In his Budget, the Chancellor claimed that ‘those currently on the minimum wage will see their pay rise by over a third this Parliament, a cash increase for a full time worker of over £5,000.’ But this wasn’t quite the whole story. What he didn’t say is that a full-time worker could see just 7pc of this pay rise in their pockets due to the withdrawal of benefits and tax credits. Osborne’s Treasury will accrue the remaining 93pc in reduced welfare payments and increased tax revenue.
The simple truth is that the Living Wage helps government more than it does workers. In Britain, tax credits and other benefits conspire to make low-paid work a fiendishly complex network of allowances and taper rates. It can be very difficult for workers to know, if they take a job or extra shift, how much better off they’ll be. For this reason, Policy in Practice has created a calculator – which Fraser Nelson referred to in his Daily Telegraph column today.
What follows is complex – but the trap that has been created for the low-paid is complex. To understand the welfare politics of the next five years, you need to get your head around it. And the concept of effective marginal tax rates. For example, if someone earns an extra £10 under the government’s new Universal Credit system they will lose £7.62 in tax and withdrawn benefit. So this means an effective marginal tax rate of 76pc. This is high, but these rates can go even higher.
For example, take the case of Sue, a lone parent working 12 hours per week at the National Minimum Wage – now £6.50. In April 2016, the minimum wage rises to £7.20 an hour so her after-tax salary will rise by £8.40 per week. But under the UK welfare system, her Income Support will also fall by £8.40 a week. So she has (to use Osborne’s term) seen a ‘cash increase’ – but also suffered an equal cash decrease. She’s no better off. So who benefits? HM Treasury. Crucially, the Government benefits from increases to the minimum wage through reduced welfare payments and increased tax revenue, at the expense of the employer.
The situation improves when she no longer qualifies for income-replacement benefits (generally when working above 16 hours per week), but not by much. If Sue were working full-time, at 35 hours per week, an increase in the minimum wage from £6.50 to £7.20 would increase her gross earnings by £24.50 each week. But only £2.32 reaches Sue’s pocket after paying tax and losing benefits as a result of her pay rise – she keeps just 9pc of it. This is because Housing Benefit, Working Tax Credit, Income Tax, and National Insurance are all being withdrawn at the same time.
So far I’ve only examined the increase to the minimum wage in isolation, but there was more to the Summer Budget than Britain’s pay rise. Next April, the withdrawal rate of Tax Credits will increase from 41pc to 48pc – so people in receipt of Tax Credits will keep even less of any pay rise. When Sue works full-time, she’ll now get to keep just 7pc of that pay rise, rather than 9pc. So the changes make it even harder for Sue, and people like her, to work their way out of poverty.
The personal tax allowance will also increase from £10,600 per year to £11,000, which means that people earning above £10,600 will pay less income tax. But as I’ve written before, raising the personal tax allowance is a very ineffective way to help those on the lowest incomes.
Sue will be worse off in 2016
(Note an interesting quirk of the welfare system: Sue’s Housing Benefit has actually gone up. This is because her Working Tax Credit has fallen, and Tax Credits are taken into account as income when calculating Housing Benefit. I told you the system was complicated.)
The new Universal Credit system is an improvement on the old mishmash of multiple benefits, but its work incentives have been weakened by the Budget - contrary to the message being sent out.
Universal Credit is intended to help low paid workers keep more of their extra earnings by combining six means-tested benefits into a single withdrawal rate.
This means that those earning below the tax thresholds will always get to keep 35pc of what they earn. Those paying income tax and National Insurance will get to keep around 24pc. It’s still a very high effective tax rate (either 65pc or 76pc) but it is certainly an improvement on the current system where the effective tax rate can run as high as 100pc.
The generous work allowances in Universal Credit were a key feature that ensured people will be better-off in work: people could do a bit of work, without it having any effect on your benefit. But the Chancellor’s Budget also put these Universal Credit work incentives under the chopping block.
Now, workers won’t get to keep any of their earnings before UC is withdrawn - unless they are parents, or are disabled. Work allowances for others have fallen to £4,764 per year for those without housing costs, and £2,304 for those who receiving housing support.
Lone parents with no housing costs are the group that feel the deepest cut to work incentives – a reduction of over £4,000 per year.
Dramatic reductions to work allowance in Universal Credit
Single person (no housing costs)
George Osborne said in his Summer Budget speech on Wednesday:
‘The OBR forecast that under the current economic conditions, almost a million more jobs will be created over the next five years. Our ambition is to go further, and create 2 million more jobs on the road to full employment. To help achieve that progressive goal, we set out today how we will make work pay.’
The Chancellor would like us to believe that simply raising the minimum wage will achieve this, but the Government benefits more from this pay rise than the low paid worker it purports to help.
What’s more, the Budget ensures that work in 2016 will pay even less for those on benefits than it does today.
Lisa Stidle is Head of Operations at Policy in Practice