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A cross-party committee of MPs has said that it would be right for the Chancellor to rethink tax credit reforms that went “too far and too fast”.

Government tax credit proposals

The cuts proposed for April 2016 would have run “against the government’s objective of making work pay”, according to the Commons Work and Pensions Committee’s report, which is summarised below.

The Chancellor announced sweeping cuts to the tax credits system in his Summer Budget. However, the proposed cuts ran into some difficulty after the House of Lords refused to pass the Government’s legislation seeking to cut tax credits significantly from April 2016. The Autumn Statement is now awaited to clarify the future of tax credits.

The Commons Work and Pensions Committee’s report

The Committee argued that offsetting factors, including the increase in the income tax personal allowance, the new national living wage and expansion of free childcare, should not be confused with mitigation for the tax credit cuts because they benefit very different parts of the working population. “The answer to tax credits is tax credits,” the Committee concluded, citing oral evidence provided by the Institute for Fiscal Studies and the Resolution Foundation. But there was “no magic bullet within the tax credit system”.

The Committee said the Treasury had been evasive and had failed to provide data about the impact of the proposed cuts on different income groups.

The MPs examined a range of broad options but accepted that there was no simple way to mitigate cuts on the scale proposed in the Summer Budget. They concluded that if the effects of the cuts could not be satisfactorily mitigated now, then any reforms should be paused until 2017/18. The Committee felt that a pause would enable necessary debate about the future of working age benefits to take place and enable more ambitious reforms to be considered.

Universal credit

The committee also called on the Chancellor to “resist the temptation to raid universal credit (UC)”. A further reduction in UC thresholds would disproportionately affect poorer claimants, the committee argued, and a 75% taper – instead of the current 65% – would give a marginal deduction rate for taxpayers claiming UC of 83%. This means that for every £1 of extra income, a person would lose 83p.

An individual’s marginal deduction rate measures the impact of earning an additional £1 on their tax and benefits. The current 65% taper in UC gives a marginal deduction rate of 76.2% comprising income tax 20p, national insurance contributions 12p, and clawback of UC 44.2p (65% of the remaining 68p). This means that for every £1 of extra income, a person loses just over 76p.

Impact of tax credits cuts

• People would tend to take home “only a small proportion” of any wage increase. Some would face a marginal deduction rate of 93%. Gains from an increased personal allowance would be small relative to the typical tax credit losses, and a high proportion of those facing tax credit cuts would not benefit from the increased tax personal allowance.
• The majority of tax credit recipients would not benefit at all from the national living wage.
• The expansion of free childcare would benefit “an even smaller subset” of those subject to tax credit cuts. Fewer than 10% of tax credits claimants are entitled to the childcare element of working tax credit in respect of a child under five. Those who do claim the childcare element already have 70% of their childcare costs funded by the taxpayer.

Mitigation

• lower taxes and higher wages
• changes to tax credits, e.g. adjustments to the threshold and taper rates, gradual introduction of the cuts, and exempting existing claimants from some or all of the cuts.

The simplest pause option was to delay implementation of the cuts by one year. The committee said insufficient information was available to estimate the cost of providing transitional protection for existing claimants. The IFS had warned that doing so would create “a very big incentive to stay on tax credits at the moment rather than risk moving off and coming back on again”.

Peers were due to debate tax credit reforms set to take effect in April 2017, including a new two-child limit for child tax credit, when the Welfare Reform and Work Bill received its second reading in the House of Lords on 17 November.

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