Universal Credit: making work pay in the UK? Paola De Agostini and Mike Brewer Lisbon – October 2 nd, 2013

To improve understanding of  How the introduction of Universal Credit will affect work incentives in the UK across various groups in the population (i.e. low paid workers, single parents, etc.)  how changes to universal credit will affect: The likely position of vulnerable families along the income distribution in future years and Their work incentives Use microsimulation methods to simulate household incomes under future tax and benefit systems In part, updating Brewer, May and Phillips (2009) Research overview

Very dramatic changes in personal taxes and benefits since election (2010), and many more in pipeline  Large rise in income tax personal allowance  Substantial cuts in welfare benefits, including through uprating rules  Major reform of working-age benefits and tax credits to start from (Universal Credit) Why are we doing this?

Will replace:  Income support, income-based jobseeker’s allowance, income-related employment and support allowance, housing benefit, child tax credit, working tax credit  NB: Non-means-tested benefits not affected. Council Tax Benefit not included in UC but also being reformed. Pension Credit unaffected. Combined means-tested benefit for those out-of-work and those in- work with low family income  Should increase awareness and take-up  Should reduce hassle & uncertainty for claimants, administration costs for government No “hours rules”. Instead, UC withdrawn gradually as earnings rise Conditionality regime to be made tougher, and extended to both partners in some working families In reality, complicated phase-in from Oct 2013 through 2017, with some transitional protection for those who lose when transferred; here, we show impact as if UC fully implemented in April 2014 Universal Credit: key features

Universal Credit Example: Couple with children Assumes: couple with 2 children, 1 £10/hr, £100/wk LHA or eligible rent. Ignores Council Tax Benefit. Source: ISER-EUROMOD Same entitlement to benefits if do not work Earnings disregard Slower withdrawal Single system: no horrible interactions, less churn between programmes, and less chance of non-take-up

Universal Credit Example: Couple with children Source: ISER-EUROMOD Assumes: £10/hr, £100/wk LHA or rent Same out of work income Slower withdrawal, so much stronger work incentives No “notch” at 24 hrs/wk Slower withdrawal, so stronger incentives to earn more Faster withdrawal, so weaker incentives to earn more Better off under Universal Credit regardless of hours worked

EUROMOD is static tax and benefit microsimulation model designed to facilitate cross-national research within the EU Base data from Family Resources Survey , with information on household demographics labour market characteristics gross market income tax and benefit instruments not simulated by EUROMOD (Same underlying dataset as equivalent models at IFS, HMT, DWP, etc...) We adjust data to represent 2013/14/15 (see later) EUROMOD-UK

No single household dataset records accurately who receives NMW (LFS) and full household characteristics and income sources (FRS) Solution  For all workers in FRS, we impute a “true hourly rate” given observed relationship observed in the LFS between true hourly rate and characteristics of the worker including weekly earnings; weekly hours; job, person and household characteristics  Method follows Skinner et al. (2003)’s suggestion for imputing accurate hourly wage for those paid by the hour (as also implemented in Brewer et al., 2008) But…

Uprating financial variables to their projected level in 2014  Using actual uprating factors from to the present (2012) from ONS  Using forecast of average earnings and consumer price index (CPI) from ONS and nominal GDP from OBR for projection beyond 2012 We do not account for demographic changes Use EUROMOD to account for announced changes in the UK T&B system that are due to take place by April  Tax liabilities and benefit and tax credit receipts; taper rate changes and hours requirements; total household benefit cap; withdrawal of child benefit from families earnings more than £50,000  More difficult reforms ad hoc sophisticated approach: LHA, transfer of recipients from IB to ESA, rise of SPA for women. Projecting FRS forward to future years (2013/14 and 2014/15)

Income of vulnerable (i.e. low paid, single parents) households, and position in the income distribution Impact of UC on vulnerable families’ income Impact of UC on measures of financial work incentives  Marginal effective tax rate (METR): amount of additional earnings taken by personal tax and benefit system  Participation tax rate (PTR): measures incentive to work at all How many workers are subject to in-work conditionality? Main outcome measures

Source: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate Notes: FRS 2009/10, weighted Changes in mean weekly net equivalised income by employment status, earnings and family type, under universal credit compared to the current system [working age households only]

Changes in mean weekly equivalised disposable income by employment and NMW status and family type

Source: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate Notes: FRS 2009/10, weighted a Proportion of working-age households facing METRs within a given interval (0-60%, 60%-80% and more than 80%) b Excluding consideration of council tax support, the number of people facing very high METRs is reduced. c In this report we use households to mean tax units or benefit units. Average METRs under current system compared to universal credit, for single parents and for all households [working age only]

Source: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate Notes: FRS 2009/10, weighted a In this report we use households to mean tax units or benefit units Average PTR of non-working single parents compared to all non-working adults in any household type under the current system and under universal credit at different hours worked [assuming minimum wage earned, working age households only]

We consider various changes to UC compare to the system as it is currently planned, to see which (if any) would achieve improvements for single parent families under UC. We consider the following four alternative scenarios: 1 – Reducing the UC taper from 65% to 55%, 2 – Increasing the basic allowance for everyone within UC by £39 per year, 3 –Increasing the amount of income disregards for everyone on UC by £39 a year, 4 –increasing income tax threshold for the basic tax rate by £300. For each scenario, we estimate its impact on the disposable income distribution and work incentives of single parents. Changes to Universal Credit

Changes to UC: impact on single parent families income

Source and Notes: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate FRS 2009/10, weighted Changes to UC: impact on income distribution

Changes to UC: Effects on financial incentives to progress in work (METRs)

Source and Notes: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate FRS 2009/10, weighted Changes to UC: impact on financial incentives to progress in work (METRs) [all workers]

Source and Notes: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate FRS 2009/10, weighted Changes to UC: impact on financial incentives to progress in work (METRs) [single parents]

Changes to UC: effects on non-workers’ PTRs if working at minimum wage 40 hours per week

Changes to UC: The effect of the four changes outlined on PTRs among single parents working 20 hours per week at the national minimum wage, compared to the baseline [currently planned] universal credit scenario

Changes to UC: The effect of the four changes outlined on PTRs among all (non-working) adults working 40 hours per week at the national minimum wage, compared to the baseline [currently planned] universal credit scenario

Source: Authors’ calculation based on FRS, , using EUROMOD and assumptions specified in the text to simulate Notes: FRS 2009/10, weighted a Base UC estimated annual extra costs compared to the current system. Estimated annual costs for each policy reform proposal compare to currently proposed UC (in millions)

Clear differences between families for whom NMW is main source of earnings, and other NMW families  Both type of families lose slightly from UC, but families for whom NMW jobs are secondary source of income lose more  But great variation within these changes some related to family type UC has complicated impacts on incomes and incentives, partly reflecting inconsistencies in current system, and partly reflecting that UC taper is on "net income", not "gross income" On average METRs fall slightly (increasing incentive to work more or seek better paid jobs).  UC reduces the number facing very high (80+) METRs but increases the number facing high METRs (60% to 80%)  More changes when broken down by family type On average UC increase PTRs of potential second earners especially for families where the main earner is paid at the NMW  Incentive to work for non-working partner of NMW workers weakened considerably by UC, especially at 20 hours Reforms to UC: None of the reforms to Universal Credit achieves both substantial redistribution of income to poor and a substantial strengthening of average work incentives. The best option depends on the government’s priorities given the available budget. Other results not included in this presentation:  number of NMW families subject to in-work conditionality" Summary

Extra Slides

Currently, the UK welfare system for working-age families includes: Income replacement to non-working families, or income top-ups to working families (JSA, ESA, IS, WTC); separate and mutually exclusive Help with family’s extra costs (HB, CTB, CTC); separate, not mutually exclusive Faults: inefficient for the government, confusing for claimants, administratively costly, reduces incentives to move into work Current system of means-tested social security benefits for working-age adults

General eligibility: low income working-age families The maximum UC is the total of: Standard/Personal allowance An amount for each child An amount for each disabled child (at a lower or higher rate) An amount for an ill or disabled adult (at a lower or higher rate) An amount for a carer An amount for housing costs An amount for childcare Earnings disregards vary with family circumstances and housing element Taper (65% on earned income; unearned income reduces UC entitlement pound-by-pound) Universal Credit: the amount

Universal Credit Example: Lone Parent Assumes: lone parent with 2 children, earns £6.5/hr, no housing costs. Ignores Council Tax Benefit. Source: ISER-EUROMOD Same entitlement to benefits if do not work Earnings disregard Slower withdrawal Single system: no horrible interactions, less churn between programmes, and less chance of non-take-up

Universal Credit Example: Lone Parent Source: ISER-EUROMOD Assumes: Lone parent with 2 children, earns £6.5/hr, no housing costs. Ignores Council Tax Benefit. Same out of work income Slower withdrawal, so stronger work incentives No “notch” at 16 hrs/wk Slower withdrawal, so stronger incentives to earn more Faster withdrawal, so weaker incentives to earn more Not much change in income for those in work either

Average weekly change (%) in equivalised family net income over the working-age income distribution, by employment and NMW status Impact of Universal Credit on income of NMW families Average weekly change (%) in equivalised net family income over the working-age income distribution, by employment and detailed NMW status

Cumulative distribution of PTRs comparing couples with and without children Non-working adults in couples before and after UC, assuming they work 10 hours/wk at the NMW Non-working adults in couples before and after UC, assuming they work 20 hours/wk at the NMW