Posts Tagged ‘Tax Credits’

Radical Welfare Reform

October 4, 2010 Leave a comment

Paul Gregg

Iain Duncan Smith (IDS), as Secretary of State for Work and Pensions has articulated the need for a radical overhaul of the welfare system.  His assertion, along with George Osborne, that the welfare system is broken deserves some scrutiny, and I intend to discuss this in my next blog. Here the options and problems with radical reform are discussed. IDS has argued that the system is too complicated with a huge number of different benefits; he states there are 50 separate benefits and tax credits, but I can only think of about 10 substantial ones, and that work incentives are too low because of excessive rates of benefit withdrawal when people earn more. IDS intimated, soon after the election, that three options were being considered – a Negative Income Tax system that integrates all major aspects of the welfare and tax system, a Universal Credit that integrates all major aspects of the welfare system but keeps them separate from the tax system and an integrated taper that does merge all the benefits but makes sure all means testing of welfare benefits operates at a single combined withdrawal rate for all benefits.

The first major problem with integration of welfare, tax credits and taxes is whether you are considering the individual or the family.  Income taxes are individually assessed whilst most benefits are family based. Thirty years ago this was more mixed with income taxes being based on joint income for couples and many benefits being based on own contribution record and assessed against own income only, though the residual Supplementary Benefit system was assessed on joint income. In the 1980s with the elimination of most NI benefits full integration of taxes and benefits might have been doable. But now a single Negative Income Tax system has the difficult choice of making the entire system based on own income only or family income only. Forcing taxation back to being jointly assessed for couples would cause outrage from many women and high earner couples as their tax bill would rise considerably. Going the other way and making benefits individualised would lead to large costs as many people ineligible because of their working partner would be able to claim. Given these two huge problems the government seems to now be downplaying this idea and focusing more on the Universal Credit.

A Universal Credit would take all income related benefits and tax credits for working age people into a single system with a single withdrawal rate as earnings rise. This withdrawal would have to be based on joint family income. However the universal credit does still need to address the residual entitlements to individual contributory benefits, mainly short term Job Seekers Allowance (for 6 months) and much longer entitlement to incapacity related benefits (5 years).  Mimicking these individual elements within the new Universal Credit would add considerable complexity, undermining the very logic of the reforms. Hence the expectation must be that the remaining contributory elements in benefit entitlement would go. This saves money but also leads to a lot of people who lose entitlement to support.

There are three additional fundamental design features that are problematic when moving to a Universal Credit. First, many benefits are supplements for specific additional costs. Housing Benefit (HB), Council Tax Benefit, the higher value of disability benefits to those for job seekers, Disability Living Allowance (DLA) and Attendance Allowance (AA) all reflect payments for large additional costs that only apply to some claimants. A single Universal Credit would not be high enough to meet these additional costs unless it was very generous and thus prohibitively costly. But keeping them as extra payments requiring additional claim details means the new system is just replicating the existing system but rather than being different benefits you have extra supplements. It was this addition of a lot of supplementary elements in the Tax Credit System that led it to being so complex. In my view this is such a profound problem that it will be at least partly fudged. I would expect that Council Tax costs, DLA and AA would stay out of the Credit. However, HB and the higher value benefits for Disability would have to be inside for the reform to be meaningful. So the government could either keep supplements for housing costs and disability, making the system complex or paying a common rate, higher than current basic benefit levels, but way below what current disabled claimants or those eligible to help for housing costs would receive. This producers winners among those with lower need and big losers amongst the most in need of extra financial help – this is a hard story to sell.

The second problem is that different elements of the current system are re-evaluated at different intervals. Most benefits are based on current income, rent etc and are reassessed whenever there is a change of job, family structure and even wages. Tax credits however, are based on last year’s earnings (from NI records) and are only reassessed within year if there is a major change of circumstance. Here there is also different flexibility if incomes rises or falls. Large income rises are tolerated so that there is no recalculation until the next year. However, significant falls in earnings trigger rapid reassessment. Crudely, it seems sensible for out of work benefits to change when people start earning or lose jobs but instant adjustment every time someone works an extra hour a week or gets a pay rise seems unwieldy.  At the moment this is partially dealt with, though not without problems, by having separate in and out- of work systems. How a single Credit would navigate this may again make it complex.

Finally, there is the issue that out of work benefits come with some conditionality about activity that claimants must undertake. There are three groupings (although the middle one is not fully operating yet at it only came into existence recently). These mean that job seekers including lone mothers with youngest child aged 10+ are required to demonstrate they actively applying for jobs and are required to take work that is offered, they can also lose benefits for leaving a job through choice. Those with health problem that are not extreme will be required to follow an Action Plan to get them back to work but are not required to look for work on day one and can refuse jobs they do not feel are suitable. Those who are extremely sick/disabled and their carers, plus lone mothers with young children are not required to undertake any activity.  Those who only claim in-work benefits such as HB or tax credits are not subject to any conditionality. Broadly speaking, at the moment, once  a family is working 16 hours per week they are left on their own. Under a single Credit deciding the appropriate levels of conditionality and the potential to extend conditionality to those who already work 16 hours or more but receive extra financial help represents a problem that could easily created widespread resentment.

So the Universal Credit represents a radical welfare reform. The simpler it is the more it will create a large number of losers even with substantial extra costs to the Treasury. The more complex it is, the less radical a reform it represents and less attractive it becomes. Selling a system with substantial extra costs and a lot of losers will prove very hard. Furthermore, doing it in one big bang may repeat the administrative nightmare that occurred with the more modest integration of three different sources of support for children that occurred with the tax credit system. Hence the government seems to moving forward might by making the reform in chunks. The easiest would to integrate the three main out of work benefits, Job Seekers Allowance, Income Support and the new disability benefit, Employment Support Allowance. The out- going government had already set this in motion with IS being phased out and plans for a Single Working Age Benefit where the disabled would receive higher levels of support. Other and more profound early steps might be to focus on three areas most in need of change, Housing Benefit could be turned into a Housing Supplement based on family size and area lived in rather than rent, a necessary step to keep it easy to calculate and added to either out of work benefits or in-work tax credits. The Childcare Tax Credit, the source of most over payment problems, needs to go the other way and be turned into a simpler childcare subsidy, outside the tax-credit system.

Welfare is an engine of mobility

September 22, 2010 1 comment

Sarah Smith

Nick Clegg declared earlier this week that “welfare needs to become an engine of mobility, changing people’s lives for the better, rather than a giant cheque written by the state to compensate the poor for their predicament.” Few would disagree that welfare should bring about real, positive changes in people’s lives but let’s hope that Nick Clegg and his advisers are aware of the evidence that – at least some of – the welfare reforms introduced by the last government seem to have done just that.

In October 1999, a package of reforms was introduced to help low income families with children. These included the Working Families Tax Credit which boosted incomes for working families as well as increases in payments to non-working families with children. The scale of the rise in government support going to families with children was unprecedented over more than thirty years. Per-child spending increased by 50 per cent in real terms between 1999 and 2003, most of it targeted at the poorest one-quarter of families.

There is now a substantial body of evidence that these reforms brought about real improvements in the lives of tens of thousands of people. A number of studies have looked at whether the reforms raised levels of employment – and using different datasets and different methodologies there is a consensus (a fairly rare thing in applied work) that the reforms succeeded in getting 60-85,000 lone parents into work and encouraged a further 40,000 to increase their hours of employment.1

Going beyond the immediate employment effects, a CMPO study has looked at the effect of the reforms on measures of well-being among lone parents and on the outcomes of their children (including self-esteem, (un)happiness, relationships with their mother, risk taking behaviour and aspirations) and found that the reforms have had significant positive effects2. At least in part, these effects come through the positive impact of the reforms on mother’s employment, but this is not the whole story. Another important channel is that increasing the money available to lone parents softened the harsh financial blow of separation – and did so without any obvious effect on the probability of becoming a lone parent. Sometimes, compensating people for their predicament (separation and divorce) is exactly what the welfare state should do – and with good reason.

This is not to say that the current welfare system cannot be improved. But in the search for a welfare system that can deliver real improvements in people’s lives, the current government should not wipe the slate clean and could learn some useful lessons from what has worked in the past.


1. See for example, Francesconi, M and van Der Klaauw, W. (2007) “The socioeconomic consequences of in-work benefit reform for British lone mothers”, Journal of Human Resources, Gregg, P. and Harkness, S. (2003) “Welfare Reform and Lone Parents Employment in the UK.” CMPO Working Paper Series 03/072, Brewer, Mike, Alan Duncan, Andrew Shephard, and Maria J. Suarez. (2006). “Did working families’ tax credit work? The impact of in-work support on labour supply in Great Britain.” Labour Economics, 13(6): 699-720.

2. Gregg, P., Harkness, S. and Smith, S. (2009) “Welfare reform and lone parents in the UK”, Economic Journal