Written Evidence from Dr Christine Davies (UCR0193)

I am a Visiting Senior Lecturer in Applied Mathematics, Royal Holloway University of London. My previous evidence to this Committee (UCU0154, in the last Parliament, and UCR0062) drew attention to the problems causes by the interaction Universal Credit with payments made under the CSA and CMS statutory child maintenance schemes. I also submitted evidence (CHM 0079 and CHM 0098) to the Committee’s Inquiry into the Child Maintenance Service (CMS) in the last Parliament.

Fundamentally flawed child maintenance calculation regulations are causing serious damage to separated families because they give amounts that many parents find impossible to pay. This aspect of child maintenance legislation was outside the remit of the CMS Inquiry and beyond the scope of the present Inquiry. Nevertheless, the problems are so severe that, sooner or later, they will have to be addressed. I take this opportunity to illustrate the problems in ways which might be helpful to the Committee’s more general deliberations.

I formally request that the Committee draw the Government’s attention to the problems arising from the Child Maintenance Calculation Regulations, either by referring to evidence already received or by making it the subject of a separate inquiry.

I restrict this evidence to the Inquiry into UC roll-out to the aspect of work incentives.

Executive Summary

• The intention of UC is to ensure that ‘work always pays’, that a person will always be better off working than when unemployed and working more hours will always give an increase in overall income. In general, this intention is fulfilled.

• However, the intention is not fulfilled in the case of parents paying child maintenance through the statutory schemes. They can be worse off working than when unemployed and working more hours can give a lower income.

• This is illustrated by means of income profiles showing the after housing costs income as an adult on national minimum wage moves from unemployment to full-time work and by marginal tax rate profiles.

• Tables of effective marginal tax rates (MTRs) show that a parent paying through the CMS pay and collect service can have an effective MTR of over 107%. This would mean that they would be 7p worse off for each additional £1 earned.

• Child maintenance is outside the scope of the current Inquiry. This evidence seeks to demonstrate the serious consequences arising from the interaction of UC with the current flawed child maintenance calculation legislation. It puts down a marker for further work. A thorough review is urgently required.

Work incentives

1.                Universal Credit (UC) was designed to address the ‘work disincentives’ of the welfare system that it replaces. The intention of UC is to ensure that ‘work always pays’, that a person will always be better off working than when unemployed and working more hours will always give a bigger income. The many practical problems that beset the roll-out of UC can obscure the underlying success in UC in meeting those intentions in general.

a)     Work incentives for a single adult

2.                The success in ‘making work pay’ can be seen by comparing the green curves in Figures 1[1] and 2. These give the residual income after housing costs (AHC) for a single adult on the national minimum wage (NMW) as they move from unemployment into full-time work. The calculations are for the 2014/15 tax year with a NMW of £6.50. They can be updated on request.

3.                Figure 1 gives the situation under the old welfare system. The green curve shows that there is little incentive for a single adult to move into work if all that is on offer is part-time work on minimum wage. Working tax credits at 30 hours provide a boost to income but the AHC income for full-time work (35 hours) is still just below the poverty threshold and well below that required to achieve the minimum income standard[2] (MIS) for a single adult.

4.                Figure 2 give the situation under UC. The green curve for a single adult shows that the intentions of UC are, indeed, fulfilled. The AHC income increases for every hour worked and rises above the poverty threshold of 60% median income after 28 hours. Note, however, that the AHC income is still short of the MIS after 35 hours and, indeed, when UC runs out at 43 hours.

Note the kink in the line at just less than 5 hours work at NMW. This occurs because, in the 2014/15 tax year, a single adult had a work allowance of £25. This allowance was removed in April 2016 so the situation is now worse than that portrayed.

Note, also, that the taper rate for UC in the 2014/5 tax year was 65%. This was reduced to 63% from April 2017.

5.                Whilst the intentions of UC are fulfilled for a single adult, this is, unfortunately, not the situation for a parent paying child maintenance through the CSA 2003 Scheme or the CMS 2012 Scheme. This can be seen from the blue curves in Figures 1 and 2.

Figure 1

Figure 2

b)     Work incentives for a parent paying child maintenance

6.                The blue curves in Figures 1 and 2 give the residual income after housing costs (AHC) and child maintenance for a parent paying child maintenance for one, two or three (or more) children under the CSA 2003 Scheme. Similar curves can be drawn for payments made under the CMS 2012 Scheme.

7.                A non-resident parent is regarded by the welfare system as a single adult - no account is taken of their child maintenance payments or other expenditure on their children, no matter how large that might be.

8.                Note the changes that occur at about 15 hours and 30 hours at NMW. These correspond to the £100 and £200 thresholds that occur in the CSA 2003 Scheme and CMS 2012 Scheme. The thresholds were given the values of £100 and £200 in 1998 and have not been updated.

9.                The blue curves in both figures lie just below the green curves until the first threshold. This is because for weekly incomes less than £100, the parent in the 2003 Scheme pays the nominal sum (“flat rate”) of £5, independent of the number of children.

10.            Once past that threshold the parent pays the “reduced rate”. Figure 1 shows that, under the old welfare system, the AHC income then drops for every hour worked until 30 hours is reached. The inclusion of working tax credits then lifts the weekly income above the £200 threshold so that the parent then pays the “basic rate”. The AHC income rises slowly but when working full-time the non-resident parent has little more than when unemployed.

11.            Note the position of AHC poverty threshold (60% median). Figure 1 shows that, on the old welfare system, the income of a non-resident parent working full-time on NMW is below this threshold even before the payment of any child maintenance. After payment for one child it falls below the 50% median line; after payment for more than one it falls below the 40% median line. A parent who was already in ‘poverty’ is now in ‘deep poverty’.

12.            Figure 2 shows that, under UC, the AHC income for a parent paying for more than one child drops for every hour worked between the £100 and £200 thresholds. Above the £200 threshold the AHC income then increases but so slowly that a paying parent gains little from working more than 15 hours, when the AHC income is just less than the 50% median. When Universal Credit runs out at 43 hours of work (annual gross earnings of £14,753) a parent paying for three children still has £9 less a week than at 15 hours (annual gross and net earnings of £5,084).

13.            The green curves in Figures 1 and 2 show that ‘work does not pay’ for a person on low income paying child maintenance on the CSA 2003 Scheme. Similar curves can be drawn for the CMS 2012 Scheme.

An alternative approach - marginal tax rate (MTR) profiles

14.            Income profiles similar to those in Figures 1 and 2 can be given for the 2012 Scheme (with or without the 20% collection fee) both under the current welfare system and under Universal Credit. However, an understanding of the problems can be obtained with much less work using the concept of effective marginal tax rates and marginal tax rate profiles.

15.            Put simply, the Marginal Tax Rate (MTR) indicates how much is deducted from each extra £1 earned. A worker on the standard rate of income tax has an MTR of 32%, made up of 12% National Insurance contributions (NICs) and 20% Income Tax (Tax). For every extra £1 earned, 32p is deducted in taxes and the worker keeps 68p. The withdrawal of benefits is not a tax but has the same effect and so can be incorporated to calculate an overall marginal deduction rate (or marginal tax rate). Similarly, for child maintenance payments (CM).

16.             Figure 3[3] shows the MTR profile for a parent paying for three children through the CMS collection service under Universal Credit for the 2014/15 tax year when the UC taper rate was 65%. This was reduced to 63% in April 2017.

Figure 3: MTR Profile under Universal Credit and the CMS 2012 Scheme with 20% collection fee, 3 children, 2014/15 tax year

17.            In 2014/15 a single person had a work allowance of £25. This was removed in April 2016 so that UC withdrawal now begins as soon as the person starts work.

18.             Note, again, the significance of the £100 and £200 thresholds. The MTR goes from 20% to 72%[4] to 109.2% as earnings pass £100 a week. The MTR exceeds 100% throughout the whole of the region between the £100 and £200 thresholds then drops to 99% and remains at that level until Universal Credit runs out. So the parent becomes worse off for every £1 earned between the thresholds and then is just 1p better off in every £1 earned above the £200 threshold.

Updated Tables

19.            The Committee asked about the impact of changing the UC taper rate. Table 1a gives effective MTRs for both the CSA 2003 Scheme and CMS 2012 Scheme with the current taper rate of 63%. Table 1b gives the figures for the taper rate of 75%, mooted in 2015. An MTR exceeding 100% means that the parent is worse off for every £1 earned.

              Marginal tax rates (percentage) for paying parent under Universal Credit

Table 1a:              63% taper rate for Universal Credit

Table 1b:              75% Universal Credit taper rate

Summary and Conclusion

20.            I appreciate that a consideration of child maintenance calculation legislation is beyond the remit of the present Inquiry. This evidence seeks to demonstrate the consequences of the serious flaws in that legislation and to put down a marker for further work. A thorough review is urgently required.

January 2018