Distributional Effect of Proposed Reforms to Tax Credits

Distributional Effect of Proposed reforms to Tax Credits Summer Budget announcement

Summer Budget 2015 announced a package of welfare measures expected to yield savings of £13 billion a year by 2020-21. This included changes to tax credits, to take effect from April 2016:

• Reducing the income thresholds in tax credits and UC work allowances, so that maximum awards start to be withdrawn at a lower income level; and
• Increasing the tax credits withdrawal rate (taper) from 41% to 48%, so that tax credits reduce more sharply as income increases.The Summer Budget also announced that the child element in tax credits and in Universal Credit to be limited to two children for new claims and births after April 2017, and that the family elements in tax credits and UC would be abolished new claims from 2017. These changes are being introduced separately by the Welfare Reform and Work Bill.
• These changes were to take effect from April 2016, and would deliver savings of around £4.4 billion in 2016-17.

Implementation

The reductions to the tax credit income thresholds and the increase in the taper rate were to be introduced by regulations. The draft Tax Credits (Income Thresholds and Determination of Rates) (Amendment) Regulations 2015 were published on 7 September.

In response to a request from the Chair of the Work and Pensions Committee, Frank Field, the Government brought forward the Commons vote on the regulations. The debate was held on the floor of the House on 15 September, and the motion to approve the regulations was agreed by 325 votes to 290.

The House of Lords debated the regulations on 26 October.

An amendment to the motion to approve the regulations tabled by the Liberal Democrats, declining to approve the regulations, went to a vote with 99 for and 310 against, so the amendment was rejected.

An amendment tabled by the Crossbencher Baroness Meacher, seeking to delay consideration of the regulations until a report has been produced addressing the Institute for Fiscal Studies' analysis of the regulations and their impact, and considering possible mitigating action, went to a vote. The amendment was agreed by 307 votes to 277 against.

Peers also voted on an amendment tabled by the Labour Member Baroness Hollis of Heigham, seeking to delay consideration of the regulations until consultation and a report to Parliament on a scheme for full transitional protection for a minimum of three years for all existing tax credit claimants, and a report to Parliament on the Government’s response to the IFS report on the changes, including consideration of possible mitigating action. This was agreed by 289 votes to 272.

At Treasury Questions on 27 October, the Chancellor announced:

“Last night, unelected Labour and Liberal peers voted down the financial measure on tax credits approved by this elected House of Commons. That raises clear constitutional issues that we will deal with. We will continue to reform tax credits and save the money needed so that Britain lives within its means, while at the same time lessening the impact on families during the transition. I will set out these plans in the autumn statement. We remain as determined as ever to build the low tax, low welfare, high wage economy that Britain needs and the British people want to see.”

Analysis and comment

Detailed background and analysis can be found in the Commons Library briefing paper Tax Credit changes from April 2016, published on 15 October 2015. The briefing outlines what tax credits are, the changes announced in the Summer Budget 2015 and how these changes were to be implemented. It also estimates what impact these changes were expected to have for families in combination with other measures announced in the Summer Budget 2015, such as introduction of the National Living Wage, the increase to the Personal Allowance and the freeze in Child Benefit.

Work and Pensions Committee evidence session

On 26 October the House of Commons Work and Pensions Committee held an urgent evidence session on the proposed reforms to the tax credit system. Representatives from the Institute for Fiscal Studies (IFS) and the Resolution attended, and were questioned by the Committee on the following topics:

• The impact of the April 2016 tax credit cuts (in isolation and in the context of other welfare measures in the Summer Budget), and the National Living Wage
• The winners and losers and their characteristics
• The extent to which the National Living Wage will compensate individuals receiving lower tax credit payments
• The distributional impact of these measures, individually and combined
• The scale of the financial gains/losses to households and what influences this
• The quality of the analysis produced by the Government to support their proposals
• Other options for achieving savings from the tax credit system that will mitigate the impact on the least well off
• The implications for work incentives and the Government's wider objectives in welfare reform

A transcript of the evidence session is not yet available, but a recording of the session can be viewed on Watch Parliament TV.