Tax credit cuts: 3m of lowest paid could be £1,000 a year worse off

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Some 13 million families will lose an average of £260 a year as a result of the benefits freeze and three million could lose an average of £1,000 a year due to tax credits changes announced in yesterday’s Budget, according to the Institute for Fiscal Studies.

The IFS warned that even if wages, including the National Minimum Wage, rose, people on tax credits would be “significantly worse off” after the Budget. Paul Johnson, director of the IFS, said: “There is simply not enough money going in to the new minimum wage to anywhere near compensate – in cash terms – people on tax credits.”

The Chancellor announced a raft of complicated measures linked to tax credits in the Budget, including a cut in the income threshold for tax credits from £6,420 to £3,850 – which will come in from next April, along with similar reductions for Universal Credit work allowances. He said the rate at which a family’s tax credit is reduced as parents earn more will be increased to 48% with the income rise disregard being reduced from £5,000 to £2,500. In addition there will be a four-year freeze on working age benefits, including tax credits and he said that public sector pay will rise by no more than 1% per year over the next four years. From April 2017, new claimants of Child Tax Credit will not be able to claim tax credits on more than two children.

The Resolution Foundation has already warned that cuts to the income disregard in tax credits and ‘work allowances’ in Universal Credit, together with a more rapid clawing back of tax credits as earnings rise, will weaken the incentive both to enter work and earn more. “This will also make it harder for families to earn their way back to their current position after losing out from tax credit cuts,” it says. “Some families will find that the introduction of the National Living Wage offsets these welfare cuts, but for many the gains will fall far short of the losses.”

The Resolution Foundation has modelled the impact of the introduction of the National Living Wage alongside changes to tax credits, housing benefit and income tax thresholds on several typical family types. It finds that by the end of the parliament:

– A low-earning single parent with one child, working 20 hours a week at £9.35 an hour, will be £1,000 a year worse off. That is, the gain associated with the increase in the personal tax allowance is more than offset by reductions in benefit entitlement. To offset this fall in disposable income would require an increase of £3,400 in earnings – equivalent to a one off 44% rise in earnings, 18 years of steady 2% pay rises, or increasing their hours by seven hours a week.

– A low-earning dual-earner couple with two children both earning £9.35 an hour will be £850 a year worse off. They would need a one-off rise in earnings of 15 per cent to recover these losses, equivalent to seven years of steady 2% pay rises or a five-hour increase in the second earner’s weekly working time.

– A mid-earning couple with two children and no rent or mortgage, with the first earner working 37.5 hours a week and earns £12 an hour and the second working 16 hours a week earning £9.35 an hour would be £50 a year better off.

– A middle-earning dual-earner couple without children where both earn £15 an hour will be £350 better off as a result of increases in personal tax allowance.

Further cuts to tax credits and Universal Credit for new claimants – removing the first child premium and restricting support to two children – mean some families moving on to the benefit after April 2017 will see far greater losses, said the Resolution Foundation. For example, it said a low-earning couple with three children making a new claim would be £3,450 worse off following the tax and welfare policies set out in the budget.

Gavin Kelly, Chief Executive at the Resolution Foundation, welcomed action on raising the minimum wage, but said: “By concentrating £12bn of cuts from a limited range of working age benefits, the Chancellor has focussed a disproportionate part of that pain on the working poor. We shouldn’t think that a higher minimum wage will compensate all low-income working families for their losses – many working households will be left significantly worse off. It will take many struggling families years before they earn their way back to their current position. And lost under the budget headlines are a range of measures that will make work less attractive by increasing the effective tax-rate facing low-income families.”

Other campaigning groups add that increases to the personal tax allowance and raising the rate at which higher tax rate is brought in will help richer families more than the poor or middle income earners.

The Child Poverty Action Group said: “Two thirds of poor children now live in working families but incredibly the Chancellor has removed tax credits targeted to help them. The suggestion that higher tax allowances will offset tax credit cuts is sheer fallacy: 44% of adults earn too little to pay income tax and those on slightly higher wages gain little because tax credits are withdrawn as incomes rises. As the Resolution Foundation says, only about 1 per cent of the billions spent on raising the personal tax allowance will actually be spent on lifting the low paid out of tax. It’s much more a tax cut for the better off than it is help for the low paid.”

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