Comprehensive Spending Review – analysis

FROM POVERTY TRAP TO ASPIRATION TRAP

The impact of fiscal tightening on squeezed low-to-middle earners

The Resolution Foundation, the low-to-middle earner research and policy organisation, today provides its detailed analysis of what the full package of fiscal tightening measures introduced by the coalition government since June means for the 11 million struggling to get by in low earner households. It concludes that reductions in tax credits, public service cuts and cost increases are all serving to create a new ‘aspiration gap’.

Gavin Kelly, Chief Executive of the Resolution Foundation said:

“Just at the time that the Government is gaining plaudits for seeking to get rid of the ‘poverty trap’ for those escaping welfare there is a real risk that a new ‘aspiration trap’ is being set for people struggling to reach a middle income.”

Matthew Whittaker, Senior Economist, added:

“In addition to the looming public sector job losses and hike in VAT, family budgets will be further squeezed due to cuts to tax credits, the abolition of Educational Maintenance Allowance (EMA) and increases in housing rents, public transport and childcare costs. The ending of key training programmes will be a further set-back to those aspiring to get on at work.”

“Withdrawal of EMAs and cuts in Working Tax Credit childcare support will have bigger impacts on recipient families on low and modest incomes than the cut to Child Benefit for higher rate taxpayers that recently attracted so much attention.”

“And for most families with children on household earnings of between £15,000 and £30,000 the Spending Review pain will greatly outweigh the gain from the increase in personal tax allowances that the Government committed to in the Budget.”

Briefing Note

Background

Despite not being the poorest or most vulnerable members of society, those in work but on low-to-middle incomes – low earners[1]– face a unique set of pressures: too poor to benefit from the full range of opportunities provided by private sector but too rich to qualify for substantial state support. Around one-third of working-age households fall into this position in the UK, covering 11.1 million adults

Low and modest earner households tend to live at the edge of their means and have little opportunity to build savings. At the same time, they struggle to access either home ownership or social housing, while their skills profiles result in restricted opportunities for training and progression in work. Because of their position on the cusp of means-tested benefits and the existence of cycles between low-pay and no-pay for some, low earners often have a complex interaction with the tax and benefit system: a difficulty that can be compounded by a lack of awareness among policy makers about the precariousness of the position of these households.

The recession highlighted the exposure of the group. In relation to those who were already largely dependent on state benefits, low earners had jobs to lose, mortgages and credit arrangements to default on and a lack of experience in accessing support from the state. In relation to those households with above median incomes, the group had far smaller safety nets – in terms of savings, insurance and redundancy payments – and displayed less ability to return rapidly to work following job loss.

The fiscal tightening set out by the coalition government poses further risks for low earners. Most basically, any slowdown or reversal of economic growth associated with the reduction in public sector activity is likely to once again fall hardest on those on modest incomes and in insecure jobs, while it is low earners working in the public sector who are also most likely to be affected by the half million job losses expected to fall in that part of the economy.

Prior to the June Budget we published What’s the damage?[2]– which considered the impact on low earners of a range of options for fiscal consolidation. While the need to act on the public sector deficit – and the pain that this would mean for UK households – was apparent, we identified a number of alternative approaches to the speed at which the tightening could take place and to the balance that could be struck between tax increases and spending cuts. We concluded that any final assessment of the impact on low earners would require an analysis of the overall package of measures in the round. Following yesterday’s Spending Review we now have a clearer idea of what that package looks like.

Impact of fiscal tightening by the coalition

Some of the measures set out by the government since June have been welcome. The Budget announcement of an increase in the personal allowance for basic rate taxpayers, the decision to extend more generous Support for Mortgage Interest Scheme, above-inflation increases in the child element of the Child Tax Credit and the commitment to maintain free nursery education will be a relief to many people struggling to get on. But there has also been much to concern members of the low earner group.

In addition to the macro-level effects discussed above, low earners are set to be disadvantaged by the fiscal tightening in three main ways:

Reduced access to state support:

• The majority of cuts to the welfare bill will have a greater impact on the out-of-work rather than the working low-and modest earner group we are focused on. However, low earners are the major recipients of tax credits and, despite the increases in the child element discussed above, the overall impact will be negative for most: tapers have been tightened and payment elements have been frozen, cut or linked to the CPI rather than the – usually higher – RPI. The IFS has identified that, overall, the tax credit giveaway of £0.7 billion a year in 2014-15 announced in the Spending Review will be more than offset by the claw-back of £2.1 billion.
• The cuts will have a major impact on household budgets within the group. For example, for a family on £20,000, the abolition of Education Maintenance Allowances (EMAs) will cost £1,170 a year, a larger cut than the withdrawal of Child Benefit for higher rate tax payers with one child (who lose £1,056). Similarly, cuts to the childcare element of the Working Tax Credit will reduce annual incomes by up to £1,560 among those eligible families with two or more children.
• While the removal of Child Benefit from households with a higher rate taxpayer is unlikely to affect many low and modest earners, the decision in the June Budget to freeze the rates for first and subsequent children for three years from April 2011 will still produce consecutive real-terms cuts for some members of the group, which will grow in magnitude over time because of compound effects.

Restricted access to services:

• Although many of the details of departmental spending cuts are yet to be published, in general, cuts to public services – at the national and local levels – will tend to fall heaviest on those in the bottom half of the income distribution. The distributional analysis set out in the Spending Review suggests that households in quintile 2 (the middle of the low earner group) consume public services[3] with a value of around £10,700 a year, compared with just £5,500 a week in the top quintile.
• In some instances low earners will face a withdrawal of services which they value highly – via the decision to refocus Sure Start on children in the poorest households for example – in others they will face significantly higher charges.

• The abolition of the ‘Train to Gain’ programme will hit low-skilled workers seeking to achieve a Level 2 qualification in order to progress in their careers. Between 2008 and April 2010, 741,100 Level 2-4 qualifications were obtained through the programme, 606,600 of which were at Level 2.
• Higher cost pressures:

• The increase in VAT from 17.5 per cent to 20 per cent will be harder for the poor to manage than the rich, increasing low earner household bills by around £400 a year on average.[4]
• Reform of social housing will lead to a growing proportion of new tenants paying rents above current levels in the sector. The £4.4 billion cut in spending in this area, coupled with already low rates of affordable house building under the previous Government which pushed the waiting list to nearly two million, will further restrict housing options for low earners, putting even greater pressure on the private rented sector.
• Dramatic reductions in local authority funding is likely to lead to the introduction or extension of user charging in a number of areas, which will have the biggest proportional impact on those just above the exemption level.
• Rising public transport costs associated with the increase in the regulatory cap on rail fares and the reduction of bus subsidies will also undermine low earners’ financial independence. This is because low earners are often reliant on such services to get to work, but do not qualify for exemptions or concessionary rates.
• In addition, the IFS has argued that, under the tuition fee proposals contained in the Browne report, only the highest earning graduates will fully repay their loans, meaning that those who find themselves on low-to-middle incomes post-university will face an effective graduate tax of 9 per cent for 30 years. The distributional analysis contained in the Spending Review attempts to model the cumulative impacts of fiscal tightening measures introduced by both the coalition and the previous administration – in terms of changes to taxes and benefits and in terms of reduced public service provision – on different income groups. It shows that, outside of the top income quintile, it is low-to-middle earners in quintile 2 that face the biggest proportional impacts by 2014-15. While households in this quintile are expected to be less affected by tax increases than members of other income groups, they will be more negatively impacted by changes in tax credits and benefits and by public service spending cuts. The IFS has attempted to model the impact of a fuller range of the proposed tax and benefit changes in 2014-15, concluding that those on low-to-middle incomes will fare significantly worse than those in deciles 6-9. The analysis also shows that working-age households – especially those with children – are expected to suffer a greater hit than retired households. This is particularly true among those with low and modest incomes.
• While the experience of quintile 2 suggests that any benefits associated with the increase in the income tax personal allowance are more than offset by the negative effects discussed above, the analysis comes with many caveats. It is not possible, for example, to model the changes brought about by a large number of the measures introduced. Moreover, the income groups include all UK households, meaning that no account is given to the different experiences facing working-age and retired households.
• Distributional impacts of all fiscal consolidation measures

Ends

[1] We define the group as covering those households with below average incomes that remain largely independent of state support: that is, they receive less than one-fifth of their income from means-tested benefits excluding tax-credits.

[2] Resolution Foundation, What’s the damage? A low earner impact assessment of deficit reduction options, June 2010

[3] Not all public service consumption can be modelled. These figures relate to the two-thirds of resource expenditure that the government is able to provide estimates for.

[4] Resolution Foundation analysis of ONS, Effects of taxes and benefits on household income shows that low earners account for around 22 per cent of all VAT receipts. £400 figure is based on application of this proportion to additional revenue expected to be raised by the measure.