Thursday 22 September 2022

UNIVERSAL CREDIT - 76% TAX RATE IN 2022/23

Some householders who get the means-tested benefit Universal Credit will keep just 24p of every pound extra they earn – an effective tax rate of 76% - this tax year and next. In some parts of England it could be more - losing up to 78.6p in every pound that is earned, leaving them with barely 21p for every extra pound they earn. Those losses could undermine the work incentives which the new system is designed to create. 

For graduates on incomes high enough to make repayments on their student loan but low enough to get Universal Credit, the deductions would be more, leaving them with less than 27p in the pound. Worst case would be earn £1 keep less than 19p.

Universal credit
Universal Credit has been rolled out from October 2013 to replace six means-tested benefits and tax credits. Now after Covid and the lockdowns it is claimed by around five million people. It is the benefit given to almost all new claims for help with income or rent. It is paid to people on low incomes who cannot work, are looking for work, or work on low or modest pay and have children.

It is supposed to let people keep more of what they earn and thus boost incentives both to return to work and to earn more once in work. For every £1 extra earned the credit is reduced by 55p from 24 November 2021 allowing the claimant to keep 45p. Before that it was 63p and had been 65p. This so called ‘withdrawal rate’ of 55p in the pound is said to be much lower than rates under the previous and allowing people to keep 45p of what they earn is seen as an incentive to work. However, that figure of 55p withdrawal rate is only accurate for people who earn less than £242 a week and are not householders.

There is one complexity to be aware of. People with a child or children and people who re judged to have 'limited capability for work' get what is called a 'work allowance'. This is not extra money but is simply an amount they are allowed to earn before the taper kicks in. It is set at £344 a month if universal credit includes help with housing costs and £573 a month if it does not. So those people can earn up to those amounts and the taper will not apply to those earnings. It does apply though to every pound earned over those amounts. And for everyone else the 55% taper applies to the first pound. 

Taxpayers
Universal Credit is worked out after tax and National Insurance have been deducted. In 2022/23 anyone earning more than £242 a week pays National Insurance and income tax. From 6 November employee's National Insurance rates are being reduced to 12% from the 13.25% which applied from 6 April 2022 to 5 November 2022. That extra 1.25%pts does not sgnificantly affect the calculation for those seven months. National Insurance takes 12p in the pound and income tax which begins at the same level takes another 20p in the pound before their Universal Credit is worked out. That leaves £68. The universal Credit taper then reduces their benefit by 55% of that net amount. The total loss from NI, income tax, and reduction in Universal Credit is just over 69p from each £1 they earn. So they keep less than 31p. But that is only part of the picture.

Householders
Universal Credit, despite its name, does not replace all means-tested benefits. It does not replace the means-tested reduction in council tax which used to be called Council Tax Benefit but since 1 April 2013 has been replaced by a similar scheme which is now called Council Tax Reduction and is operated by local councils. Like all means-tested benefits Council Tax Reduction is withdrawn as income rises. The standard taper is 20p for each £1 rise in net income (after the tax, NI, and Universal Credit withdrawal). In other words for each extra pound of net income help with council tax is reduced by 20p. The result is that for each £1 earned a total of nearly 76p disappears in tax, NI, reduced Universal Credit, and reduced Council Tax Support. The calculation is at the foot of this blogpost.

Localism
In some areas of England and Wales the reduction for every £1 of income earned may be even higher as local councils struggle to save money by raising the taper from 20% to as high as 30%. In areas which raise the Council Tax Reduction taper to 25% householders on Universal Credit who pay tax will find that 77p of each pound earned disappears in deductions. In areas with a 30% taper they will lose nearly 79p and keep barely 21p for each extra pound earned after deductions for income tax, National Insurance, Universal Credit taper, and reduced Council Tax Reduction. 

Students
Students with a Plan 1 or Plan 2 student loan make repayments of 9% of on every pound they earn above a threshold (currently £388 a week for Plan 1 and £524 a week for Plan 2). That is in effect an extra 9% tax and those whose income is low enough to be entitled to Universal Credit lose typically 73p in the extra pound keeping just 27p. If they pay council tax then they keep less than 21p and in areas where the council tax withdrawal rate is 30% they keep just 19p of every extra £1 they earn.

It is a tax
Some people object to the deductions made from a means-tested benefit being called a 'tax'. They say that the taper rate reduction in a subsidy from taxpayers is not a tax. Tax, they say, means a levy on your own money not a reduction in the money the state gives you. 

But it is a tax. And officially so. In his Spring Budget, 8 March 2017, Chancellor Phillip Hammond confirmed that the tapered loss of this benefit was a tax. He confirmed the reduction in the taper rate by saying "the Universal Credit taper rate will be reduced in April from 65% to 63%, cutting tax for 3 million families on low incomes." These words were echoed by Chancellor Rishi Sunak in his Autumn Budget on 27 October 2021 "This is a tax on working people -- and I'm cutting it from 63 to 55 per cent...Let us be in no doubt: this is a tax on work. And a high rate of tax at that."

So it is a tax. And a high one. 

Conclusion
Losing 76% or more of each extra pound you earn is hardly an incentive to work or to work harder. It is almost twice the 42% tax and NI deductions for higher rate taxpayers with incomes over £50,270, three times the minimum wage.
CALCULATION OF TOTAL DEDUCTIONS FOR A TAXPAYER HOUSEHOLDER
FOR EACH £1 OF EXTRA INCOME WITH 20% COUNCIL TAX TAPER SHOWING EFFECT OF 55% UC TAPER FROM APRIL 2022

EARNS EXTRA
£1.00
Tax
20%
-£0.20
NI
12%
-£0.12
Net after tax
£0.68
UC reduction
55%
-£0.37
Net after UC
£0.31
CT Reduction
20%
-£0.06
NET GAIN
£0.24
Effective tax
76%

This blogpost replaces the one originally published 19 September 2012.

17 October 2022
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