PETER WHITEFORD – WRITTEN EVIDENCE (EUC0024)
The economics of Universal Credit
Reforming Universal Credit – are there lessons from Australia?
Peter Whiteford, Crawford School of Public Policy, Australian National University 
- The introduction of Universal Credit has been described as one of the most important social security policy changes in the UK since the Beveridge Report more than 70 years ago. This is a radical change that removes the distinction between workers and non-workers in means-tested social security benefits for people of working age. The aim of the reform is to make work pay, particularly part-time work, but also to encourage recipients to move into full-time and better-paid work – to achieve in-work progression. Since its introduction however, Universal Credit has been dogged by controversy, both in relation to administration and design.
- It is often assumed that Universal Credit is unique to the UK. In fact, while it is not widely recognised, Universal Credit will make the UK system of income support for people of working age more similar to the Australian benefit system - except that the Australian system has been operating in this way for more than 25 years (Whiteford, 2019).
- The submission addresses the final question asked by the Committee “If Universal Credit does not adequately reflect the lived experiences of low-paid workers, how should it be reformed?”
- Income-testing has developed differently in Australia from the UK. Australia has never had an hours rule for out-of-work benefits, as is the case with Income Support and Jobseekers Allowance in the UK, which generally excluded those working 16 or more hours per week.
- However, in the past there have been high withdrawal rates for earned income in Australia. Up until 1969 all income support payments had 100 per cent withdrawal rates; that is, above ‘free areas’ – the amount of gross income allowed before benefits start to be reduced – payments were reduced dollar for dollar, as gross private income increased. This was very much like the income test for applying to Income Support in Britain, and in most European systems of social assistance.
- Since then, this approach has changed significantly initially for payments for the retired, but also people with disability and lone parents. Income tests for working age payments changed somewhat later. From the late 1970s onwards, with rising levels of unemployment, there were concerns that these income tests could overlap with the tax system to produce high EMTRs and thus create ‘poverty traps’ and ‘unemployment traps’ that meant there were significant disincentives for the unemployed to accept low-paid or part-time work.
- Starting in 1980 the main allowance income tests were gradually liberalised, first by the introduction of a 50 per cent taper range immediately following the free area, followed by an increase in the free area, then by abolition of the separate, dollar-for-dollar income test withdrawal of private rental costs assistance within the free area in 1987.
- Further liberalisations were made between 1990 and 1995, including the introduction of a mechanism for accumulating credits when earnings were low to be applied in future assessment periods from 1994, and the complete phasing-out of the 100 per cent withdrawal rate, as well as the partial individualisation of benefit entitlements for couples (discussed below).
- The allowance income test was further relaxed in 2006, with an increase in the income range over which the 50 per cent reduction rate applied and a reduction from 70 per cent to 60 per cent in the top taper rate for the personal income test and the rate for partnered allowees.
- As a result of these changes, benefits for the unemployed are now reduced, first by 50% and then by 60% as additional income is earned, rather than 63% as is the case for Universal Credit. However, benefits in Australia are reduced on account of income before tax rather than after-tax income, with the result that effective marginal tax rates can be higher than 60% for those with more substantial private incomes.
- For lone parents, the withdrawal rate is 40%. Additional payments for children are separately income-tested, with a withdrawal rate of 20%, an income range where payments are not income-tested, and then a withdrawal rate of 30%. For private renters with children, assistance with rental costs is withdrawn after their higher rate of child payments has been reduced.
- In summary, the Australian system retains different benefits, targeted at specific groups (unemployed, carers, lone parents, etc.) rather than a single payment, as is the case for Universal Credit. There is no separate in-work benefit or tax credit, but the relatively generous treatment of earnings through the income allowance free area and the taper rates means that people in paid work can continue to receive benefits.
- For example, a single “unemployed” person could be working for 3 days a week at the minimum wage before their benefit entitlement is reduced to zero. In a single earner couple, the worker could be working 45 hours a week at the minimum wage before losing their combined income support entitlement, but where there are children they would still be receiving their higher family payments and rent assistance.
- Overall, these changes meant that support for people not in paid work shifted from a tightly targeted ‘social assistance model’ towards allowing a ‘benefits plus work’ model more similar to Universal Credit.
- As a result, there is now a significant overlap between receipt of income support and part-time work in Australia (Whiteford and Heron, 2018). Overall, in June 2019, there were close to 500 thousand people both working and receiving social security payments, which was equivalent to around 12% of all part-time workers in Australia. Around 70 thousand of these were working less than 15 hours a week.
- For recipients of working age – excluding those receiving Disability Support Pension - around 23% have earnings as well as their payments. The highest level of earnings is received by those receiving Youth Allowance for students (38%) who have the highest income test free area, single parents receiving Parenting Payment (Single) (25%) who have the lowest taper rate (40%), followed by those receiving unemployment payments (Newstart Allowance at 21% and Youth Allowance Other at 19%).
- There is also evidence that receipt of earnings while on income support is associated with lower lifetime social security costs and greater likelihood of exiting income support. Analysis by PriceWaterhouseCoopers (2019) for the Department of Social Services estimated that working age people with employment earnings are around two times more likely to exit the system than those without any employment earnings (PWC, 2019, p.81).
- There are some features of the Australian approach to income testing that may be worth further examination. First, the shape of the income tests – with a free area/work allowance and tapered withdrawal rates - is broadly similar in Australia and the UK. But these free areas are available for all claimants in Australia, including unemployed singles and couples without children, unlike the UK where the work allowance in Universal Credit applies only to people with children and those with limited capability for work. As noted, Australia also has lower taper rates.
- Second, in Australia, income support assessment and payment periods are fortnightly rather than monthly. This means that there is a much shorter waiting period at the start of the claim than in the monthly UK system. It also aligns with most Australian wage and salary earners, who are also paid fortnightly. In contrast, Universal Credit has a fixed monthly assessment which does not always tally with when wages are paid. The Department for Work and Pensions provides detailed guidance on this, noting that people paid every four weeks are likely to get two payments of earnings within a Universal Credit assessment period once a year.
- The income fluctuations and losses caused by this have recently been the subject of a High Court Case brought by CPAG and a private law firm, on behalf of a number of working lone mothers. The High Court has found that this practice is unlawful, or that in other words, wages are to be allocated to the month in which they were earned, rather than to the assessment period in which they were received. How this is to be achieved in practice remains to be seen.
- The Australian system has a feature that specifically addresses variability in income, by allowing unused work allowances to accumulate over time. This Working Credit is calculated automatically and starts to accumulate when total income (including from paid work and investments) is less than $48 per fortnight. It is possible to build up a maximum of 48 Working Credits each fortnight to a total “bank” of 1,000 Working Credits for those receiving most working-age payments, and 3,500 Working Credits for those receiving Youth Allowance as a job seeker (the payment for unemployed people less than 22 years of age). For students, the Income Bank arrangement is similar, but much more generous.
- The Working Credit allows people to earn more before their payment is reduced when income goes over $48 per fortnight. In these fortnights, available Working Credits offset excess earnings until the Working Credit balance is zero, and then the income support payment starts to reduce. Thus, the Working Credit takes account of fluctuations in earnings by smoothing out the impact of these over time. There is no such provision in Universal Credit.
- There are also a range of provisions in Australia designed to smooth transitions between the income support system and employment, or back into the income support system. For example, there are abridged reclaim procedures if a person loses qualification for a payment or benefit and reapplies for that payment or benefit within 13 weeks of the cancellation. These have the effect of reducing the incidence and severity of breaks in receipt of government benefits following ‘peaks’ in receipt of private income.
- In addition, transition between payments are made without any loss of continuity, either transitions from lower to higher payments (from Newstart to Disability Support Pension) or transitions from higher to lower payments (from Parenting Payment to Newstart). In these cases, periods of entitlement are reduced to daily rates and recipients are paid the appropriate number of days at the appropriate rate, meaning that they neither have a gap in payments, nor an overpayment leading to a debt. This transition in Australia is facilitated by the shorter assessment and payment period, and the fact that the one government agency is responsible for all benefit payments.
- On the other hand, as in the United Kingdom, Australia has a one-week ordinary waiting period for payments for the unemployed or short-term sick, after the lodgement of an application form. However, there are a further range of waiting conditions that potentially apply to extend the period before payments are received.
- A ‘liquid asset waiting period’ may apply if a person has liquid assets beyond a set level. The maximum waiting period is 13 weeks. Liquid assets include cash, shares and debentures, and bank (including term) deposits. The thresholds are AUD 5,500 for singles and AUD 11,000 for couples or singles with dependants. Claimants do not have to reduce their assets below these levels in order to qualify, but they must serve these longer waiting periods. This provision exists because the general level of assets allowed for receipt of benefits in Australia is much higher than in the United Kingdom. For example, a single unemployed person who is a homeowner can have up to $263,000 in assets before they are ineligible, while a single non-homeowner can have up $473,000 in assets. For couples, the corresponding figures are $394,000 and $605,000.
Partial individualisation in the Australian system
- Another reform of working age payments was in 1995, when there was a change to the income test treatment of couples where both members of the couple attracted an allowance payment. The income test that was applied to joint income was replaced with one that was sequentially applied, that is, the personal income was applied to each member of a couple with any ‘partner excess income’ then reducing a partner’s payment. The taper rate on ‘partner excess income’ was aligned with the top taper rate of the personal income test, so that the earnings of one partner in a couple did not reduce the partner’s payment until the first earner’s component was fully extinguished.
- This provides a form of ‘partial individualisation’. Each member in a couple has their own individual work allowance and the income test is sequentially applied. This means that the earnings of one partner in a couple does not reduce the partner’s payment until the other earner’s component is fully extinguished. Thus, there are financial incentives to work for both partners in couples.
- The effects of this are shown in Figure 1, which compares changes in disposable income for a couple with two children where one partner is earning the minimum wage, by single hourly increments up to 45 hours per week. The figures for Northern Ireland in 2017 come from Simpson and Patrick (2018), which we have replicated for Australia on the basis of the Australian minimum wage and the same calculations of benefit entitlements and taxation.
- The top line shows the total change in disposable income that the family enjoys as hours of work rise. It is notable that the shape of this curve appears very similar across countries, with disposable incomes in Northern Ireland rising from under £400 a week at zero hours of work to a little over £500 per week at 45 hours, while for the corresponding Australian couple disposable incomes rise from £395 a week to £535 a week (PPP adjusted) over the same range of hours.
- However, the composition of disposable income differs significantly between the two examples. In Australia, the non-earning spouse’s income does not start to be reduced until the primary earner is working around 26 hours per week. The situation is also gender-neutral, the primary earner could be either male or female. It is also notable that the child-related payments - which are paid to the mother in Australia – remain more substantial than Child Benefit in the United Kingdom/Northern Ireland. This is because, the withdrawal of child payments does not start until higher levels of earnings in Australia.
- This design is very different from Universal Credit, where the joint work allowance for couples (in addition to other features of Universal Credit) means that prospective second earners – often women - have little financial incentive to work. In addition, while benefits may be paid into joint bank accounts (although this is not compulsory), entitlements in Australia are individual. This means that each person has their own access to payment, potentially giving greater financial independence to women.
- Lesson learning across countries can be a challenging activity, as often provisions do not transplant well to a different context. But all means-tested/income-tested system must address similar problems, and the UK and Australia could potentially learn more from each other.
- Some of the problematic features of Universal Credit appear to reflect the decision to have a monthly assessment and payment period. With a fortnightly payment period, Australia does not face some of these problems, but this solution may not be transferable. However, developing mechanisms for smoothing transitions off payments when earnings fluctuate may be relevant, as may the mechanisms for transitioning people from Income Support to Universal Credit in the next phase of implementation. The partial individualization of benefits would also seem an option that British policy makers could consider.
Millar, J. and P. Whiteford (2020), “Timing it right or timing it wrong: How should income-tested benefits deal with changes in circumstances?” Journal of Poverty and Social Justice. DOI: https://doi.org/10.1332/175982719X15723525915871
PriceWaterhouseCoopers (PWC) (2019) 30 June 2018 Valuation Report, Department of Social Services, Canberra. https://www.dss.gov.au/review-of-australias-welfare-system-australian-priority-investment-approach-to-welfare/2018-valuation-report
Simpson, M. and R. Patrick (2018) Universal Credit in Northern Ireland: interim report, https://www.ulster.ac.uk/__data/assets/pdf_file/0004/415372/Universal-credit-in-Northern-Ireland-interim-report-public-version.pdf
Whiteford, P. (2019) “Social Security since Henderson”, in P. Saunders (Ed), Social Security Reform: Revisiting Henderson and Basic Income, Melbourne University Press, Melbourne. https://www.mup.com.au/books/revisiting-henderson-paperback-softback
Whiteford, P. and A. Heron, (2018) “Non-standard workers in a tax-financed social protection system: The Case of Australia” in The Future of Social Protection: What works for non-standard workers? OECD, Paris. https://www.oecd.org/els/the-future-of-social-protection-9789264306943-en.htm
26 February 2020
Figure 1: Comparison of disposable incomes for single earner couple with two children, Northern Ireland and Australia, 2017
By hours of work at minimum wage, Adjusted by PPPs £1.00 = $1.87
Source: Simpson and Patrick (2018) and own calculations
26 February 2020