Who is paying for the child tax credit increase?

By Declan Gaffney

During the election campaign, Labour attacked Conservative proposals to reduce tax credit entitlement for better off families, saying that the savings they were aiming for would require cuts to entitlement for families with much lower gross incomes than the threshold of £40,000 which the Tories had referred to. The Conservatives responded angrily, insisting that Labour was distorting their position in order to raise anxieties among groups who they had no intention of targeting. The so-called emergency budget announced both cuts and increases to tax credit entitlements. As Will Straw has pointed out, the claim that families with incomes below £40,000 would not be affected is inconsistent with one of the tables in the budget document, which shows child tax credit falling away for a family with one child at a gross income level of £25,000.

The insistence on the figure of £40,000 during the election campaign may explain one of the more puzzling features of the budget – the two stage cut to the ‘family’ element of Child Tax Credit, the quasi-universal payment which was the focus of the acrimony during the election campaign. The threshold at which the ‘family’ element (worth £545 a year) is withdrawn is to be reduced first from £50,000 to £40,000 in 2011 – consistently with the position taken by the Tories during the election campaign – and then to be aligned with other elements of tax credits in 2012, so that the family element will be withdrawn from the point that the more targeted ‘child’ element (worth £2,235 a year per child at the maximum) is reduced to zero. It is hard to see what policy rationale there could be for this two stage process given the coalition’s expressed desire for urgent cuts – or to avoid the conclusion that it is intended to buy time for the memory of election campaign pledges to fade.

Table 1 below shows that the income level at which the family element will be tapered away in 2012 for many families is a lot lower than £40,000. The numbers of families affected are also of a different order. Table 2 shows that those with gross incomes over £40,000 are a small minority of tax credit recipients (14%). Although not all families with incomes below £40,000 will be affected in the same way, the 2012 change will certainly impact on far more families than the 600,000 implied by the Conservative election campaign position.

Taking the change to the family element in isolation in this way is arguably unfair. After all, the budget raised the basic child element award by £150 in 2011 and a further £60 in 2012, although it also increased the rate at which tax credits are withdrawn as gross income rises from 39% to 41%. And of course the income tax personal allowance has been raised by £1,000 with the explicit intention of improving incomes for lower paid workers. How far do these measures compensate families with incomes below £40,000 for the loss of the family element of CTC?

Taking all these measures into account the effect of the cut to the family element (families lose up to £545) is reduced, but not in general eliminated. Chart 1 shows the effect of the changes for a single earner family paying a social rent with two children with no additional tax credit entitlements apart from the 30 hour element. Note that this is an illustrative scenario, not an attempt to capture the impact on all families.The positive distributional impact of the combined changes at lower income levels can be seen: not enormous for most families, and sharply reduced for those with the lowest earnings who lose much of the increase in tax credits and the reduction in income tax to housing benefit withdrawal (shown by the kink in the line when earnings are around £11,000), but nonetheless mildly progressive. Not all of this is due to the tax credit increase, and critics of the income tax cut should acknowledge that it will have some progressive effect on lower incomes.

Nonetheless, even with the positive impact of other changes, net losses still kick in at £24,000. There is no question therefore that the Conservative election position has been abandoned. Along with that position the coalition should also drop the pretence that tax credits are a source of pain free spending reductions. Both LibDems and Conservatives talked up the payment of the family element to better off families during the election campaign and in the run-up to the budget, and LibDem statements since the budget have implied that the rise in the child element was paid for by reducing these payments. [http://www.libdemvoice.org/nick-clegg-and-simon-hughes- on-the-budget-20030.html.]Such claims are arithmetically untenable: the 2bn cost of the CTC increase could not be met by taking £545 a year from the 600,000 recipients with incomes over £40,000, or even the million and a half with incomes over £30,000. The increase is also to be paid for by sharpening the withdrawal rate, by other cuts to tax credits, such as additional payments for those with very young children and by cutting the family element much lower down the income scale than had been suggested. There may be sound arguments to support those cuts: the claim that the increase in CTC is primarily funded by redirecting giveaways to the affluent to those most in need is not one of them.