Ed Davies is Policy Director at the Centre for Social Justice.
The Government is approaching the budget next month in a difficult bind. Firstly, this is a political budget for an election year; the Conservatives will want to cut tax to bolster the voter base.
Secondly, it is facing record levels of economic inactivity; this has been the Treasury’s keenest focus since the Covid pandemic but it is a problem that predates that.
Finally, both these factors are taking place in the context of a sluggish economy, which has had anaemic growth for well over a decade.
There are no magic bullets in politics or economics, but there is one option that has the potential to move the dial in all three areas: sensible adjustment Universal Credit.
UC was designed with the flexibility to adapt to the economy with two main levers, which are basically taxes on low incomes.
The first is the taper rate – the rate at which benefits are withdrawn as you increase your earned income. It currently sits at 55 per cent, i.e. your UC payment is reduced by 55p for every pound you earn.
The second is the work allowances – the amount of money you can earn when you first enter work before your benefits start to reduce and the taper rate kicks in. Depending on your particular circumstances, the amount can be between about £300 and £600.
Both of these levers are often seen as fixed technical points within the welfare system. But they were actually designed, just like any other tax, to be used flexibly and respond to what the economy needs.
(They have moved before: it was only a couple of years ago that Rishi Sunak announced the reduction in the taper rate from 63 per cent to 55 per cent.)
For example, if general employment is high but people are not taking on many hours of work, you can lower the taper rate to incentivize people to take on more hours (and take home more money).
On the other hand, If the challenge is, as now, to encourage more people to get that first foot on the ladder, then increasing the work allowances means that somebody has a greater incentive to start any job without immediately losing their benefits.
This is what the Chancellor should consider. Not only is this a fairly simple measure to do, but it has the added benefit of being cheaper and more targeted than most other tax breaks.
For example, the idea of increasing the lower tax thresholds has become a nice political soundbite about “lifting low-earners out of tax completely”. In reality there will be a lot of those low earners who are choosing to earn less because they don’t need more money – a second earner in the household, somebody with savings, etc.
Moreover, high earners benefit too. You aren’t just lifting low earners out of tax, you are also reducing overall tax for everybody – including millionaires who really don’t need it.
By contrast, investing in the work allowance is perfectly targeted on the people who, by definition, need most income support, and gets to them far more cheaply than a universal tax break would.
If 2024/25 Universal Credit work allowances were arbitrarily raised by £100, this would cost the Exchequer a little under £2 billion (with very small offsetting savings on other benefits).
Contrast that with 2p off main rate of National Insurance, or 1p off basic rate of Income Tax, which on the same year basis would cost HM Treasury just above £9 billion and around £5.5 billion respectively. (Again, both with some savings elsewhere in the welfare system owing to tax and benefit rules.)
The Government is, of course, free to raise these allowances, letting claimants in work keep more of their earned money, by as much as they like.
But even this illustrative example shows that Universal Credit affords an option both much cheaper and better targeted, with the savings available to be spent on other priorities.
Work allowances were always meant to be the first step away from economic dependence, and in the original UC design were for that reason intended to be much more generous than they are at present.
Increasing them would be a double-win for Jeremy Hunt: a tax cut that effectively encourages people into work. Better still, and again unlike a universal tax cut, almost every penny saved by UC recipients is likely to be spent in the economy.
Of course, one might argue that if it hits fewer pockets it may win fewer votes. But the same can be said of many levers of government. On the merits, though, raising the work allowances looks like just about the best tax cut the Chancellor could announce today.
Ed Davies is Policy Director at the Centre for Social Justice.
The Government is approaching the budget next month in a difficult bind. Firstly, this is a political budget for an election year; the Conservatives will want to cut tax to bolster the voter base.
Secondly, it is facing record levels of economic inactivity; this has been the Treasury’s keenest focus since the Covid pandemic but it is a problem that predates that.
Finally, both these factors are taking place in the context of a sluggish economy, which has had anaemic growth for well over a decade.
There are no magic bullets in politics or economics, but there is one option that has the potential to move the dial in all three areas: sensible adjustment Universal Credit.
UC was designed with the flexibility to adapt to the economy with two main levers, which are basically taxes on low incomes.
The first is the taper rate – the rate at which benefits are withdrawn as you increase your earned income. It currently sits at 55 per cent, i.e. your UC payment is reduced by 55p for every pound you earn.
The second is the work allowances – the amount of money you can earn when you first enter work before your benefits start to reduce and the taper rate kicks in. Depending on your particular circumstances, the amount can be between about £300 and £600.
Both of these levers are often seen as fixed technical points within the welfare system. But they were actually designed, just like any other tax, to be used flexibly and respond to what the economy needs.
(They have moved before: it was only a couple of years ago that Rishi Sunak announced the reduction in the taper rate from 63 per cent to 55 per cent.)
For example, if general employment is high but people are not taking on many hours of work, you can lower the taper rate to incentivize people to take on more hours (and take home more money).
On the other hand, If the challenge is, as now, to encourage more people to get that first foot on the ladder, then increasing the work allowances means that somebody has a greater incentive to start any job without immediately losing their benefits.
This is what the Chancellor should consider. Not only is this a fairly simple measure to do, but it has the added benefit of being cheaper and more targeted than most other tax breaks.
For example, the idea of increasing the lower tax thresholds has become a nice political soundbite about “lifting low-earners out of tax completely”. In reality there will be a lot of those low earners who are choosing to earn less because they don’t need more money – a second earner in the household, somebody with savings, etc.
Moreover, high earners benefit too. You aren’t just lifting low earners out of tax, you are also reducing overall tax for everybody – including millionaires who really don’t need it.
By contrast, investing in the work allowance is perfectly targeted on the people who, by definition, need most income support, and gets to them far more cheaply than a universal tax break would.
If 2024/25 Universal Credit work allowances were arbitrarily raised by £100, this would cost the Exchequer a little under £2 billion (with very small offsetting savings on other benefits).
Contrast that with 2p off main rate of National Insurance, or 1p off basic rate of Income Tax, which on the same year basis would cost HM Treasury just above £9 billion and around £5.5 billion respectively. (Again, both with some savings elsewhere in the welfare system owing to tax and benefit rules.)
The Government is, of course, free to raise these allowances, letting claimants in work keep more of their earned money, by as much as they like.
But even this illustrative example shows that Universal Credit affords an option both much cheaper and better targeted, with the savings available to be spent on other priorities.
Work allowances were always meant to be the first step away from economic dependence, and in the original UC design were for that reason intended to be much more generous than they are at present.
Increasing them would be a double-win for Jeremy Hunt: a tax cut that effectively encourages people into work. Better still, and again unlike a universal tax cut, almost every penny saved by UC recipients is likely to be spent in the economy.
Of course, one might argue that if it hits fewer pockets it may win fewer votes. But the same can be said of many levers of government. On the merits, though, raising the work allowances looks like just about the best tax cut the Chancellor could announce today.