Reducing the Universal Credit taper rate and the effect on incomes

As part of his Autumn 2021 Budget, Chancellor Rishi Sunak announced that the Universal Credit (UC) taper rate was to be reduced from 63% to 55%.

The taper sets the rate at which UC is withdrawn as claimants’ earnings increase. The Chancellor described it as a “hidden tax on work” and argued that this policy represented a “tax cut for the lowest-paid workers in the country”.

It was also announced that UC work allowances would be increased by £500 per year.

But what does this mean in practice? This Insight looks at the effect of recent changes to UC on claimants’ incomes.

How does the taper rate work?

The maximum amount UC claimants can receive depends on their household’s circumstances. For claimants who are in work, the amount may be reduced based on earnings.

This reduction is based on two factors:

• The work allowance is the amount that a claimant can earn before their UC starts to be reduced.
• The taper is a constant rate at which the award is withdrawn once earnings exceed the work allowance.

Not all households receiving UC have a work allowance. These are currently only available to households with children, or with health conditions or disabilities resulting in ‘limited capability for work’. For households without a work allowance, their UC begins to taper away as soon as they start earning.

How much are UC claimants taxed?

In the UK there are two taxes on earnings: Income Tax and National Insurance (NI). Benefit recipients, if they earn enough, pay these taxes at the same rates as others.

Strictly speaking, the taper rate is not a tax. It does not affect gross earnings from work as it is only applied to the UC award. In fact, most state benefits (including UC) are exempt from tax.

Although the taper rate is not a tax, the effect felt by claimants is arguably similar and commentators often include it in analysis of the “taxes” on working claimants.

Marginal deduction rates

The marginal deduction rate (MDR – sometimes also referred to as the marginal effective tax rate) measures the combined effect of tax and benefit deductions on income. It is the percentage of each extra £1 of gross earnings that is then deducted in the form of income tax, NI and withdrawn welfare support (benefits and tax credits).

The general principle is the lower the MDR, the greater the work incentive because people keep more of their earnings.

The charts below compare the MDRs faced by a single parent with one child, earning the National Living Wage (NLW) and receiving UC, before and after the implementation of the Autumn Budget changes. The darker shading represents the claimant’s earnings and the lighter shading their UC.

When a claimant’s income exceeds the UC work allowance, they face an MDR equivalent to the taper rate (currently 55% following the Autumn Budget changes). This means that for every additional £1 earned over the work allowance, 55p is deducted as the UC award starts to be reduced.

As income rises, exceeding the NI primary threshold and Income Tax Personal Allowance, the MDR increases again to reflect these taxes being paid. Once the UC award is fully tapered away, the MDR falls to 33.25% (comprising 20% income tax + 13.25% NI). However, the claimant in the example in the chart would need to be working considerably more than full time before they would face an MDR lower than 70%.

Before the Autumn Budget changes, the claimant would have had their UC reduced to nothing once they were working 44 hours or more. With the changes in place, they will be able to work up to 50 hours and still receive some UC payment.

Who will benefit from these changes to UC?

While some households’ incomes will have increased following the Autumn Budget changes, these measures only benefit claimants who are in work.

The Treasury says that 1.9 million working households are expected to gain, on average, around £1,000 per year. In August 2021 there were 4.9 million households on UC (see our Universal Credit rollout data dashboard for the most up-to-date figures).

The picture is slightly different when considering the context in which these changes happened. The Budget announcements came after the removal of the £20 per week uplift to the UC standard allowance. This had been introduced as a temporary measure in response to the coronavirus pandemic. Its removal marked a shift back to pre-pandemic real-terms levels of benefit, amounting to a £1,000 loss in annual income for all UC recipients. For further information, see the Library briefing Opposition Day Debate: Universal Credit and Working Tax Credits.

The chart below shows the UC entitlement of a single parent household with one child, under three different policy scenarios: with the Autumn Budget changes in place; if the £20 uplift had been retained; and under the pre-pandemic system, without any of these measures implemented.

For the highest earning UC families, changes to work allowances and the taper rate will offset the loss of the £20 uplift. The same single parent will be better off than they had been with the uplift if they are earning £18,200 or more.

Lower earning families are still expected to lose out following the removal of the uplift, but by less than they would have if the Autumn Budget measures had not been introduced. Whereas out-of-work families will feel the full effect of the removal of the uplift, with their UC awards falling back to pre-pandemic levels.

Analysis by the Resolution Foundation shows that ¾ of families on UC are expected to be worse off than they would have if the £20 uplift had been retained instead.

About the author: Esme Kirk-Wade is a statistics researcher at the House of Commons Library, specialising in social security.

Image: Job Centre Plus by HelenCobain under CC BY 2.0