Cable is wrong: Working families will be worse off after tax credit changes

While recent announcements have led to increases in the child element, they have also led to significant cuts in the basic element, 30 hour element and childcare elements as well increasing the rate at which tax credit awards fall in relation to rising household incomes. In contrast to the business secretary’s claim, the reality for many working families (particularly those with childcare costs) is therefore that the total impact of these changes means they will receive far less now than they would do if current policy remained in place.

This morning, on the Today programme, business secretary Vince Cable claimed the coalition was increasing tax credits for working families. It is correct that as a result of measures in the budget and spending review the child element of child tax credit – which is available to families in and out of paid employment – is being increased by £180 in 2011/12 and by £110 in 2012/13.

Were the element only to be increased in line with RPI inflation (based on inflation as of September of this year and as per the OBR’s forecast for next year) it would be worth £120 less by 2012/13 than it will be under the Coalition’s plans. The newly announced increases are therefore a positive development and are to be welcomed.

But Tax Credits are complicated as the actual amount that each family gets depends both on their specific household income and on the different elements that their award is made up of. A working family (with a low enough income) will receive child tax credit (which is made up of a family element, a child element and additional premiums for disabled and severely disabled children) and also various elements of working tax credit (including the basic element, the couple or lone parent element and, if a member of the household is working more than 30 hours, the 30 hour element).

If the household has eligible childcare costs, they can also receive considerable help with this expenditure through a childcare element. This maximum total award is then tapered off at a rate of 39p in the pound as their household income rises above £6,420. This means that for every £1,000 a household’s income rises above £6,420, £390 of their maximum tax credit award is lost.

While recent announcements have led to increases in the child element, they have also led to significant cuts in the basic element, 30 hour element and childcare elements as well increasing the rate at which tax credit awards fall in relation to rising household incomes. In contrast to the business secretary’s claim, the reality for many working families (particularly those with childcare costs) is therefore that the total impact of these changes means they will receive far less now than they would do if current policy remained in place.

The easiest way to show this is to consider a sample family. The following analysis considers a couple household with two children, where one adult works full time (35 hours) and the other part time (16 hours), both at minimum wage. Both their children spend 14 hours a week in childcare, at a total cost of around £106 a week to the household.

A number of changes announced in the budget and spending review will reduce the entitlement this family has. These include the move to uprate tax credit elements by CPI rather than RPI, to freeze some elements, to increase the overall withdrawal rate and to reduce the amount of childcare costs that can be reimbursed. As a result a family with two children and one full time and one part time worker each on minimum wage are £729 a year worse off by 2012/13.

The following table shows these changes, and contrasts them with what this family’s entitlement would be if current policy were to remain in place:


Child tax credit

Elements (annual)

Policy change

Elements (annual) 2012/13 changed policy

Change in entitlement (from current rules)

Family element

£545 (assume frozen as was the case between April 2009 and April 2010)

No change

£545

= no change
Child element (per child) £2,471 per child = £4,942 (assume uprating by RPI) Above inflation rises announced in Budget and CSR £2,590 per child = £5,180 = £238 increase
         
Working tax credit        
         
Childcare 80% of eligible costs (with total eligible costs capped at £300) = £4,410 Proportion of eligible costs met by tax credits will fall from 80% to 70% 70% of £106 per week = £3,858 = £552 loss
Basic element £2,063 (assume uprating by RPI) Frozen for 3 years rather than increased by RPI £1,920 = £143 loss
Couple element £2,030 (assume uprating by RPI) Element will be increased by CPI rather than RPI £1,995 = £35 loss
30-hour element £849 (assume uprating by RPI) Frozen for 3 years £790 = £59 loss
Total maximum award £14,839   £14,288  

Tapered final award:

Total award after taper = £11,344

Rate at which award is withdrawn changes from 39 per cent to 41 per cent

Total award after taper = £10,614

= £729 loss (as a result of lower maximum award and increased taper rate)

Even if you add in the amount the family will gain as a result of the change in the income tax threshold, they remain significantly worse off. And if you add in other losses the family could incur as a result of changes including the freeze in child benefit levels, the abolition of Educational Maintenance Allowance and the reversal of the previous government’s policy to introduce a £4 a week toddler tax credit, their losses rise further still.

In addition, if the family had a new baby they would feel the loss of the Health in Pregnancy Grant (£190) as well as the complete abolition of the tax credit baby element (which is currently worth £545 on their maximum award).

The family could also be hit by the proposals in the budget which reduce the backdating period for tax credit awards to one month (it is currently three months). If they don’t get their claim in on time, they could lose several months of their entitlement. And if the full time worker in the household were to lose their job, the family could find they lose all of their working tax credit entitlement (as a result of the government’s plan to increase the hours threshold for working tax credit entitlement for couples from 16 working hours to 24 hours a week).

They also face new penalties if both remain in work but on reduced hours, as new rules announced in the budget mean that families experiencing a fall in income will have the first £2,500 of their new income disregarded when their in-year entitlement is re-calculated, meaning that until the new financial year they will end up with the same entitlement as a family in the same circumstances earning £2,500 more.

This sample family is far from unique. Families on minimum wage as well as median incomes are losers from these tax credit changes – it is simply inaccurate to claim otherwise.

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