How the tax and benefit system creates a poverty trap and is destroying Britains families.

by Virginia Newsom Virginia is a trained accountant, specialising in tax, with over ten years of experience of working with people struggling with debt. Few Oscar winners stand up and say Thank you I did it all alone no, they thank and recognise the support of others. Footballers that work together as a team win. People live in communities and work as teams. Therefore why do we have a tax system that fails to recognise households as teams, but breaks them up? Families in the UK are struggling as highlighted by recent headlines. UK families have the highest marginal tax rate at 73% than virtually all other OECD countries. (CARE report the taxation of families international comparisions 2012.) The current sytem of working age benefits is confusing and often unreliable. It can also provide very high financial disincentives to taking up work. (Joseph Rowntree
Foundation - Universal Credit analysis)

The UK has a higher % of single parent families than most EU countries. (Office of National Satistics 2013 Families and households). The UK ( after Spain) has the highest % of low skilled poorly paid jobs in the OECD. (Chartered Institute of Personnel report 2014) There are more children in poverty in families where one person is working than any others. (Joseph Rowntree Foundation Budget 2014 submission) Recent reports suggest family separation is costing the UK taxpayer about 44bn a year, and child poverty 29bn. ( Tavistock Institute Feb 2014, Joseph Rowntree Foundation 2013) The UK has a tax/benefit system that traps millions in low income state support.(About 4.3m familes receive at least 50% of their income from state support. Guardian 6/4/13 )

For more than ten years, both as an adviser with Citizens Advice and more recently as a debt budgeting coach I have worked with families on low income. I have seen firsthand their struggles with tax and benefits, seen how they are trapped by the system on low income. I am often asked to run calculations to see if a person would be better off separated from their family, or if a couple could afford to live together. Sadly, often the answer is that couples with children are financially better off apart. It was tragic to see a loving father leave his family purely because of the tax system. The problem is explained in the CARE research reports on the taxation of families. In the UK, tax is based on the individual, but benefits are based on households. The tax system does not recognise family responsibilities. When people take up work and move off benefits the result is an effective marginal tax rate of at least 73% ( which will increase to 76% under Universal Credit and become more obvious in pay packets). This means an extra 100 overtime leaves 27 in the pocket. The rest goes back to the Government. This high rate spreads across a large range of incomes, from those on minimum wages, around 10,000 pa, to salaries above 40,000 for VCN April 2014

those with three children. It creates an invisible financial barrier, blocking improvements in living standards The graphs below illustrate the problem Graph 1 is for a single person, graph 2 is for a family with two children and a single earner under universal credit, graph 3 is the family separated. The blue lines show income for the household and the red is what goes to the Government. The vertical axis shows earning increments of 2,000.
0% Graph 1 46-48k 42-44k 38-40k 34-36k 30-32k 26-28k 22-24k 18-20k 14-16k 10-12k 6-8k 2 - 4k BENEFIT BENEFIT 50% 100% Graph2 46-48k 42-44k 38-40k 34-36k 30-32k 26-28k 22-24k 18-20k 14-16k 10-12k 6-8k 2 - 4k BENEFIT BENEFIT BENEFIT BENEFIT 19.3k BENEFIT BENEFIT BENEFIT 16.6k 0% 50% 100% Graph3 46-48k 42-44k 38-40k 34-36k 30-32k 26-28k 22-24k 18-20k 14-16k 10-12k 6-8k 2 - 4k 0% 50% 100%

A single person unable to work receives benefits of about 8,300pa. When they work, benefits are withdrawn, then earnings are taxed. When they reach earnings of about 16,000pa they escape the bottle neck and have a minimum income standard In comparison, a family household of two adults and two children, with no earnings, receives benefits of about 19,300 pa. Then if one person in the family is working, they do not escape the high effective tax rates until salaries of 38,000. This is the poverty trap. For a family extra work does not bring much extra income. The same trap applies to single working parents. VCN April 2014

The third graph shows how much better off a family is when they separate. The earner leaves and is taxed alone, whilst the single parent and children stay on benefits.

The high effective marginal tax rates across a large income range; are a disincentive for households to earn more, create a culture of dependency, result in many families being financially better off separated, leave families unable improve their standard of living through work.

Most solutions tend to focus on increasing an individuals wages but not looking at their expenses. Raising the minimum wage, new starting tax rates, increasing tax free thresholds fail to tackle the real problem, we need look at the household as a whole. Any business which only looks at turnover and not expenses goes bankrupt so we should not take the same approach to families. Graph 4 shows the profile for the same family if a fully transferable tax allowance system was introduced. The graph shows the profile if each dependent could transfer 2,500 to the earners in the family.
0% Graph4 46-48k 42-44k 38-40k 34-36k 30-32k 26-28k 22-24k 18-20k 14-16k 10-12k 6-8k 2 - 4k 50% 100%

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A system of transferable tax allowances can easily recognise household responsibilities in the tax system. These would allow households to work and provide for basic needs before paying tax. It would particularly help families with single earners, the largest group for which children are in poverty, but could also ease the burden on single working parents, and couples where one person loses their job. They provide a fairer system. They also remove the discrimination against families in the tax system which seems to be unique to the UK out of all highly developed economies. They would; raise the level at which families start paying tax, ease the bottleneck blockage caused by the marginal effective tax rate, reduce dependency on the state, enable more earners to support their household allow families choice as to how they provide for their family. give value to all members in the family. support families to work together and provide mutual care.

Each family is a team with different needs and skills. These vary over time and families should be allowed to choose how they support themselves, to be flexible as circumstances change, to support each other in careers, periods of redundancy or sickness, setting up businesses, and looking after children, or disabled relatives. If a family is able to earn a basic living and stays together, this reduces cost to the UK and means the tax payer no longer needs to support the single parent family, deserted by their partner. Over the last two decades, as personal tax allowances have risen and certain benefts become more generous, families have been left behind. The Joseph Rowntree Foundation Minimum income standard, a measure of what is needed for a reasonable lifestyle, finds that a pensioner couple can almost reach this standard on benefits alone, whereas a family ( with three small children) with a sole earner needs a salary of 42,000 well above the UK median wage of 22,000. The new Universal Credit (UC) has addressed some problems of the benefit/tax credit system by introducing: real time calculations, a single monthly payment, and no requirements to work a minimum number of hours. It is accessible to more and encourages people to take on small amount of work. However it does not address the high effective tax rate barrier. Furthermore there is some uncertainty about how Universal Credit will treat a parent with considerable care responsibilities at home. In the recent budget the Government allocated 1.41bn to raising the personal tax threshold by 500. According to the IFS most of this goes to those in the top half of the income distribution. In contrast the cost of the 1,050 transferable allowance was 0.25bn, which is restricted to basic rate tax payers. VCN April 2014

It makes financial sense for families to stay together, and work together. To do that the UK needs to join the developed world and recognise households in the tax system.

Explanatory note :- How the current system works: 1. A single person on benefits receives about 8,300 pa (ie 4,500 housing, 3,700 living). A family of two adults and two children receives benefits of 19,300 pa ( ie housing 5,600, living 3,700 1st adult, 2,100 2nd adult, 1st child 4,400 and 2nd child 3,400). 2. When a person starts work they can earn 1,300 pa (2,600 per couple) before having to repay UC. Tax credits are recoverable above 6,400. Above these income thresholds UC is recovered at 65% of income after tax, or tax credits at 41% of gross income. 3. National Insurance at 12% is paid on income above 8,000 and income tax of 20% on income above 10,000. This means earnings above these amounts are taxed at around 73% ( NI 12%, IT 20%, TC 41%) or 76% if repaying UC. 4. A single person earning more than 16,000 will have repaid credits, and is then only subject to income tax and NI at 32%. However a family does not escape these high tax rates until income levels are reaching the higher tax brackets of 42% at 40,000. 5. A single person on 17,000 can do a 100 overtime and take home 68. A family person on 17,000 can do 100 overtime and take home 27 for their whole family. 6. An alternative tax system could use transferable tax allowances to replace virtually all benefits. An amount of tax allowances could be cashed in at a discount of say 85% . On a weekly basis a household could cash in a housing allowance and each individual a living allowance. Any amounts cashed in would alter the tax code and reduce tax free earnings. The advantages of this type of tax system are; everyone could have their basic needs catered for, everyone would be treated equally, benefits are not given and then taken away. Working would be more rewarding. It would be simple, help with budgeting, and less open to error and fraud.

VCN April 2014