Creditworthy: assessing the impact of tax credits in the last decade and considering what this means for universal credit

a research paper by Paul Gregg (University of Bath) and Alex Hurrell and Matthew Whittaker (Resolution Foundation) published by the Resolution Foundation

Introduction

The emergence of the tax credit system – from Family Credit to Working Family Tax Credit, Working and Child Tax Credits and now the proposed Universal Credit – represents perhaps the most substantial development in social policy over the last 30 years. Reforms under the previous Labour Government were particularly significant, resulting in the creation of a new system of redistribution towards in-work families with children. This system has provided a balance against both the shift from a family-based income tax system to an individualised one and the increasing focus on a family-based means test in the welfare system.

However, having been at the heart of government policy for much of the last decade, tax credits are now at something of a critical juncture. The political and economic circumstances that drove the evolution of the policy have changed, as have the details underlying some of the challenges which tax credits were designed to tackle. Further significant growth in tax credit spending looks unlikely: from a peak of £28.6 billion in 2009-10, total expenditure on tax credits is set to fall steadily in real-terms in the coming years, dropping to £25.4 billion in 2016-17.¹ At the same time, roll-out of the Universal Credit from 2013 onwards will blur the distinction between in-work support and out-of-work benefits, potentially undermining some of the protection from retrenchment that it was hoped would be afforded to tax credits by their identification as tax rebates for working families rather than benefits.

Yet, against the backdrop of an individualised approach to income tax, tax credits continue to hold a vital role in underpinning family-level progressivity (and it is income at the family level that has most relevance for questions of poverty and living standards). Therefore, while policy objectives may need to be more limited or more effectively achieved in the future, tax credits clearly have much to offer. The challenges of the coming years therefore provide for an opportunity for further evolution of the policy.

This paper takes a first step towards picturing what this evolution might look like. By assessing the impact of tax credits in a number of areas over the past decade or so, we can identify what worked – and should therefore be retained or developed in any future system – and what didn’t. A second paper, due for publication later this year, will build on this work to consider a range of tax and benefit options for meeting the needs of low to middle income families.

We begin by looking briefly in Section 1 at the story so far for tax credits. We consider the factors behind their development and look at who benefits and who doesn’t. In Section 2 we assess the impacts associated with tax credits in five areas: child poverty; in-work incomes; employment; wages; and family formation. Finally, in Section 3 we consider changes in the nature of some of the problems tax credits were designed to counter, including the growing importance of working poverty and the increasing difficulties faced by families reliant on the traditional male breadwinner. It is this discussion which we will pick up in the second paper.

A variety of appendices provide further details of the development of tax credits and eligibility and awards under the current system.

¹Based on projections for tax credit expenditure and inflation set out in the OBR’s Economic and fiscal outlook, March 2012. Figures are in 2009-10 prices, deflated using the RPI

Full text (PDF 66pp)

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