Tax credits are very much in the news at the moment, not least because of the powerful appearance on BBC Question Time of Michelle Dorrell with her concern about the personal impact of these cuts.

I have recently completed a big exercise, using our Future Benefits Model, looking at the effect of all the announced changes on people over the next five years.

Like all of the other analyses, I found huge cuts in real income that will not be offset by increases in tax allowance or the new National Living Wage (a misleading label, as it has no relationship to any assessed living costs or needs).

I haven’t yet published anything covering my modelling around tax credits, as it seemed that it would be fairly repetitive, although I now have a very rich data set covering hundreds of thousands of scenarios.

The focus on tax credits cuts at the moment, although they will cause enormous suffering to many people, may be diverting attention from something even more serious.

Tax credits, and their cuts, will not be with us for too many more years.  They will be replaced by Universal Credit in due course, albeit several years later than planned. It seems unlikely, but not impossible, that there will be tax credits in payment in 10 years’ time.

Well before then, Universal Credit will have become the standard way of delivering support to people in low-paid work, such as Michelle Dorrell.

On today’s rules, when she moves onto Universal Credit she will find herself much more worse off than under tax credits, even after the cuts come into effect.

As a self-employed person with four children, and extremely low earnings, several commentators have pointed out that she may not be affected by this round of tax credits cuts directly.

Her current earnings appear to be lower than the reduced threshold at which reductions will start to be applied and, as her children are already born, she will not be affected by the forthcoming tax credits limit on the number of children receiving support.

On the other hand, as she is self-employed, the National Living Wage won’t change her earnings either that it will have no direct impact on the prices asks for her services. She also doesn’t seem likely to gain from the rise in personal allowances she doesn’t earn enough to pay tax.

Universal Credit

She can move onto Universal Credit in one of two ways.

The first, and the best for her, will be if she is ‘migrated’. This means that she would be moved from the tax credits system to Universal Credit as part of a ‘managed move’. This will happen when the DWP are transferring people from the old benefits and tax credit systems en masse.  The old benefits system will be closed down and everybody moved onto Universal Credit.  This may not happen at the same time across the country but there will be no individual circumstances which force the move.

People who are migrated will be entitled to be ‘transitionally protected’. That means that, if their calculated entitlement to Universal Credit is less than they were getting previously, they will continue to receive the amount of money that they were getting under the old system. Their Universal Credit won’t however go up annually when benefits rates change. They will continue to get the same cash amount of benefit until their Universal Credit calculated entitlement passes that amount.

The other way she might move onto Universal Credit is because her own circumstances change. For example, if her earnings were to rise, so that she was no longer entitled to tax credits, and then drop later then she would have to claim Universal Credit and her entitlement would be whatever the rules in force at the time said. There are many possible ways in which she might have to move onto Universal Credit.

Transitional protection will be very important particularly for those people moving from tax credits where the rules about earnings and capital are very different from those applied by Universal Credit.

If she doesn’t have transitional protection, or if circumstances were to change in such a way that she lost the protection, she would face a very much less generous situation than the tax credits would offer, even after the cuts.

Earnings

If you’re self-employed for Universal Credit then the way in which earnings are treated is very different than that for tax credits, which follows closely on from their treatment for tax.

Universal Credit needs the self-employed to provide, every month, a statement of the money in and out of their business. The difference is treated as their earnings.

If they earn less than, typically, 35 times the minimum wage each week then their benefit is calculated as if they were earning that amount. That level of notional earnings will, of course, reduce their entitlement to benefit. On today’s minimum wage figure that means that Michelle would be treated as having a net income of over £1000 a month when calculating her entitlement to Universal Credit. That’s a lot more than she appears to be actually earning, which is the figure used for tax credits.

Each notional £1 above her real earnings figure will reduce her real Universal Credit by 65p.

Children

In 2017 the government are introducing stringent new rules about the number of children who will be entitled to benefit. Only the first two children in the family, where there are any born after that date, will count towards tax credits. All children born before April 2017 will continue to count for tax credit purposes.

That’s the case even where tax credits are claimed after that date.

It’s not the case for Universal Credit. Where there are more than two children born before April 2017 they will count where Universal Credit was being claimed at that date and continues to be claimed. If Universal Credit stops for some reason and then is reclaimed only two children will count regardless of when they were born.

So Michelle’s four children will continue to count for tax credits, as long as she continues to receive it or reclaims it, but they won’t count for Universal Credit if she was to stop getting it and then have to reclaim.

On today’s figures that means a drop in her benefit of £5,500 a year – £105.77 a week.

That’s on top of the equivalent changes that are being made to Universal Credit to match the cuts in tax credits.

Conclusion

The tax credit changes are indefensible, if this government is genuinely trying to support and help low-paid workers. They will make the worst paid of the hard-working worse off.

The cuts are being carried across into Universal Credit as well, removing much of the work incentives which were such a foundation of that benefit.

If you are self-employed with low earnings, or if you have more than two children, then you will find yourself hit worse under Universal Credit than under the tax credit cuts.

If you happen to be self-employed with low earnings and to have more than two children then you face a very bleak future.

Gareth Morgan

October 2015