Resolution Foundation warns that pushing ahead with tweaked proposals on tax credits would be expensive and still leave most families worse off

Published on Tax and Welfare

New research shows the Treasury could reverse the most damaging tax credit cuts and still meet key fiscal objectives

The government has several options for funding a reversal of its planned tax credit cuts, but pushing ahead with tweaked proposals would be expensive, leave millions of families worse off,  and produce perverse work incentives, according to a new comprehensive report published today (Thursday) by the Resolution Foundation.

Under current plans, 3.3 million working families are set to be worse off by an average of £1,100 from next April – despite an above-inflation increase in the Personal Tax Allowance (PTA) and the welcome new National Living Wage (NLW). However, the planned cuts were blocked by the House of Lords, prompting the Chancellor to say that he would look at “lessening the impact of families during the transition.”

The report looks at the full range of options for mitigating the impact of tax credit losses – including tax cuts, childcare support, a higher minimum wage, phasing-in the reforms and protecting existing claimants – and concludes that reversing the most punitive elements of planned cuts is the only route to helping low-income families.

In particular it says that the reduction in the earnings level at which tax credit entitlements start to be tapered away – set to save £3.4bn by 2020 – should not go ahead. The Foundation says that pushing ahead with this change, even on a revised timetable, would be a mistake, particularly when the same savings can be made elsewhere.

The report sets out five ways to pay for the reversal of that planned cut:

  • Increasing the Personal Allowance in line with inflation, rather than accelerating it towards £12,500, would raise £4.9bn by 2020.
  • Increasing the Basic Rate Limit to rise in line with inflation, rather than accelerating it so that the higher rate threshold reaches £50,000, would save £1.3bn by 2020.
  • Reversing the increase in the inheritance tax threshold and cuts to corporation tax would save £3.4bn by 2020.
  • Clawing back the over-indexation above earnings of the State Pension from the last parliament by limiting pension rises in this parliament would save around £6bn.
  • Returning spending on tax reliefs to 2010 levels by 2020 – and thereby reducing the UK’s current £100bn spend on around 1,000 different reliefs – would save around £10bn.

The Foundation notes that the two income tax pledges, for which more than four-fifths of the gains go to the richest half of households, are set to cost roughly £6.2bn. This alone would provide more than enough to reverse the tax credit cuts, and release additional funds for moving the point at which individuals pay National Insurance (NI) towards the income tax threshold.

Such a move would provide more concentrated support for those on low to middle incomes and help around 1.8 million low earners who pay NI but not income tax. This approach would also be significantly less damaging to work incentives than taking more money out of Universal Credit to fund changes in the Autumn Statement.

With the Chancellor’s budget surplus estimated to reach around £10bn by 2019-20 and £11.6bn by the end of the parliament, the Foundation adds that he could cancel the planned cuts to tax credits without any revenue raising measures and still meet his two main fiscal objectives of debt falling as a proportion of GDP and a surplus by 2019-20.

The report warns that further pledged increases in the NLW and PTA will do relatively little to offset tax credit losses over the course of the parliament, with at least 2.7 million working families still worse off in 2020 after the Summer Budget. Phasing in the cuts would therefore fail to mitigate their losses and simply spread them over the course of the parliament, says the Foundation.

The analysis acknowledges that using transitional protection (applying the tax credit cuts only to new claimants) would reduce the number of losing families substantially. However, this approach would drastically slow the pace of savings to the Exchequer.  The expected £4.4bn saving in 2016 would fall to just £400m, before rising slowly to £1.4bn by the end of the parliament.

The Foundation notes that this proposal would also significantly undermine Universal Credit’s goal of boosting work incentives and have the disadvantage of creating a strong disincentive for families to work or earn more (and therefore move off tax credits). That’s because they would face a huge financial penalty should they need to return to claiming benefits at a later date (for example following a job loss).

David Finch, Senior Economic Analyst at the Resolution Foundation, said:

“The £4.4bn of tax credits cuts due to take place from next April will leave millions of low-income working families significantly worse off. The cuts will also make it harder for these families to recover these losses through work, as many will keep just 20p of extra pound they earn.

“However, the Chancellor now has an opportunity to think again and limit the losses in his Autumn Statement on 25 November.

“His options come down to pushing ahead with the reforms while trying and failing to compensate those losing out at significant expense, protecting current claimants at the price of much lower savings and creating perverse incentives, or finding the money to reverse at least the most damaging of the cuts.

“Many proposals have been suggested to soften the impact of the changes – from further tax cuts, to a phasing-in of the reforms – but none of them make much of an imprint into the scale of losses being imposed on low income working families.

“If the government is serious about providing more help to working families, its only option is to reverse the cuts. Fortunately there are plenty of ways to fund this move – such as cancelling tax cuts targeted at better off households. And with a surplus of close to £12bn pencilled in for the end of the parliament, the Chancellor can afford to cancel the tax credit cuts and still eliminate the deficit.”

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