1990s and between 2008 and 2009 could have led to poverty being reduced.
- The Financial Times article talks about different levels of poverty across the country. What can explain these regional disparities?
- The Coalition government has pledged to lift the income tax threshold to £10,000. What effect could this have on unemployment and poverty? How might this effect the poverty trap?
- The Guardian article ‘What the poverty figures show’ says that high levels of child poverty will cost the country at least £25bn a year. Why is this?
Over the past 13 years of the Labour government, the incomes of the richest 1 per cent in the UK have grown substantially faster than that of other income groups, as they also did under the previous Conservative governments from 1979 to 1997. But, thanks to complex redistributive policies, including tax credits, the rise in relative poverty that occurred in the 1980s and 90s has been arrested. With the exception of the top 1 per cent, disposable income growth has been similar across the income groups.
As Larry Elliott, the Guardian’s Economics editor argues:
During the Thatcher-Major years, real incomes for the richest fifth of the population rose fastest, averaging growth of about 2.5% a year. The next richest quintile did a little less well, the middle 20% a bit less well still, and so on all the way down to the poorest 20% of the population, which saw the smallest real income gains of less than 1% a year.
Under Labour, the very high rewards secured by the top 1% of earners has obscured an even distribution of real income growth across the five quintiles.
The new coalition government maintains that anti-poverty policies have failed:
… Iain Duncan Smith, the work and pensions secretary, made a statement trashing Labour’s record: “Vast sums of money have been poured into the benefits system over the last decade in an attempt to address poverty, but today’s statistics clearly show that this approach has failed. Little progress has been made in tackling child poverty, society is more unequal than 50 years ago and there are more working age people living in poverty than ever before.
A new approach is needed which addresses the drivers behind poverty and actually improves the outcomes of the millions of adults and children trapped in poverty.”
The following articles explore what has been happening to inequality and poverty and look at the policies proposed by the coalition government. The data on inequality are also given, along with commentary on them by the Institute for Fiscal Studies
Articles
Labour’s poverty record may be flawed, but the damage was done by the Tories Guardian, Larry Elliott (24/5/10)
The distribution of income: For richer, for poorer Guardian editorial (24/5/10)
What the poverty figures show Guardian Joe Public blog, Julia Unwin (chief executive of the Joseph Rowntree Foundation) (21/5/10)
Data and reports
Households Below Average Income (HBAI) 1994/95-2008/09 Department for Work and Pensions(19/5/10)
Households Below Average Income (pdf file) National Statistics, First Release (20/5/10)
Effects of taxes and benefits on household income Office for National Statistics (see also, especially Tables 26 and 27)
Poverty and inequality in the UK: 2010 Institute for Fiscal Studies
A range of poverty data The Poverty Site
Questions
- What has happened to the distribution of original, gross, disposable and post-tax income distribution (a) by percentage shares of quintile groups of income; (b) in terms of gini coefficients? (See the “Effects of taxes and benefits on household income” reference above.)
- Why is income inequality likely to increase unless strong redistributive policies are pursued by the government?
- What are ‘the drivers behind poverty’?
- To what extent is there a trade-off between economic growth and redistributing incomes from rich to poor?
- Why is it argued that in an increasingly interdependent world, senior executives have to be paid extremely high salaries and be given very large bonuses in order for a company to recruit sufficiently talented people and yet wages have to be kept low to allow goods to remain competitive?
- Why was income much more equally distributed in the 1960s and 70s than it is today?
- What redistributive policies is the new coalition government in the UK pursuing? What factors will determine their success?
In 2008, the UK government set up a National Equality Panel to investigate inequality. “The Panel was asked to investigate the relationships between the distributions of various kinds of economic outcome on the one hand and people’s characteristics and circumstances on the other.” The panel delivered its report, An Anatomy of Economic Inequality in the UK, in January 2010. It “addresses questions such as how far up or down do people from different backgrounds typically come in the distributions of earnings, income or wealth?”
The aspects of inequality examined include: educational outcomes, employment status, wages and other sources of income (such as benefits) both for the individual and the household, and wealth. “In our main report, we present information on the distributions of these outcomes for the population as a whole. Where possible we indicate how they have changed in the last decade or more, and how the UK compares with other industrialised countries. But our main focus is on the position of different social groups within the distributions of each outcome.”
A major influence on people’s income was the income, wealth and class of their parents since these affected education, peer groups and a whole range of other life chances. This made it virtually impossible to achieve equality of opportunity.
The report also looks at policy implications. These include not just the redistribution of incomes, but also the more fundamental issue of how to create equality of opportunity. “The challenge that our report puts down to all political parties is how do you create a level playing field when there are such large differences between the resources that different people have available to them.”
So what has happened to inequality? What explanations can be offered? And what can be done to lessen inequality? The following articles look at the findings of the report and offer their own judgements and analysis.
Rich-poor divide ‘wider than 40 years ago’ BBC News (27/1/10)
The Big Question: Why has the equality gap widened even through the years of plenty? Independent, Sarah Cassidy (28/1/10)
UK is one of world’s most ‘unequal’ societies Irish Times, Mark Hennessy (28/1/10)
Unequal Britain: richest 10% are now 100 times better off than the poorest Guardian, Amelia Gentleman and Hélène Mulholland (27/1/10)
No equality in opportunity Guardian, Phillip Blond and John Milbank (27/1/10)
Has the wealth gap really widened? Guardian, Tom Clark (27/1/10)
Inequality in a meritocracy Financial Times, Christopher Caldwell (29/1/10)
Who wants equality if it means equal poverty? (including video) Times Online, Antonia Senior (29/1/10)
A Major miracle on equality Public Finance, Richard Reeves (29/1/10)
UK one of the worlds most unequal societies; report says The Sikh Times (29/1/10)
Only policies, not posturing, will bring down inequality Independent (28/1/10)
The Report
The full 457-page report can be accessed here.
A 44-page summary of the report can be accessed here.
A 6-page executive summary can be accessed here.
Click here for the charts and tables from the report.
Another good source of information on the distribution of income is the Annual Survey of Hours and Earnings published by the Office for National Statistics.
Questions
- How can we measure inequality?
- Outline the findings of the report.
- Why is inequality so high in the UK and why has it continued to deepen?
- Have tax credits helped to reduce inequality?
- To what extent are greater equality and faster economic growth compatible economic objectives? How are incentives relevant to your answer?
- What specific policies could be adopted to give greater equality of opportunity? Identify the opportunity costs of such policies.
One of the most controversial policy changes being made by the Conservative government relates to the tax credit system. For many years, the tax and benefits system in the UK has come in for significant criticism. It has been described as overly complex, a system that doesn’t reward work and yet a system that doesn’t provide sufficient incentives to move off benefits and into work.
The idea is that this will help to target the benefit more tightly – make it more vertically efficient. But, the concern is that this will also mean that low-income working households are worse off, despite the introduction in April 2016 of the National Living Wage. The Chancellor suggests that anyone who is working full time will be better off following these changes and that as such the changes will actively encourage work and lead to an increase in the supply of labour. This, the government argues, is a good policy for the working population, tax payers and for the wider economy.