Living standards· Universal Credit· Tax· Welfare The new financial year: No fireworks yet but is pain brewing for low-to-middle income households? 6 April 2016 by Matthew Whittaker Matthew Whittaker Prior to the government’s tax credit U-turn in last year’s Autumn Statement, 6 April 2016 was set to be a red letter day – representing the point at which more than 3 million tax credit recipient families would face the reality of reductions in their annual awards of £1,300 on average. Having shelved the cuts in the short-term the Chancellor is likely to be entering the new tax year not quite in party mode maybe, but at least he has avoided what would have been a very nasty hangover. Absent the tax credit cuts, the aggregate picture looks broadly neutral for the coming year. In many ways one of the largest and most radical changes to the benefit system is now underway with the introduction of the new ‘Single Tier’ state pension. But this shouldn’t obscure the ongoing changes to the tax and benefit system mostly affecting working age families that are also beginning. Focusing just on those policies that directly affect households and which only start to bite from this year, the government is introducing a net takeaway of just over £50 million – small beer in the large scheme of things. As the chart below shows though, this figure is underpinned by plenty of movement in either direction. Policies announced pre-election amounted to a £2.2 billion giveaway in 2016-17, which has been entirely reversed by a £2.3 billion takeaway in policies announced post-election. This broadly neutral overall position masks a complex distribution of winners and losers, with many households gaining from some policies and simultaneously losing from others. Indeed, even the government has an imperfect sense of how some of the changes will play out. The estimated cost of the savings tax, ISA flexibility and dividends tax reform have been described as being of ‘medium-high’ uncertainty by the OBR. The distribution of gains and losses are hard to predict in many cases. For example, by raising the tax rates paid on dividends but simultaneously introducing a £5,000 allowance, the dividends tax reform is set to benefit those higher and additional rate taxpayers with dividend income up to roughly £20,000 a year, while raising significant funds from those with higher dividend income levels. And, for the first time, basic rate taxpayers will be liable for tax on their dividend income. Given the sums involved, we can expect significant behavioural changes. From a political perspective, changes that are hard to measure and potentially spread across different parts of the income distribution have the advantage of avoiding the sort of heat associated with the previously planned tax credit cuts. However, many of the other policies due to come in have a clearly regressive impact. For example, raising the income tax personal tax allowance – while often sold as a ‘low earner’ tax cut and a means of taking people out of tax – directs the largest gains towards the top half of the household income distribution. Adding in above-inflation increases at the point at which people start paying the 40p rate of tax further skews the distribution. Of the combined £2.4 billion being spent on income tax cuts from April 2016 as a result of pre-election (£1.2 billion) and post-election (£1.2 billion) policy announcements, roughly £2 billion (83 per cent) is set to flow to the richest half of the country. The top 20 per cent alone are likely to benefit to the tune of around £1.1 billion. At the same time, roughly £320 million is about to be withdrawn from low and middle income tax credit and Universal Credit recipients. That comprises £110 million associated with the removal of the family premium in any new Housing Benefit claims; £90 million from a reduction in the tax credit income rise disregard (the amount that a claimant’s income can rise within the year without affecting their entitlement); and £120 million from a cut in UC work allowances (the amount a household can earn before its UC award starts to be withdrawn). These reductions will hit a limited number of families this year, but the impact will grow sharply over as UC is more fully rolled-out. By 2020-21, the same package of measures is estimated to save the government £3.9 billion a year. By chance, this is almost precisely the same amount as the government expects to spend on delivering its currently announced package of income tax cuts by 2020. As we’ve shown before, the combined medium-term (i.e. by 2020) impact of policies announced since last year’s election (or at least those which can reasonably be modelled) is an average loss of £565 for the poorest 30 per cent of households and an average gain of £280 among the richest 30 per cent – even after taking account of the very welcome boost to six million of the lowest paid via the introduction of the National Living Wage. The new tax year may lack the once-predicted fireworks, but it is still set to deliver painful new realities for many low and middle income households. With more to follow, the Chancellor is likely to find that subsequent new tax years deliver more than a few headaches.