Further details of the new Universal Credit were recently announced, with much fanfare. The plans integrate a number of different benefits and tax credits into one system which will make transitions in and out work administratively easier for claimants.
The new system also makes taking mini-jobs (under 16 hours) far more attractive, both to those out of work and to those currently working 16 to 20 hours in order to be eligible for the in-work tax credits introduced by Gordon Brown.
When Ian Duncan Smith first discussed the need for reform he also highlighted the very high effective tax rates people face when earning more. We all pay income taxes on extra earnings but tax credits and the new Universal Credit are also withdrawn, leading to high effective tax rates. The details show what will happen to these effective tax rates under the new system and compares it to what it calls the current system.
The current system will apply from April this year, which is important because the new government increased these effective tax rates in their first Budget. The table below shows the figures announced today in the final two columns. It shows how the new regime will reduce the numbers of people with effective tax rates over 80%, but increase the numbers facing 70% to 80% tax rates. It will also increase the numbers facing 60-70% tax rates; this is people just on Universal Credit. Overall there is an increase of half a million people facing effective tax rates at 65% or over.
But this excludes the effects of the Budget earlier this year and in the first two columns I report the numbers produced by HM Treasury at the time. They are not quite identical for the ‘current’ system for reasons that are not clear. But the point here is that this Budget sharply increased the numbers facing tax rates between 70 and 80%, though to be fair this was mostly a move from 70% to 72 or 73%.
But the point is that despite earlier statements from Ian Duncan Smith, the numbers facing punitive tax rates will have risen by 300,000 under this government and the normal tax rate for these people will have moved from 70 to 76%. As such the new regime encourages people to work a little bit, but reduces the incentive for people to work more.
Paul Gregg is professor of economics at the Centre for Market and Public Organisation at the University of Bristol. This post first appeared on CMPO Editor
| Marginal Effective Tax Rates | Financial year 2010/11 | Financial year 2011/12 | Current | Projected under Universal Credit (IFS) |
| 80%+ | 0.3 | 0.3 | 0.7 | 0 |
| 70-80% | 0 | 1.4 | 1.7 | 2.0 |
| 60-70% | 1.6 | 0.2 | 0.2 | 0.9 |
| Under 60% | 1.3 | 0.9 |
