George Osborne’s living standards pitch: Who will lose out?
His bold move on the living wage may stand to benefit a substantial number of workers, but many families stand to lose out.
Today the chancellor garnered a great deal of attention for a bold move on the living wage, as part of his plan to turn the UK into a ‘low tax, high wage, and low welfare’ economy. But beyond this announcement, who really stands to win, and who will lose, from today’s budget?
Firstly, the chancellor has delivered the Conservative goal of cutting £12 billion from the welfare bill in full. As was widely expected, he has had to turn his sights to the working-age welfare bill – particularly tax credits and the new Universal Credit – in order to meet this goal.
Around a quarter of the £12 billion comes from freezing all working-age benefits and tax credits for four years from 2016/17. Since working-age benefits have typically been indexed to prices, holding them flat in cash terms can generate big savings. This follows a similar strategy to that used in the last parliament, which saw the value of benefits move out of line with prices in the economy, and means that by the end of the decade, working-age benefit rates will have been frozen for seven years, and child benefit for nine. This is likely to continue to hit those families in the bottom half of the income distribution that are the most likely to receive benefits, especially those with children.
Families losing out
A further half of the welfare savings come from changes to tax credits (TC), and their successor, universal credit (UC). Two key changes are being made. TC and UC allow claimant families to earn a given amount before their income affects the amount of benefit they receive. After that point, both TC and UC are withdrawn for each extra pound earned. The government has identified savings of over £3.3 billion in 2019/20 by reducing the amount that families can earn before this withdrawal kicks in. One of the key aims of UC is to improve incentives to work, but these changes are actually likely to create a disincentive to work more hours, as the high effective tax-rate once withdrawal begins will start at a lower level of income.
The second key change is to limit the per-child elements in both TC and UC to two children. For tax credits, this only applies to new births – someone who already has three children will not see their award fall. But our reading of the budget documents suggests that all new claims for UC will be assessed on this basis. Given that over the next five years all tax credit claimants will shift to UC, the hundreds of thousands of families with more than two children making the change to UC face a steep loss of income. Proponents of the change will present it as trying to influence behaviour and encourage smaller families, but in fact will penalise those who already have children.
Taken together, the changes to in-work benefits will see some families lose out considerably: one estimate suggests that a family on tax credits with one full-time and one part-time earner, both on £8 per hour, and two children are set to lose £2,400 a year. The government estimates that 800,000 families will see their UC or TC awards fall, with many no longer eligible at all.
Wages, income tax and (dis)incentives to work
Elsewhere in the welfare budget, new claimants of employment support allowance (ESA) in the work-related activity group (that is, those assessed as being nearer to moving into work) will have their weekly entitlement cut from £102 a week to £73, the same rate as jobseeker’s allowance. While it may be argued that this will increase their incentive to move into work, ESA has had a very poor performance at supporting this group through the Work Programme, and cutting claimant’s incomes is unlikely to help. Instead, the government needs to have a deep rethink about the support offered to ESA claimants.
The government has sped up its plan to cut income tax; next year the personal tax-free allowance will rise to £11,000, and the threshold at which people start to pay the 40p higher rate will rise to £43,000. We knew this was coming: the Conservative manifesto contained a commitment to a £12,500 personal allowance and a £50,000 higher rate threshold by 2020. Much of the discussion around the personal allowance changes have seen it presented as a boost for those on low incomes. However, while it is true that millions will see their income tax fall as a result of this policy, it is important to note that those already earning less than the personal allowance will see no gains from the policy. For example, someone working 25 hours on the higher minimum wage announced today will not gain anything in reduced tax. In fact, the biggest winners will be those in the very top of the income distribution. Compounding this, the rise in the higher rate threshold will in fact only benefit those in the top 20 per cent of the earnings distribution. By 2020 the total package will cost around £7 billion, while doing little to offset the cuts coming to working-age welfare.
The chancellor’s plan for a higher-wage economy centres around the creation of a new, higher, minimum wage rate for the over-25s, set at £7.20 initially and rising over time to 60 per cent of median hourly earnings by 2020. This is a good idea, and the choice to offset the cost to business through cuts in corporation tax and employers’ national insurance is sensible. It is unlikely to compensate many families who are facing dramatic falls in tax credit income over the coming years, as many of the earners in those families will be earning above £7.20. Also, as the OBR and others have pointed out, close to half of low-paid workers live in households in the top half of the income distribution. Nonetheless, it is likely to provide a pay boost to many, and to have an impact on productivity in low-wage sectors. Just don’t call it a living wage. It isn’t.
The axes yet to fall
Over the coming days and weeks we will get a lot more detail on the groups that will win or lose most from these changes. The key point is that highly targeted welfare for families, particularly those with children and those with health conditions, is being cut aggressively in order to pay for very poorly targeted income and inheritance tax cuts. Also, attention will soon turn to where the cuts to public services will fall. These will need to be closely watched to ensure that cuts to services don’t inflict even greater pain on the most vulnerable in society. At IPPR we have consistently argued for action to tackle the underlying causes of the rising welfare bill, by shifting money aware from welfare and towards spending on services. Of the announcements today, only the plan to increase the minimum wage fits the bill – and by itself it will do little to compensate many families with children who will be worse off as a result of today’s welfare cuts.