Akey aim of Universal Credit (UC) is to provide a better system for working families. One way it is expected to achieve this is by creating a single system in which people do not have to make a new claim for their entitlements when they move into work. Once in work, the system is meant to be responsive to monthly fluctuations in earnings, removing the under- and over-payments that affect the current tax credits regime.
Importantly, UC was also designed to improve financial incentives to enter work and then progress, or ‘to make work pay’. The return to work is determined through two main components, the ‘work allowance’ and ‘taper’.
Work allowance
The work allowance is a monthly earnings disregard – that is, an amount that can be earned each month without benefit entitlements being reduced. These allowances are set at £409 per month for homeowners and £198 per month for renters. They only apply to families with children, and those with a long- term health condition or disability which limits their ability to work.
UC entitlement is reduced by 63p for every pound of net earnings (after tax and NI) above the level of the work allowance. For example, a single-parent homeowner with one child has a strong incentive to enter work, increasing income by £78 per week if working 11 hours (see chart). The incentive to progress is weaker though. Income increases by £36 a week if the parent works another 12 hours. Clearly the income has increased while in work – work pays – but the questions to ask are: by how much; and is it enough?
The answer depends on the hours of work the parent works. At very low levels of earnings the work allowance provides a very strong financial incentive. It is much stronger than in the current system where each pound of earnings would reduce benefits by a pound when earning less than around £85 a week. Therefore we can expect this feature of UC to be of particular advantage to groups who find they can only manage to work few hours.
Once earning above the work allowance, UC entitlement falls as earnings rise. For a taxpayer (and because UC is assessed on net earnings), for each £1 earned, net income would rise by only 25p. That may seem relatively little yet represents an improvement for some people. For example, renters in the current system can keep less than 10p in the £1 due to interactions between housing benefit and tax credits. For many it provides little change (taxpayers in the tax credits system keep 27p for each £1 earned).
How will this affect behaviour?
A key question is how will people respond to these incentives? Are they strong enough to encourage more people into work, and for those already in work is there a strong incentive to progress?
In many respects the answer is unclear. Mothers – a group who face a clear trade-off between working or looking after children – tend to be most responsive to financial incentives. An example of how parents have adapted to the financial incentives created by the tax and benefit systems are the working patterns of single parents. Many work precisely 16 hours, the minimum needed to receive Working Tax Credit.
With a work allowance we might expect single parents to be better able to pick a pattern of work that is best for them, rather than stick at 16 hours a week. But there is also a risk that the same group trades down their hours of work for a slight reduction in income. Due to the taper, moving from working 16 to eight hours is equivalent to an income loss of only £23 per week. With relatively poor returns from earning more, working parents may become trapped at low levels of income.
In-work support
Often overlooked is the plan for ‘in-work conditionality’, which extends Jobcentre Plus adviser or ‘work coach’ support, usually reserved for the unemployed, to people with low earnings. Those earning less than the equivalent of a full-time role at minimum wage will be encouraged to earn more (with reductions in this expectation for carers of children and others).
This is potentially the most radical, but also most uncertain, part of UC reforms. It may be hard to engage people already in work, a group who are likely to need different practical support from people looking for work. Getting it right could provide vital help for people to improve their earnings and progress.
