UK Tax Credits Discourage Poorer Jobseekers

by Jason Gorringe, Tax-News.com, London

06 October 2006

A report published this week by the Institute for Fiscal Studies has suggested that the government's tax credit system and benefit reforms have weakened the incentive for those on lower incomes to work, as they may often find themselves relatively speaking worse off once in paid employment.

The report, funded by the Joseph Rowntree Foundation, suggested that on average, tax and benefit changes since 1997 mean that someone choosing to work harder gets to keep 2½p less of each extra GBP1 they earn.

The Institute explained that the trend has not been universal, as reforms have strengthened incentives for lone parents to work at all, and have strengthened incentives to earn more for some groups previously facing the weakest incentives.

However, the weakest work incentives are now faced by people on low incomes who may have their means-tested benefits or tax credits withdrawn if they increase their income.

The IFS observed that:

"Such disincentives are much greater than those imposed on high-income people through higher rates of income tax. Over two million workers in Britain stand to lose more than half of any increase in earnings to taxes and reduced benefits. Some 160,000 would keep less than 10p of each extra GBP1 they earned."

It went on to add that:

"An alternative would be to target the sort of families that are likely to be poor, rather than directly to those that are poor. For example, an extra credit for families with three or more children would be well targeted on the poorest children, and would hardly affect work incentives. But this approach is not without drawbacks: it might be considered unfair on those who are poor but in small families, and it might affect families’ childbearing decisions."

"The report considers a number of other possible reforms that might reduce poverty or strengthen work incentives. Housing benefit recipients face some of the weakest work incentives, and a reform in keeping with changes since 1997 would be to reduce the rate at which it is withdrawn with income."

"This would help some families on low income, and strengthen incentives for those currently facing housing benefit withdrawal to earn more. But such a reform would involve a considerable extension of means testing, weakening incentives to earn more for those families who became newly entitled to housing benefit."

Stuart Adam, one of the authors of the report, observed that:

“Two strategies that governments have to help people on low incomes – providing them with financial support directly, and encouraging them to earn more – generally conflict. There is no easy solution to this trade-off. Ultimately, governments need to decide how much they want to redistribute income to low-income families, and how much they mind if people work less as a result.”

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