3 Encouraging Work - continued

Making Work Pay

3.25 People are understandably reluctant to take work that does not pay. This Budget begins the process of tax and benefit reform to ensure a New Deal for Working Families - the next stage of the modernisation of the welfare state. It includes reforms to the tax system to ensure that work and opportunity are encouraged and rewarded, rather than penalised, for millions of families. This will be achieved through reforming national insurance and a new Working Families Tax Credit. A childcare tax credit within the WFTC will improve the in-work help with the costs of childcare, which is for many parents a barrier to work.

3.26 The Government's view on how tax, benefit and employment policy needs to adapt to meet the changes in the labour market and in society was set out in "Employment Opportunity in a Changing Labour Market", one of the publications accompanying the Pre-Budget Statement. Many people who can and who want to work, are discouraged from doing so by the low return from working more or even taking a job at all. This frustrates people's ambitions to provide for themselves and their families. The financial difficulties caused, when people start work or increase their earnings, are often expressed in terms of two different, but connected, traps:

• the unemployment trap, where the income they can make from working is little or no higher than the income they would receive if they did not take a job; and

• the poverty trap, where there is little reward to someone in work increasing their earnings. Very high Marginal Deduction Rates (MDRs)[1] penalise work. The most extreme form of the poverty trap occurs when MDRs exceed 100per cent, ie when the tax and benefit system mean that people receive less income as their earnings rise.

3.27 This Budget will dramatically reduce the number facing very high MDRs. It will also ease the unemployment trap by raising the incomes of those in work.

Taylor Report

3.28 Martin Taylor's Taskforce on taxes and benefits has assisted the Government in producing these reforms. The Government is publishing a series of papers on "The Modernisation of Britain's Tax and Benefit System" to mark the staging posts on the road to reform. "Employment Opportunity in a Changing Labour Market" was the first paper in the series. Martin Taylor's recommendations are being published alongside this Budget, as number two in the series. Some of these recommendations are taken on board in the Budget, and others are under further consideration. A third paper describes in detail the Working Families Tax Credit and the effect it will have on work incentives.

National insurance contributions

3.29 The Budget contains the biggest reform to the structure of national insurance contributions (NICs) since 1975, at a cost of around £1.4 billion a year from April 1999.

3.30 The current structure of NICs bears particularly acutely on the low-paid and discourages job creation at the lower end of the earnings distribution. Steps in the structure of NICs, whereby a one penny increase in pay can trigger an increase in NICs of up to £6.30 a week, distorts the labour market, discouraging progression up the earnings ladder. These distortions are greatest at the lower earnings limit, where a rise in earnings from £63.99 to £64 a week triggers a NIC charge (the "entry fee") for employees of £1.28 and for employers of £1.92 a week: one of the last remaining causes of people being worse off when they earn more.

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3.31 The Budget measures will abolish the "entry fee" for employees and employers, and end the additional steps in employers' contributions at £110, £155 and £210 a week. In line with Martin Taylor's recommendation, the structure of national insurance will move more into line with income tax to simplify the system and to reduce administrative burdens on employers. From April 1999, the threshold for employer national insurance contributions will be aligned with the personal allowance for income tax (£81 a week 1998-99). The lower earnings limit for employees will remain unchanged (at £64 in

1998-99). But the Government is committed to aligning it with the personal allowance as soon as it has reformed the rules for contributory benefits to ensure that those who are taken out of national insurance contributions do not lose their right to accrue benefit entitlement. Martin Taylor's report will be examined further with a view to introducing possible reform of the NICs system as it applies to self-employed people.

3.32 From April 1999, employees will pay no NICs on their first £64 a week of earnings, and 10 per cent thereafter up to the upper earnings limit, £485 a week (all limits and thresholds are in 1998-99 prices). Employers will pay no NICs in respect of their employees' first £81 of earnings a week, and will then pay a single rate of 12.2 per cent thereafter. The employer package is revenue-neutral, so that the burden of employer NICs as a whole will remain unchanged. But employers will no longer have to pay NICs in respect of up to a million employees earning between £64 and £81 a week. They will also pay lower NICs in respect of (approximately) another 12 million employees earning between £81 and £450 a week (broadly, male average earnings).

3.33 The NICs reform will improve work incentives and make it more attractive to employ those moving off welfare and into work. The reduction in NICs at illustrative points on the earnings distribution at the lower end is set out in Table 3.2 below:

Table 3.2: Reduction in burden of national insurance contributions

Arrangements for contracting out of SERPS will continue broadly as at present.

3.34 As outlined in Chapter 4, the Contributions Agency will move to the Inland Revenue in April 1999.

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A Working Families Tax Credit

3.35 The Government will introduce a new tax credit for working families with children, which will be administered by the Inland Revenue and will replace Family Credit. The Working Families Tax Credit (WFTC) will boost the incomes of low- and middle-income working families with children. As a tax credit, it will demonstrate more clearly the rewards of work over welfare and reinforce the minimum wage in making work pay. The new tax credit will also provide increased help with the costs of childcare.

3.36 The WFTC will provide around £5 billion a year of support, which represents approaching £1 1/2 billion more resources than Family Credit. By 2001, about 1 1/2 million working families will be receiving the WFTC, around 400,000 more families than would have received Family Credit.

3.37 The WFTC will ease both the unemployment trap and the poverty trap, as well as helping parents with childcare costs. It will:

• provide a guaranteed minimum income for working families. The guarantee will be at least £180 a week for a family with full-time earnings of £100 a week.

• raise the point at which families begin to pay tax: families earning below £220 a week (which is about half male average earnings) will not pay net tax after the WFTC has been introduced.

• reduce the unemployment trap by raising in-work incomes in relation to those out of work. This Budget will make a couple earning £200 a week (the average entry wage for an unemployed person returning to full-time work) more than £23 a week better off if they have two young children.

• ease the poverty trap in two ways. The taper - the rate at which the tax credit is withdrawn as net income increases - will be 55 per cent in the WFTC, compared to 70 per cent in Family Credit. As a result, half a million families will see the return from increasing their earnings rise by one-half. And the WFTC will not begin to be withdrawn until net income reaches £90 a week, an increase of £11. These reforms will cut the number of families facing high marginal deduction rates: the number of families losing more than 90 pence of any extra £1 of earnings will fall from 130,000 to 20,000. And instead of 3/4 million families losing 70 per cent or more of any extra income they earn (as now), there will be only 1/4 million.

• end the inefficient system whereby almost 1/2 million families paid tax to the Inland Revenue while receiving Family Credit from the Department of Social Security. 97 per cent of these families will no longer pay net income tax.

Table 3.3: Effects of Budget on number of families with high marginal deduction rates(1)

1 Figures are for families where at least one partner works 16hours or more, and are based on 1997-98 caseload and take-up rates.

3.38 The basic tax credit in the WFTC will be £48.80 a week for each family (in 1998-99 prices). There will also be tax credits in respect of each child and for childcare. The amount paid in respect of children under 11 will increase by £2.50 a week, narrowing the gap between it and that paid for older children. The evidence suggests that the costs associated with younger children are closer to those of older children than the benefit scale rates imply. Every family working 16 hours or more and earning £90 a week or less will receive at least £77.60 a week in WFTC and Child Benefit.

3.39 The WFTC will be introduced from October 1999. It will be payable through the wage packet from April 2000. Couples will be able to choose which partner receives the WFTC.

Table 3.4: Structure of the Working Families Tax Credit

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3.40 People working more than 30 hours a week, and receiving Family Credit, can find that their income actually falls if their earnings increase. The interaction between Housing Benefit, Council Tax Benefit, and the 30-hour premium in Family Credit means that about 5,000 families face being worse off if they increase their earnings. That will not happen under the WFTC. The Government will change the disregards in Housing Benefit and Council Tax Benefit which cause these Marginal Deduction Rates (MDRs) of over 100per cent. No family will lose as a result of this change. Reforms to national insurance contributions will remove the other cause of low-paid employees facing MDRs over 100per cent.

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A childcare tax credit within the WFTC

3.41 Childcare is a crucial part of the equation for parents, in assessing the financial implications of making the move off benefits and into work. This Government is determined to make work pay, and to ensure that no parent should be unable to take up the opportunity of work through lack of access to affordable quality childcare.

3.42 The Government is therefore greatly improving the help with childcare costs which is available to low- and middle-income working families. The WFTC will include a new childcare tax credit, worth 70 per cent of eligible childcare costs, up to a limit of £100 of eligible costs for families with one child and of £150 for families with two or more children. It is more generous then the current disregard in Family Credit in two ways:

• the maximum amounts are much higher;

• the credit will help those on lowest incomes (the benefit disregard provides no help to those with incomes below £77 a week).

3.43 In addition, the lower taper in the WFTC will enable people to keep more of their income. So parents will see their return from working increase, even if they have childcare costs.

3.44 The Government will also improve the childcare help available to working families in Housing Benefit and Council Tax Benefit. There will still be a disregard to meet eligible childcare costs. The maximum disregard will be equal to the maximum size of the childcare tax credit, ie £70 for one-child families and £105 for other families (up from £60 and £100 respectively).

3.45 The childcare and other changes made in introducing the WFTC will make many working families with children substantially better off. A two-earner couple, earning £450 in a week, and spending £150 on registered childcare for their two children, would receive £45 a week in the WFTC. They would receive nothing under the current rules for Family Credit and the other in-work benefits.

3.46 The new childcare tax credit within the Working Families Tax Credit will play a key underpinning role to the National Childcare Strategy, by ensuring that childcare is affordable for working families. The Government's National Childcare Strategy also aims to ensure an increase in the supply of childcare to meet the increased demand, by tackling systematically the barriers to the supply of good-quality provision, and by ensuring that all relevant partners are able to play a role in delivering this shared vision. As a start, the £300 million investment in out-of-school childcare announced in the Pre-Budget Report will be coming on-stream in April 1998, with £40 million available in the first year to fund an expansion of out-of-school provision.

A Disabled Person's Tax Credit

3.47 The Government will also introduce a Disabled Person's Tax Credit (DPTC) alongside the WFTC to replace the existing Disability Working Allowance (DWA). DWA has failed as an incentive to work. Although it has helped some people back into work, take-up is a quarter of the level forecast when it was introduced. As well as making the tax credit more generous than DWA (matching the rates, tapers and thresholds in the WFTC), the Government is looking at other ways in which the DPTC can be more effective and more attractive than DWA. Taken together with the New Deal for Disabled People and the changes to linking and other benefit rules (see paragraph 3.20), this demonstrates that the Government regards helping those people with disabilities who want to work to get back to work as one of its key priorities.

A National Minimum Wage

3.48 The National Minimum Wage will help underpin these reforms. It will help promote work incentives, tackle exploitation and ensure greater decency and fairness in the workplace. It forms an integral part of the strategy for making work pay. The Government is determined to introduce the minimum wage in a sensible way, taking into account the wider effects on the economy. The Government will decide on the level and the coverage of the minimum wage when it has received and considered the recommendations of the Low Pay Commission, which are due by May 1998.

3.49 Taken together, these reforms to taxes, NICs and benefits will, supported by the National Minimum Wage, help to make work pay.

Investing in Skills

3.50 Good education and basic skills are essential foundation stones for a flexible and adaptable labour market. Since May 1997, the Government has introduced a range of measures to raise educational achievements and announced £2.3 billion of extra expenditure on schools in the July Budget, including the New Deal for schools which will ensure that more children are taught in an environment conducive to learning. For people that have already left school, the Government is considering a range of Lifelong Learning measures, as set out in the Green Paper "The Learning Age" (February 1998), many of which are also being examined in the Comprehensive Spending Review.

3.51 The underspend during 1997-98 has enabled the Government to spend more on education, to invest in schools and measures to improve skills. This spending will reflect immediate priorities, in particular the shortage of people with skills in information technology (IT) following structural changes in the use of IT in the early 1990s. The "Millennium time bomb" has added to this problem. And there are significant shortages in other areas of high technology, a reflection of inadequate education and training in the past. The University for Industry (UfI) will have a vital role in spearheading the skills and learning revolution. The extra provision of £10 million for the UfI is seedcorn funding that builds on the £5 million from the Windfall Tax announced in the July 1997 Budget. This £15 million investment provides a solid foundation on which to build a new public-private partnership, with a mission to ensure that both business and individuals can readily get access to flexible and cost effective training, tailored to their particular needs. The Individual Learning Accounts (ILAs) announced in the July 1997 Budget will help to fund the training needs of one million people on low incomes, whether using the UfI, FE colleges or other training providers.

Setting the International Agenda

3.52 The UK Government currently holds the Presidency of both the European Union and the Group of Eight leading industrialised nations. The Government has placed employability at the top of the international agenda.

3.53 At the Luxembourg Jobs Summit in November 1997 the European Union agreed concrete steps to demonstrate its new common concern about employment policy and tackling the unacceptably high levels of unemployment and exclusion in the Union. The first ever set of European Union Employment Guidelines were agreed. These Guidelines include commitments for every young person to be offered a new start before reaching six months of unemployment in the form of training, work experience, a job or another employability measure. The guidelines likewise include commitments for all unemployed adults to receive a similar fresh start before reaching 12 months unemployment.

3.54 The UK and its European partners agreed to produce by April Employment Action Plans showing how the Employment Guidelines are being implemented. The UK was the first country to produce an Action Plan which was published on 27 February. The Government intends to make employment a key focus of the Cardiff European Council in June where there will be an assessment of the 15 Action Plans.

3.55 The Government's focus on employment internationally has not been restricted to the European Union. In the G8 the Chancellor and the Secretary of State for Education and Employment co-hosted a conference in London on 21-22 February under the title "Growth, Employability and Inclusion". The conference agreed important conclusions where all members of the G8 gave their agreement to endorse the seven policy principles to generate new job opportunities and tackle unemployment and exclusion. These are:

• to promote sound macroeconomic policies;

• to institute structural reforms to labour, capital and product markets;

• to enhance employment, education and training opportunities for the young and long-term unemployed, lone parents and disabled people;

• to reform tax and benefit systems to provide work incentives;

• to foster entrepreneurship, and create a climate favourable to new and small businesses;

• to encourage lifelong learning;

• to promote equal opportunities and combat discrimination.

3.56 The G8 countries agreed to produce Action Plans showing how they are turning the principles into practice by the time of the G8 Heads of Government Summit in May, where employability will be one of the main issues to be discussed.

Note

[1] The Marginal Deduction Rate is the proportion of extra earnings that is lost through higher income tax and NICs, and lower entitlement to in-work benefits. back