The cost of living crisis – what can the Government do?

Families are facing a cost of living crisis. Rachel Maclean a Government minister has said families can overcome the crisis by working more or getting a better job. For the five million plus families on universal credit working more makes very little difference.

Don Draper of Tax and the Family explained on SKY News that earning more they have to pay more income tax, pay more national insurance, and their universal credit is reduced. When you add it all together, they are in effect being taxed at 70% on their extra earnings.

If they were able to earn an extra £100, this would only increase their disposable income by £30. At the minimum wage of £9.50 this means they would have to work for over 10 hours to earn a mere £30 – another 2 days a week.

For millions of people who are caught in this tax trap, earning more will not solve the cost of living crisis.

“It is alarming that Ministers appear so out of touch that they do not even understand the problems real families are facing. If they don’t understand the problem, they are not going to come up with answers that work” Don Draper has said.

The answer is you don’t start by reducing their incomes. Income tax needs to take account of the number of mouths there are to feed not just earnings. In other countries, in Germany, France and the US for example families with modest incomes would not be paying income tax. They should not be paying income tax here.

What can the Government do?

The Government must act. This is not the time for ideology and sound bites. It is the time for facing realities. Help must be targeted at families who are struggling with their finances - those most in need.

The Government has three options. It can seek to reduce the rise in the cost of living, or it can act through the benefit system, or through the tax system to increase the incomes of the most needy households. It probably needs to do all three.

The majority of children in poverty are in households in which one or more parent is in work and many will be paying income tax. There is a good case for saying that families should be able to keep more of what they earn.

The problem for the Government is that both income tax and national insurance contributions, which together account for almost half of all government revenue, are blunt instruments. The increase in the national insurance threshold that will happen in July will cost £6 billion, but this will mainly increase the incomes of households without children. The Government is planning to cut the basic rate of income tax, but this too will cost £6 billion and will mainly increase the incomes of better- off households.

If at this difficult time the Government wants families to keep more of what they earn it needs, to concentrate any cut in income tax on that paid by families. The Treasury say they can’t do this because we have a system of independent taxation.

This is an excuse rather than a reason. Independent taxation does not mean they have to rule out tax changes, which allow families to keep more of their earnings.

Nigel Lawson, who planned independent taxation, had envisaged that married couples would be allowed to share their personal allowances. This did not happen, but when independent taxation was introduced, there were allowances to ensure that families did not see their tax liabilities increase. These allowances were an essential part of the structure if households with children were not to end up bearing an unfair share of the tax burden. But this is what happened because the allowances were gradually withdrawn over the 1990s before being abolished in 2000.

Given the political will, the income tax burden could be reduced for households with children. There are these options.

The “marriage allowance” allows someone to transfer 10% of their personal allowance to their spouse or civil partner. This could be increased and extended to all couples, and the cliff edge withdrawal replaced by a marginal provision.

The married couples allowance and the additional personal allowance which were part of the tax system in 1990 could be reintroduced.

Child allowances could be introduced

The income level at which the High Income Child Benefit Charge (HICBC) applies could be raised and the marginal provision which is especially onerous for large families could be redrawn. Despite its name the Charge can apply to low-income households.

Although this cannot the done overnight, the cost of living crisis has highlighted the need for more fundamental reform. Families should be given the option of being taxed jointly as is the case in other counties. The financial problems which households with children face are deep seated and will not go away when the cost of living crisis eases. In countries like Germany, France and the USA families who in this country have significant income tax liabilities do not pay any income tax at all because they can ask to be taxed jointly.

The one option that should not be on the agenda is bringing forward the tax cut in the basic rate of tax, which is planned for 2024. This will cost the Treasury another six billion pounds, but most of the benefit will go to taxpayers without families or with high household incomes who will not be experiencing the most extreme pressures on their living standards. Households with two earners would get a double benefit and a family on universal credit would get less than half of what a taxpayer not on universal benefit would get. A taxpayer on £25,000 would see their income tax come down by £124 a year or £10 a month. A family on £25,000 claiming universal credit would end up with gaining only £70 because for universal credit purposes income is measured after tax. The cost to the Treasury would be large, but cutting the basic rate would make little difference to family finances. Any tax cut should be focussed on households whose finances will be under the most extreme pressure.

Are increasing benefits a better solution?

There are problems with using universal credits as a means of helping families.

The first is that they are destructive of incentives. They are certainly slightly less destructive of incentives than were tax credits and housing benefit, but even following the reduction in the taper rate to 55%, families will still face an effective marginal rate of 70% following the increase in the nic rate. Even families paying a modest rent face this rate on incomes in excess of £50,000. If the view is taken that people should be allowed to keep more of what they earn, it makes little sense to be making families more and more dependent on means tested benefits.

The second is that not all low-income families can benefit from universal credit. For example, a couple with two children needs a gross income of over £36,000 to be in the third decile – the poorest 30% - according to the ONS. Yet if this family has a mortgage it is unlikely to be getting to be getting universal credit and it would not benefit even if the £20 “Covid uplift” were reinstated.

An increase in universal credit may well be necessary as a short-term measure to help families on universal credit with the cost of living crisis and the two child restriction should go, but the tax system should first be made fairer to reduce the need for families to depend on benefits.

Child benefits were for many years the mechanism of choice for supporting families when the tax system ceased to take account of family responsibilities. The benefit has however has been all but frozen since 2010. The benefit has effectively been taken away from some families with a high earner through the HICBC. Two income families are more likely to be getting child benefit, whereas some families with very low household incomes are not getting child benefits. This will be particularly so in the cases of families with three or more children who need a bigger income to avoid being in the poorest 30%.

Nevertheless the possibility of using child benefit as a way of supporting families facing the cost of living crisis should not be overlooked. It is not means tested which means that it does not discourage recipients from trying to earn more. It does not affect entitlement to other benefits. It would seem to be a better option than cutting the basic rate which is budgeted to cost six billion pounds. It may even be a better short term option than increasing universal credit. There are approximately 14 billion children in the UK which means that the Treasury could afford to give all families over £400 for each child if it has £6 billion to spend.