Saturday, 4 December 2021

UNIVERSAL CREDIT - 76% TAX RATE IN 2022/23

Some householders who get the means-tested benefit Universal Credit will keep just 24p of every pound extra they earn – an effective tax rate of 76% - from April 2022. In some parts of England it could be more - losing up to 78.6p in every pound that is earned, leaving them with barely 21p for every extra pound they earn. Those losses could undermine the work incentives which the new system is designed to create. 

For graduates on incomes above £19,895 but low enough to get Universal Credit, the deductions would be more, adding about 3.2 percentage points to those figures. Worst case would be earn £1 keep just 18p.

Universal credit
Universal Credit has been rolled out from October 2013 to replace six means-tested benefits and tax credits. Now after Covid and the lockdowns it is claimed by around five million people. It is the benefit given to almost all new claims for help with income or rent. It is paid to people on low incomes who cannot work, are looking for work, or work on low or modest pay and have children.

It is supposed to let people keep more of what they earn and thus boost incentives both to return to work and to earn more once in work. For every £1 extra earned the credit is reduced by 55p from 24 November 2021 allowing the claimant to keep 45p. Before that it was 63p and had been 65p. This so called ‘withdrawal rate’ of 55p in the pound is said to be much lower than rates under the previous and allowing people to keep 45p of what they earn is seen as an incentive to work. However, that figure of 55p withdrawal rate is only accurate for people who earn less than £190 a week and are not householders.

Taxpayers
Universal Credit is worked out after tax and National Insurance have been deducted. In 2022/23 anyone earning more than £190 a week will pay National Insurance and once they earn more than £242 a week income tax begins. Someone paying National Insurance will lose 13.25p in the pound before their Universal Credit is worked out. The total loss from NI and reduction in Universal Credit is 61p from each £1 they earn. So they keep just 39p. If they pay income tax as well they lose 70p of each pound and keep just 30p. But that is only part of the picture.

Householders
Universal Credit, despite its name, does not replace all means-tested benefits. It does not replace the means-tested reduction in council tax which used to be called Council Tax Benefit but since 1 April 2013 has been replaced by a similar scheme which is now called Council Tax Reduction and is operated by local councils. Like all means-tested benefits Council Tax Support is withdrawn as income rises. The standard taper is 20p for each £1 rise in net income (after tax, NI, and Universal Credit withdrawal). In other words for each extra pound of net income help with council tax is reduced by 20p. The result is that for each £1 earned a total of 76p disappears in tax, NI, reduced Universal Credit, and reduced Council Tax Support. The calculation is at the foot of this blogpost.

Localism
In some areas of England and Wales the reduction for every £1 of income earned may be even higher. As part of the transfer to local councils the Government has cut the money it currently pays towards help with council tax. From 1 April 2013 councils were given only 90% of the money they used to get to pay Council Tax Benefit. The Government insisted that out of that reduced budget they have to pay exactly the same benefit to anyone over pension age. Nearly half of all Council Tax Benefit recipients are pensioners so the other half – working age people who can claim Universal Credit – will bear the whole of the funding cut. That will mean a reduction for them of between 19% and 33% according to the Institute for Fiscal Studies (www.ifs.org.uk/comms/comm123.pdf chapter 5). 

Some councils have saved money by raising the taper from 20% to as high as 30%. In areas which raise the Council Tax Support taper to 25% householders on Universal Credit who pay tax will find that 77.5p of each pound earned disappears in deductions. In areas with a 30% taper they will lose 79p and keep 21p for each extra pound earned in income tax, National Insurance, reduced Universal Credit and reduced Council Tax . 

Students
Students with a Plan 1 or Plan 2 student loan make repayments of 9% of on every pound they earn above £382 a week (£19,895 a year), That is in effect an extra 9% tax and whose income is low enough to be entitled to Universal Credit lose typically 74p in the extra pound keeping just 26p. If they pay council tax then they keep less than 21p and in areas where the council tax withdrawal rate is 30% they keep just 18p in every extra £1 they earn.

It is a tax
Some people object to the deductions made from a means-tested benefit being called a 'tax'. They say that the taper rate reduction in a subsidy from taxpayers is not a tax. Tax, they say, mean a levy on your own money not a reduction in the money the state gives you. 

But it is a tax. And officially so. In his Spring Budget, 8 March 2017, Phillip Hammond confirmed that the tapered loss of this benefit was a tax. He confirmed the reduction in the taper rate by saying "the Universal Credit taper rate will be reduced in April from 65% to 63%, cutting tax for 3 million families on low incomes." These words were echoed by the Chancellor Rishi Sunak in his Autumn Budget on 27 October 2021 "This is a tax on working people -- and I'm cutting it from 63 to 55 per cent...Let us be in no doubt: this is a tax on work. And a high rate of tax at that."

So it is a tax. And a high one. 

Conclusion
Losing 76% or more of each extra pound you earn is hardly an incentive to work or to work harder. It is almost twice the 43.25% tax and NI deductions for higher rate taxpayers with incomes over £50,270, three times the minimum wage.
CALCULATION OF TOTAL DEDUCTIONS FOR A TAXPAYER HOUSEHOLDER
FOR EACH £1 OF EXTRA INCOME WITH 20% COUNCIL TAX TAPER SHOWING EFFECT OF 55% UC TAPER FROM APRIL 2022

EARNS EXTRA
£1.00
Tax
20%
-£0.20
NI
13.25%
-£0.13
Net after tax
£0.67
UC reduction
55%
-£0.37
Net after UC
£0.30
CT Reduction
20%
-£0.06
NET GAIN
£0.24
Effective tax
76%

This blogpost replaces the one originally published 19 September 2012.

4 December 2021
Version 1.00