Reform of Universal Credit could lift 500,000 people out of poverty, says NEF

By agency reporter
October 16, 2020

A package of reform to Universal Credit (UC) to ensure work always pays would reduce tax rates for low earners, boost disposable incomes by £1,100 per year and lift 500,000 people out poverty, according to the New Economics Foundation (NEF). The total cost would be less than the £9 billion earmarked for the flawed Job Retention Bonus, which the CEO of HMRC argued was poor value for money.

The analysis shows that those on the lowest earnings from work pay some of the highest tax rates in the economy. Cutting taxes directly for these groups is therefore likely to be far better targeted where it is most needed, compared with cutting VAT for hospitality (such as in the government’s Winter Economic Plan), or reducing employer payroll taxes through the Job Retention Bonus (such as in the government’s Summer Plan for Jobs). For example:

  • A single parent on UC earning £13,600 per year as a cleaner has an effective marginal tax rate of 75 per cent: they get to keep just 25p in every extra £1 of earnings, after taking into account income tax, national insurance and withdrawn benefits.
  • An IT technician earning £35,000 per year and not receiving Universal Credit has an effective marginal tax rate of 32 per cent: they get to keep 68p in every extra £1 of earnings, after taking into account income tax and employee national insurance.
  • A person earning £200,000 per year has an effective marginal tax rate of 47 per cent: they get to keep a minimum of 53p in every extra £1 of earnings after income tax and national insurance if they pay themselves through PAYE. If they receive income through dividends or selling shares they will likely have an even lower marginal tax rate and keep even more than 53p in every extra £1.

The ‘taper rate’ of UC sets the rate at which benefits get withdrawn for every additional £1 in earnings from work, and the ‘work allowances’ set a threshold for earned income, above which the taper is applied. The new modelling from NEF shows that reducing the taper rate by just three percentage points would boost incomes for the poorest 20 per cent of working families by more than £100 per year, while increasing work allowances by the equivalent of just one additional hour on minimum wage per week would boost incomes for the same households by £70 per year. The analysis also looked increasing support for childcare for those on UC, since the costs of childcare can be key a factor in determining the amount of earnings that are effectively retained from work.

Based on the findings of the analysis, NEF sets out an illustrative package of reform to Universal Credit that allows people to keep more of what they earn, containing the following features:

  • Increase all current work allowances by the equivalent of one hour per week at national living wage (NLW)
  • Extend work allowances to workers without children at the equivalent of eight hours per week at NLW
  • Ensure all second earners in a family also have a work allowance on the same basis as primary earners
  • Reduce the taper rate from 63 per cent to 50 per cent
  • Increase support for childcare costs from 85 per cent to 100 per cent.

The analysis shows that this package would reduce the earnings lost through tax and withdrawn benefits for an unemployed single parent getting a new minimum wage job on 30 hours per week (what economists call the effective 'participation tax rate') from 31 per cent to 25 per cent. The same person would also be able to keep 34p for every extra £1 in earnings, compared with 25p in the current system. Overall the package would see disposable incomes rise by £1,100 per year (or 14 per cent) on average for working families among the poorest fifth of all households, and £1,200 per year (or five per cent) among the next poorest 20 per cent, while also lifting more than 500,000 out of poverty. In total the package would cost £8.8 billion, less than the maximum £9.4 billion earmarked for the Job Retention Bonus.

Lukasz Krebel, Economist at the New Economics Foundation, said: “The government should be commended for supporting millions of jobs through its furlough scheme. But with the new Job Support Scheme set to do little to avert a tsunami of redundancies, the UK is now facing a severe and avoidable jobs crisis.

“Much of government support so far has come in the form of a tax cut, such as through VAT or an effective cut to employer payroll taxes through the Job Retention Bonus. But this has failed to target tax cuts where they are most needed – for the some of the lowest income families that get to keep just 25p for an extra £1 in earnings.

“Addressing these eye watering tax rates experienced precisely where increased hours, earnings and spending is needed most, should be an uncontroversial goal that both left and right can get behind. Fortunately, there are already quick and straightforward ways of achieving this, that could be pursued alongside deeper reform of Universal Credit and the establishment of a new minimum income guarantee.”

Upcoming work at NEF will call for a permanent replacement to Universal Credit to accompany its existing Minimum Income Guarantee policy.

* New Economics Foundation https://neweconomics.org/

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