In the Summer Budget delivered on 8 July 2015, the Chancellor announced sweeping cuts to the tax credits system. This article provides more detail, explaining how you might be affected.
Background
The current tax credits system was introduced in April 2003 and replaced working families’ tax credit, disabled person’s tax credit, children’s tax credit and the child elements in various DWP benefits. There are two tax credits – child tax credit (CTC) and working tax credit (WTC).
WTC is paid to people who work and are on a low income – it does not matter whether you are an employee or self-employed. You do not need to have children to get WTC.
CTC is paid to people who have children. It is paid in addition to child benefit and you do not have to be working to get it.
You can find out more about the qualifying conditions for both benefits as well as how the calculation works in the tax credits and benefits section of the LITRG website.
Implementation of changes announced in the Summer Budget
Some of the changes will be introduced from April 2016 with the remainder following from April 2017. Many existing tax credit claimants will see decreases in their awards from April 2016 and those having children after April 2017 may be affected by the new rules.
Increase in taper rate to 48% and decrease in the income threshold to £3,850 (April 2016)
These two changes together will affect many existing claimants and mean that they are likely see a fall in tax credits.
When calculating tax credits, there are two ‘thresholds’ that are important. Above these thresholds, WTC and CTC amounts are reduced as income rises. Currently, tax credits are reduced (tapered) by 41p for every £1 that income rises above the following thresholds, which is a 41% taper rate:
- For WTC only claims, the threshold is currently £6,420.
- For CTC only claims, the threshold is currently £16,105.
- For WTC and CTC claims, the threshold is currently £6,420.
The Summer Budget announcement sees two major changes – the taper rate will increase to 48% and the threshold for WTC only and WTC/CTC cases will be reduced to £3,850. Although not directly announced, these two changes, combined with the freeze on some elements of tax credits, mean that the CTC only threshold will also be reduced as a consequence down to £12,125.
Broadly, this means that people with incomes above the new thresholds will see their tax credits reduced lower down the income scale and at a much faster rate.
Example 1
Krysten is a lone parent with two children. She works 30 hours a week and claims tax credits including some help with childcare costs of £150 a week. Her salary is £18,000. Her 2015/16 tax credits award is around £11,600. Krysten will see that reduced by £2,050 in 2016/17.
This is because under the current system, Krysten’s tax credits do not start to be reduced until her income goes above £6,420 and when it does she loses 41p of tax credits (from her maximum possible amount) for each £1 of income she has above £6,420. However from April 2016, Krysten will see her tax credits start to be reduced when her income goes above £3,850 and when it does she loses 48p of tax credits for each £1 of income she has above £3,850, which is much faster than the current rates.
Some people will not be affected by these two changes. Anyone who has income below the new thresholds or who is in receipt of income support, income based-jobseeker’s allowance, income-related employment and support allowance or pension credit will continue to receive maximum tax credits based on their circumstances (although they will be affected by the freeze to some elements explained above).
Example 2
Jason is a lone parent who is looking for work. He has 1 child and receives income-based jobseeker’s allowance. His tax credits for 2015/16 are £3,325. His tax credits in 2016/17 will remain as £3,325 if he continues to receive IBJSA.
Freeze on WTC and CTC elements (April 2016)
Prior to 2011, tax credit elements were increased each year using the Retail Prices Index (RPI). From April 2011, this changed to the Consumer Prices Index (CPI) and at the same time the basic element of WTC and the 30-hour element were frozen for 3 years.
From April 2014, it was announced that most tax credit elements would only increase by 1%, with the exception of the disabled adult and child elements which increased by the higher CPI.
It was announced in the Summer Budget that all elements of WTC and CTC would be frozen for 4 years with the exception of the adult and child disability elements. The disability elements will continue to be increased by CPI. This means that many people will not see an increase in tax credits from April 2016.
Decrease in income disregard to £2,500 (April 2016)
Tax credits are initially paid based on current circumstances and household income from the previous tax year. After the tax year ends, HMRC compare actual income for the year just ended with income for the previous year. Currently, provided the income for the year just ended is no more than £5,000 higher than in the previous year, the award will be unaffected and there will be no overpayment. Hence the term ‘disregard’, because the first £5,000 of any income increase is disregarded when calculating your award.
When tax credits began, this disregard was set at £2,500. It was increased to a very generous £25,000 from 6 April 2006 in an effort to reduce the volume of overpayments. It was reduced to £10,000 from 6 April 2011 and then again to £5,000 from 6 April 2013.
The Summer Budget announced that the disregard would be reduced again to £2,500 from 6 April 2016.
Example 3
Bridget has been working in the same job for two years and her earnings for 2015/16 were £15,000. After doing well at work, Bridget is promoted to a supervisor role from April 2016 and her salary for 2016/17 will be £19,000.
Under the current rules, Bridget’s 2016/17 tax credits award would not be affected by her pay rise because the increase of £4,000 is less than the £5,000 disregard. Bridget would not see a fall in her tax credits until April 2017.
However, under the new disregard, Bridget’s 2016/17 tax credits award would be based on income of £16,500 meaning she would see a fall in tax credits from April 2016 rather than April 2017.
Limiting CTC to two children (April 2017)
Currently, child tax credit includes a child element which is available at 3 different rates:
- Standard rate £2,780
- Disabled child rate £5,920
- Severely disabled child rate £7,195
The amount actually received depends on household income. A separate child element is included for each child.
Example 4
Gita and David have three children. David receives income-related employment and support allowance. Their tax credits for 2015/16 (assuming David remains on IRESA) will be around £8,885 which is made up of 3 x child element standard rate and 1 x family element.
The Summer Budget announcement means that anyone who has a third child on or after 6 April 2017 will not receive the standard rate child element for that child. LITRG understands that the extra amounts for disabled children and severely disabled children above the standard rate will remain payable.
Example 5
Assume Gita and David have two children in 2015/16 and have their third child on 6 April 2017. Their 2015/16 award will be around £6,105. Their 2016/17 award is likely to be similar assuming their circumstances remain the same. In 2017/18, under the current rules they would have seen their award increase to around £8,885; however, because of the new rules they will continue to receive around £6,105 in 2017/18 despite having an extra child.
Removal of the family element (April 2017)
All families with children currently receive a family element included in their award. It is £545 and has never been increased since tax credits began in 2003.
This element will not be available to those starting a family from April 2017, although there appear to be some proposed exceptions and LITRG will provide updates once more details are known.
Example 6
Christopher and Diana have two children born on 6 April 2017. Under the current rules, their award would have been around £6,105. However, because of the new rules they will receive no more than around £5,560 in 2017/18. The reduction is due to the removal of the family element.
Other effects
Tax credits can act as a passport to other benefits such as free school meals and help with health costs. Many of these passported benefits have thresholds that have been set close to the CTC only threshold. It is not yet clear whether there will be any changes to those thresholds.
If a tax credit claimant has an overpayment from a previous year, it can be recovered from their ongoing award at a rate of 10% or 25%. The 10% rate is available for those who are in receipt of ‘maximum tax credits’. As a direct consequence of the Summer Budget announcement, some people who were on the 10% recovery rate will find that not only has their award been reduced because of the changes to the taper rate and thresholds, but also that they move into the 25% recovery band as they are no long receiving maximum tax credits.
The Summer Budget also announced a ‘living wage’ premium for those aged 25 and over which would see the current National Minimum Wage topped up to £7.20 an hour from April 2016. For tax credit claimants, any rise in their gross salary will see a reduction to tax credits of 48p for each £1 of salary. However, because of the income disregard in tax credits, claimants may not see a reduction in tax credits until the following tax year. Any loss of tax credits may be slightly offset by the extra take-home pay and increases to the tax personal allowance.
Overall impact
The individual changes have been explained above; however, some tax credit claimants may be affected by one, two or all of the changes mentioned above, meaning that the actual impact on you will depend on your circumstances and income (for more than one tax year).
It is important when looking at how the changes affect you to look at all changes including the increase in the personal allowance tax threshold, the new living wage premium and reductions or increases to other benefits, such as housing benefit, as well as changes to tax credits.
Tax credits are due to be phased out over the next few years and replaced by the new Universal Credit. Although the Government promised that no-one would be worse off at the point they are moved to Universal Credit, this only applies to making sure they are not worse off compared to whatever tax credits they are receiving at the time. The cuts to tax credits announced in the Summer Budget mean that people are likely to be on lower levels of tax credits at the point they move across to Universal Credit.
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