It is important to move beyond the controversy over the implementation of Universal Credit and try to understand its impact on the labour market. While it will no doubt boost work incentives, it could have the perverse effect of keeping people on short hours and in low pay.
Universal Credit is intended to ‘make sure work pays’ by simplifying the benefits system and improving financial incentives. It aims to help more people into work, and then earn more once they are in work. As currently designed it should achieve the former, but there is a much bigger question mark over the latter.
It is important to get beyond the current debate on the implementation of UC which has seen continued delays to the IT development and timetable for delivery. Understanding the real impact on the jobs market and people’s earnings potential is vital for a benefit expected to touch on the lives of over eight million families at any given point in time, and many more over the lifetime as families circumstances change.
There is much that is right with UC. The interim report of the Resolution Foundation’s expert panel-led review argues that combining six working-age benefits into one system, smoothing the transition into work and increasing take-up of benefits for low income families are significant improvements on the current system.
Crucially, the work allowance – which allows people to keep all of their benefits as they enter employment – provides a powerful new work incentive. This should help more people into work, particularly those who only want to work short hours. However, because work allowances run out relatively quickly for people claiming support with their housing costs, there is a risk that some will work fewer hours. The fact that they tend to be used up in full by the main earner in a couple also creates a possible risk that some second earners may choose not to work at all.
The incentives within UC to earn more once work allowances have been used up are relatively weak. Beyond this point benefits are withdrawn – recipients will receive 35p of every pound that they earn, falling to 24p if they pay income tax and National Insurance.
This – and the absence of the hours rules from the current system that require people to work a specified number of hours to qualify for working tax credit – creates a potential risk that some UC recipients could become trapped at the level of earnings at which their work allowance runs out.
If people work fewer hours than they currently do it would result in increased costs to the Exchequer through lower tax receipts and increased UC payments. It would also, perhaps more importantly, limit the ability of households to work their way out of poverty or improve their incomes.
The report illustrates how a single parent with housing costs and earning £7.50 an hour will find it easier to reduce their hours compared to the current system. In the current system they would need to work 16 hours a week to claim working tax credits. But under UC, their work allowance would run out at 8 hours. Halving their weekly hours from 16 to 8 would reduce their net income by only £21 a week – a far shallower fall compared to the current system – as their UC support would increase by £39.
We know that single parents are responsive to changes in financial incentives – indeed 1 in 5 working single parents who rent do the exact hours required to meet the hours rule. So it’s entirely possible that many will respond to new incentives in UC.
UC also provides in-work support to over a million low-paid workers without children, many of whom would have received little or no support in the current tax credit system. Under-25s will receive support for the first time. This lack of previous interaction means that little is known about how they could respond to these new financial incentives. But with some workers able to work a day less on the minimum wage and lose just £12 a week it is again possible that this group will choose to reduce their hours of work.
The likelihood of these risks becoming manifest is highly uncertain, but it is real enough for the government to propose a new and untested system of in-work conditionality to try and reduce the extent to which people may respond and limit their earnings. An awful lot rests upon it.
The risks are real enough to mean that we should consider how UC might be reformed to better deliver on its original aims. It’s important we strengthen the key potential benefits of Universal Credit, as well as mitigating the risks. That’s what we’ll turn to in the final report, due to be published after the election.
David Finch is a senior economic analyst at the Resolution Foundation
