Jobseekers' Allowance recipients can pay 111% marginal tax rates on returning to work. Policy Exchange recommend letting them take home more of their earnings.
Our guest writer is Lawrence Kay, Economics Unit Research Fellow at Policy Exchange
Nobody I have ever met likes the idea of someone living in absolute poverty. The trauma of not having enough to eat or a place to sleep is sufficient for all of us to agree that everyone in Britain should have these things. In other words, the abolition of want is a near-universal principle held among Britons. Regardless of its form, the welfare state is going to be around for a lot longer.
But are there any consequences to us wanting to keep people out of poverty? It would be remarkable if this were not to have even some bad effects, would it not? The answer, of course, is the ‘poverty trap’. Whenever a government decides that it wants to give a person money while they are unemployed or not earning enough, it gives them a reason to think twice about trying to earn that money themselves. This is a problem that all governments face, but how bad is this problem in Britain’s benefit system?
Pretty bad, actually. In a Policy Exchange’s latest report out today we show how, when even the most straightforward costs of work are taken into account, the financial boost that benefit claimants get for working is tiny. For example, if you compare the income of a normal Jobseeker’s Allowance claimant over 25 (£122.42, a figure which includes other benefits, like help with council tax and housing) to what they would get after 40 hours work on the minimum wage, the overall gain is only £51. That works out at a paltry £1.28 per hour.
This occurs because as someone tries to leave benefits they start to lose the money they are getting from the government. The Jobseeker’s Allowance claimant loses £1 of the benefit for every £1 earned. This means that the abolition of poverty, plus the need to make sure the state does not end-up paying money to everyone and anyone, leads to a perverse outcome: the poorest people in Britain face the highest tax rates. Think about it: as they earn more, they lose benefits and start to pay tax, so their effective tax rate must be high. For the Jobseeker’s Allowance claimant the tax on deciding to work, say, 20 hours per week is 111%.
The answer to this, as our report argues, is to let people on all benefits keep more of their earnings as they work. By tightening the tax credits regime and other benefit spending we can save £6.5 billion on the overall welfare bill. We can then put some of this money back into the system to allow anyone on welfare to take home £92.80 before their benefits start being squeezed.
Unemployment is only likely to get worse over the next year or so. It is vital that we make sure everyone on benefits can see a good financial reason to keep looking for the jobs available.
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9 Responses to “How to shrink the poverty trap”
Sevillista
Agree that poverty traps are an issue (though post-1997 reforms few are on 100%+ marginal effective tax rates and tax
credits and the minimum wage have helped make work pay, the flip-side of tax credits is a large number of people
on 70% effective tax rates). Very costly to resolve unless the answer is screw down benefits even further.
Would take issue with the assertion £51 per week (over £2,600 a year) isn’t a lot of
money in the context of an income of income of £122 a week – a 42% increase. Has the author tried living on £122 a week? Amounts of far less than this are alleged by many as being crippling if levied on middle-class familes with £60K+ household incomes as tax increases.
B Dog
While I think this report has many good ideas, I am confused by the fact that you think it is suitable to use £92.80 as the cut-off point before benefits are gradually withdrawn. Everybody knows that £92.90 is a much more natural, fair and morally acceptable line than your vindictive £92.80.
John77
Sevillista should read the report – it makes the point that childless people on benefit are worse off working 16 hours a week than not at all, even before taking in the cost of travel and clothes, and couples with children are only marginally better off (single parents would be better off but by less than £2 per hour worked). The £122 is for a single jobseeker living in one room – if he/she had a house then the figure would be higher – and the £52 includes keeping most of the wage packets for the last few hours of work after all the benefit has been clawed back
The report wants most of the money to come from an increased clawback rate of Family tax credit above the level where all Child Tax credit has been clawed back, so only affecting those with on incomes above median (well above, if they have children).
It is after all, silly to have people worse off as a result of taking a job. I should prefer to set a maximum clawback rate of less than 100% (preferably 50% or less), but Policy Exchange has gone for an easy-to-administer option of setting the exemption figure at 16 times the minimum hourly wage (in case B Dog hadn’t noticed) because above that level working tax credit cuts in.
Most economists would argue that the cost would be trivial because most of those benefiting would not otherwise work and so would be receiving all the benefits that they would not lose under the proposal and a majority (or maybe even a multiple) of the cost to the Treasury in higher benefit payments will be recouped by higher Employers’ NI payments, VAT receipts and Income and Corporation tax payments as a result of the stimulus to economic activity. I haven’t had time to do the sums so I couldn’t possibly comment.
The disincentive is smaller higher up the scale but a married man with two kids on £20k has a marginal tax rate of 71% – far more than the bankers are squealing about – and if the older one is at University it goes up to 81%.
Sophia Parker
I think this is an interesting report and it’s good to see people getting stuck in on the question of welfare reform. It’s also great to see how NMW and the existence of a tax credit system – two things introduced by this govt that have made a material difference to low earning households in the UK – are now accepted as important and significant reforms to be built upon rather than chucked out.
Some further thoughts this raised for me:
I would have liked to see what happened to Lawrence’s modelling over time. When a person moves from benefits to work, their tax credits are likely to be quite generous in the first tax year because the ‘income’ figure used to calculate them is that of the previous year. That changes in the second tax year of working when their tax credit payment reflects their income received once in work.
Did Lawrence think at all about the intra-household dynamics of his proposals? I appreciate his attempts to try and work through the impact of his proposals on different households but the more aggressive tapers he proposes are likely to have differential impacts on primary and secondary earners – something that the IFS (whose work really underpins this report as far as I can see) itself acknowledges in its Green Budget.
I think I agree with Lawrence that ‘a pound earned is worth more than a pound given’ BUT I also agree with Sevillista: his proposals are talking about cutting benefits and tax credits for families already surviving on extremely small household incomes. Low earners – those families living on below median income but independent of state support – are spending 41% of their total monthly income on essentials. They are experiencing a higher inflation rate than better-off households. It is harder for them to access affordable credit or get good deals on debt management. In this context proposing to cut benefits and undo the uprating commitments of PBR09 risks further reducing household income and thus pushing people into crisis.
A final reflection (and I defer to others who know more about this than me) but it strikes me that Lawrence is slightly at risk of proposing to replace a taper with a cliff-edge, with all the unintended consequences and behavioural effects that is likely to bring. Nevertheless he’s asking the right questions and I hope the debate continues….