Parties’ plans for £11 billion tax cuts will miss out poorer working families new research shows

Research undertaken by Loughborough University shows tax cuts proposed by Labour, Liberal Democrats and the Conservatives at the next election are not a cost effective way of helping low income working families.

According to new analysis undertaken by the University’s Centre for Research in Social Policy (CRSP) for the Joseph Rowntree Foundation (JRF), the tax cuts will cost the public purse at least three times as much as more targeted policies and fail to help families in greatest need.

Wages, taxes and top-ups is the report, written by CRSP’s Donald Hirsch for JRF.  It analysed a range of policy options – including those promoted by the three main parties – to assess their ability to help low income working households.

The paper shows how changes in wages, tax rates and in-work support (such as tax credits) have had a changing influence on family income in recent years. Wage increases have been modest, but in the past 15 years the state has stepped in to give substantial top-ups to working families.

While the parties have introduced and proposed a range of measures to improve the incomes of poorer families - some of which have had impact - the report concludes that well-targeted support through Universal Credit is the most cost effective way to help such families. This means allowing parents to keep more of what they earn to ensure they fully benefit from future tax cuts.

Currently, a family with two children and both parents working on low wages are £20 a week short of what they need to reach the Minimum Income Standard, a benchmark<> of minimum living standards set by members of the public.

Making up this modest £20 shortfall through tax cuts would cost at least between £8 billion and £11.5 billion a year to fund. For example:

* The Liberal Democrats and Conservatives have both talked about further rises to the income tax allowance after the election. It would have to be increased to £12,500 to make the family £20 a week better off. This would benefit 24 million basic rate taxpayers, most of them not on low incomes, and cost at least £11.5 billion.

* Labour has talked about introducing a 10 per cent starting rate of tax. To deliver £20 a week to a working couple would require a starting rate tax band of £5200, taxed at 10 per cent rather than 20 per cent, which would cost an estimated £11 billion.

* Various commentators have suggested increasing the threshold above which employees start paying National Insurance Contributions (NICs). Raising it by £4,330, would increase a working couple with two children’s income by £20 a week. It costs less than raising the income tax allowance because pensioners would not benefit since they do not pay contributions. The estimated cost is over £9 billion.

* The Conservatives are introducing a married tax allowance in April 2015. It allows up to £1,000 of tax allowance to be transferred where only one partner uses their full allowance, so it does not help the two-earner family being considered here. However, some have pressed for the policy to go further. If a higher allowance was given to one member of a married couple regardless of whether their spouse used their own allowance, it would need to be worth £5,200 to generate the £20 a week net income for the two-earner couple with children. This would cost approximately £8 billion a year. While this is slightly cheaper than the other policies, it would be more selective by only reaching those who are married.

* Under Universal Credit, low income working families will not get the full benefit of tax cuts. This is because their support is withdrawn on an after-tax basis, meaning for every £1 gained through a tax cut, a family will lose 65p to reduced Universal Credit entitlement. This means about three times as much would have to be spent on the above policies just to deliver a modest boost of £20 per week.

By contrast, boosting the support available through in-work benefits to top up low wages and allowing people to keep more of what they earn under Universal Credit could have the equivalent impact for between £1 billion and £4 billion. Such support needs to sit alongside improved wages as a twin-track approach to improving the incomes of low-earning working families.

The report calls for the following policies to be considered:

* Increasing the amount of earned income that families can keep: At present the amount a family can earn before their entitlement to in-work benefits starts to be withdrawn (the “work allowance” or “disregard”) is frozen. Allowing the couple to keep an additional £31 a week would deliver the £20 top up for £2 billion and benefit four million working families with children.

* Making sure low income families do gain fully from future tax cuts. The simplest way of doing this would be to increase the amount that can be earned before Universal Credit entitlement starts to be withdrawn each time the tax allowance increases.

* Indexing the level of support for childcare through Universal Credit: Government plans to increase support available for childcare costs through Universal Credit from 2016 will provide a big boost to eligible families’ incomes. However, unless the limits on eligible childcare costs increases in line with actual childcare fees, these costs could still pose a significant barrier to work.

* Restoring the link between in- and out-of-work benefits and the cost of living: At present the level of both tax credits and Universal Credit is rising by only one per cent. This means families relying on credits are bound to get worse off. And even if they do get healthy pay rises and benefit from tax cuts, two thirds of their extra income will be lost (under UC) to withdrawn benefits.

Chris Goulden, Head of Poverty Research at JRF, said: “As the living standards election approaches, the main parties have set out their tax pledges. While they will have some benefit, they will cost the public purse at least three times as much as more targeted policies and fail to help families in greatest need.

“The Government has topped up the income of low earning families’ since 1971. This support is particularly crucial in periods where wages are stagnant and the cost of living rising, as has been the case in recent years.

“Wage levels and tax cuts are part of the mix for improving the living standard of low income working families, but how the state supports low earning families is also pivotal. This underlines the importance of Universal Credit in making work pay, as part of a comprehensive anti-poverty strategy.”

Donald Hirsch, the report author, said: "Ensuring a decent living standard for working families requires a range of approaches. In the longer term, better pay is essential but state support for families on modest earnings will also be needed to help make ends meet - particularly with childcare costs. Cuts in this support hit working families hard: income tax cuts help to offset this but only weakly, because help is spread so thinly.

“Universal Credit shows the government still believes in giving a boost to working families’ earnings. The final levels of support in UC will be crucial in determining whether those on low incomes have the opportunity to truly benefit from economic recovery."

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