Some householders who get the means-tested benefit Universal Credit keep just 26p of every extra pound they earn – an effective tax rate of 74%. That hardly fits in with Labour's promise in the King's Speech to 'make work pay'. In some parts of England it the loss could be more - losing up to 77p in every extra pound earned, leaving them with 23p for every extra pound they earn. Those losses undermine the work incentives which Universal Credit is was designed to create.
For graduates on incomes high enough to make repayments on their student loan but low enough to get Universal Credit, the deductions would be more - they earn an extra £1 and keep just 14p.
Automatic pension deductions reduce these figures even further.
So it is a tax. And a high one.
Universal credit
Universal Credit has been rolled out since October 2013 to replace six means-tested benefits and tax credits. It is currently claimed by around five million people. It is the benefit given to 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. People with children get more for two of them and many do not get all their rent paid.
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. But since November 2021 for every £1 extra earned the credit is reduced by 55p allowing the claimant to keep just 45p. The previous Government - which reduced the withdrawal rate from 63p - said allowing people to keep 45p of what they earn was an incentive to work. However, that figure of 55p withdrawal rate is only accurate for people who earn less than £242 a week and are not householders.
There is one complexity to be aware of. People with a child or children and people who are judged to have 'limited capability for work' get what is called a 'work allowance'. This is not extra money but is simply an amount they are allowed to earn before the taper kicks in. It is set at £404 a month (£93.23 a week) if universal credit includes help with housing costs and £673 a month (£155.31 a week) if it does not. So those people can earn up to those amounts and the taper will not apply to those earnings. It does apply though to every pound earned when their income is above those amounts. And for everyone else the 55% taper applies to the first pound earned.
Taxpayers
Universal Credit is worked out after tax and National Insurance have been deducted. In 2024/25 anyone earning more than £242 a week pays National Insurance and income tax. National Insurance was recently reduced and now takes 8p in the pound and income tax which begins at the same level takes another 20p in the pound before their Universal Credit is worked out. That leaves 72p of each pound. The Universal Credit taper then reduces their benefit by 55% of that net amount. The total loss from NI, income tax, and reduction in Universal Credit is 68p from each £1 they earn. So they keep less than 32p. 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 is now called Council Tax Reduction and is operated by local councils. Like all means-tested benefits Council Tax Reduction is withdrawn as income rises. The standard taper is 20p for each £1 rise in net income (after tax and NI, and the Universal Credit taper). 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 nearly 74p 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 local councils struggle to save money by raising the taper from 20% to as high as 30%. In areas which raise the Council Tax Reduction taper to 25% householders on Universal Credit who pay tax will find that 77p of each pound earned disappears in deductions. In areas with a 30% taper they will lose nearly 79p and keep barely 21p for each extra pound earned after deductions for income tax, National Insurance, Universal Credit taper, and lower Council Tax Reduction.
A new way of calculating council tax reduction is to put income into bands and only change the reduction as income crosses from one band into another. If extra earnings do not change the band of earnings then the council tax reduction taper is effectively zero. However, if it does move income across a band the taper can be a lot higher than 20%. About one in four councils in England now use a banded scheme.
Pension contributions
Everyone who earns over £10,000 a year (£192 a week) has to be enrolled in a company pension scheme. They can opt out but most do not. The standard contribution for employees is 5% of pay and this is deducted along with tax and national insurance and it is this amount net amount to which the taper applies. However, the 5% (and 3% from the employer) is paid into a pension fund so remains the property of the individual. Calculations in this blogpost ignore these contributions but their deduction does affect net income.
Students
Students with a Plan 1, Plan 2. Plan 4 (Scotland only) or Plan 5 student loan make repayments of 9% of on every pound they earn above a threshold (currently £480 a week for Plan 1 or 5, £524 a week for Plan 2, £603 for Plan 4, and £403 for a postgrad loan). That is in effect an extra 9% tax (6% for postgrad loans). However it is not counted as a tax for Universal Credit calculations. So it is taken off the final figure after that calculation. Graduates whose income is low enough to be entitled to Universal Credit lose typically 83p in the extra pound keeping just 17p, if they pay council tax.
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 reduces a subsidy from taxpayers is not a tax. Tax, they say, means 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, Chancellor 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 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."
Conclusion
Losing 74% of each extra pound you earn is hardly an incentive to work or to work more hours. It is the highest marginal tax rate in the system aside from the reduction in child benefit for those who earn £60,000 to £80,000 a year and have at least ten children. It is far more than the 42% tax and NI deductions for higher rate taxpayers with incomes over £50,270, more than double the minimum wage. And more even than the highest marginal rate of income tax in Scotland which can reach 67% for those earning over £100,000 - £125,140.
TOTAL DEDUCTIONS FOR A TAXPAYER HOUSEHOLDER FOR EACH £1 OF EXTRA INCOME WITH 20% COUNCIL TAX TAPER, IGNORING PENSION CONTRIBUTIONS AND STUDENT LOAN REPAYMENTS.
Earns extra
|
£1.00
| |
Tax
|
20%
|
-£0.20
|
NI
| 8%
|
-£0.08
|
Net after tax
|
£0.72
| |
UC reduction
|
55%
|
-£0.40
|
Net after UC
|
£0.32
| |
CTR cut
|
20%
|
-£0.06
|
Net gain
|
£0.26
| |
So earn extra £1 and keep just 26p.
An effective tax rate of 74%
19 July 2024
Version 4.0
Version 4.0
This blogpost replaces the one originally published 19 September 2012 and revised in October 2022.
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