Reducing Tax Credits and Housing Benefit

The Chancellor of the Exchequer has decided that £12bn must be cut from the benefits bill, and that much of that saving will come from reducing the levels of Tax Credits (the means-tested benefit for people in employment) and Housing Benefit. Estimates from the Resolution Foundation suggest that the majority of the cuts will fall on the poorest 30% of families, and none on the 40% wealthiest, who will benefit most from increases in the Income Tax Personal Allowance.

What the last Labour Government called Tax Credits are not Tax Credits. They are a means-tested benefit, like Housing Benefit. This means that as someone’s earned income rises, the amount of means-tested benefit that the household receives falls. Research from the Centre for Labour and Social Studies shows that someone earning above the Income Tax threshold can face a total withdrawal rate of 96% on additional earned income, because on every extra £1 earned National Insurance Contributions and Income Tax have to be paid, and Housing Benefit and Tax Credits are withdrawn. (See p.27 of the report for the full list of withdrawal rates.) Anyone in this position receives just 4p of any additional £1 of earnings. Compare this with the 53p out of every extra £1 received by anyone earning above £150,000 per annum.

So we can agree with the Chancellor, the Prime Minister, and the Secretary of State for Work and Pensions, that there is a lot wrong with Tax Credits. However, we disagree over what to do about the problem. Simply reducing the value of Tax Credits and  Housing Benefit will make poor families poorer, and will leave the current taper rates in place, so the total withdrawal rates faced by low-earning families will remain the same. It will be simply impossible for the families affected to earn enough additional income to repair the gaps in their finances. The situation will be slightly better if ‘Universal Credit’ is introduced. The highest total withdrawal rate on additional earnings will drop from 96% to 76% (although this figure will vary somewhat with different local Council Tax Support regulations). But that still leaves a family with only 24p out of every extra £1 earned. This is not the way to enable families to earn their way out of poverty.

There is an answer. The answer is to pay to every legal resident an unconditional, nonwithdrawable income: a Citizen’s Income; and to pay for it by abolishing the Income Tax Personal Allowance and either abolishing or recalculating means-tested-benefits. As research published by the Institute for Social and Economic Research has shown, this is perfectly feasible. A household’s Citizen’s Incomes would never be withdrawn, so it would be perfectly possible for a family to earn its way out of poverty – which at the moment it usually isn’t.

The Chancellor is hoping that reducing Tax Credits will spur employers into paying higher wages. Wage levels are a function of a firm’s productivity, the competition that it faces, and other firms’ wage levels, as well as of the financial needs of its employees. There is no guarantee that to increase the amount that employees need to earn will result in their employers raising their wages. As things stand, cuts in Tax Credits and Housing Benefit will simply make a lot of families a lot poorer. And if they do manage to find additional employment, or to start their own businesses on the side, then for every extra £1 that they earn they might be only 4p better off. If instead of Tax Credits the household was receiving Citizen’s Incomes of a similar value, then if they found additional employment, or started their own business, they would be able to keep 68p of every extra £1 they earned.

The increasingly complex economy and society in which we now find ourselves require radical action, and not tinkering around with the current benefits system. It is time for the Government, political parties, and think tanks to join in the research and education that we shall require if we are to construct a tax and benefits system that will serve the British people rather than penalise them. The Citizen’s Income Trust will do all it can to help.

Further information on the Citizen’s Income proposal can be found at The most thorough recent introduction to the subject can be found here, and a new brief introduction here.