Working tax credit
Encyclopedia
The Working Tax Credit is a state benefit
in the United Kingdom
made to people who work on a low income. It is a part of the current system of refundable (or non-wastable) tax credits introduced in April 2003 and is a means-tested social security
benefit. In addition, people may also be entitled to the Child Tax Credit
(CTC) if they are responsible for any children.
Despite their name, tax credits are not linked to a person's tax bill. The WTC can be claimed by working individuals, childless couples and working families with dependent children. The WTC and CTC are assessed jointly and families remain eligible for CTC even if where no adult is working or they have too much income to receive the WTC.
In 2010 the coalition government
announced that the Working tax credit will, by about 2016, be integrated into and replaced by the new Universal Credit
.
The WFTC shared its assessment of means and period of renewal (6 months) with FC but moved towards a tax credit approach styled on schemes in other countries, which used an annual declaration of income to assess entitlement for a whole year. Tax Credits also replaced the child elements in means tested benefits, the Children's Tax Credit in the tax system, and disabled persons tax credit.
The component called Elements is based on circumstances whilst the Withdrawal component is income based. The following sections describe how each component is arrived at.
Each element that applies to a claimant's circumstances is added together to determine the maximum award of tax credit (before any withdrawal is considered). For example, a couple would have elements calculated as
As withdrawal of tax credits is based on 'gross' rather than 'net' income, however, the claimant is also subject to Class 1 NIC national insurance contributions at 11 percent and UK income tax at 20 percent—making an effective marginal tax rate of 70 percent.
For example, if one person in a couple earns £10,000 pa, then the amount of withdrawal is
Under withdrawal, entitlement to WTC is gradually reduced first until 'exhausted' at an income level that can be calculated from the first threshold and the basic award. For a couple, for instance, this would be:
£6,420, plus (£1,890 + £1,860) divided by 39%. That is £16,035 in rounded figures.
If they are claimed together, both combine to form the basic award. This combined award is subject to withdrawal from the point at which WTC entitlement would have been zero (called the First threshold for those entitled to Child Tax Credit only). In 2009/10 this threshold was £16,040.
However, unlike WTC, CTC does not continue to reduce to zero. It reduces only until it reaches the "basic family element" of £545pa. Thereafter it remains fixed until the household reaches a second income threshold (£50,000 in 2009/10). After that it reduces again at a rate of £1 for every £15 of income.
Recipient households of combined WTC/CTC awards thus fall into three categories
Since large fluctuations from year to year would be undesirable, broad allowance is made for this by disregarding the first £2,500 of any increase in the final income from one year to the next. Only changes in excess of this income disregard are taken into account in establishing a final award. Overpayments are recovered by adjustment to the amount of the following years' interim award.
Tax credits have not proved to be nearly as robust or well administered as the initial design envisaged. Claimants have not always recognised the need to report any change of circumstances immediately. The time taken by the system of administration to then take these into account adds to any overpayment generated and shortens the time available for their recovery. This led to significant levels of overpayments. In order to reduce the overpayment problem, the income disregard was raised tenfold from £2,500 to £25,000 with effect from 2006/07.
By comparison with other means test
ed benefits
, the income treatment of claimants of tax credits is especially generous; it permits deduction of the full gross amount (rather than 50% net)of any individual pension
contributions and any Gift aid
payments. Since increases in income are subject to withdrawal at 39%(in the initial range), such reductions are effectively 'rebated' at the same rate through the tax credits received. Thus, while a pension (or Gift Aid) contribution of £100 will cost the employee £80 (after basic rate tax relief) directly from net pay, it attracts an additional £39 in tax credits; so the true cost is only £41.
Other concessions with regard to assessment of income (in contrast to means testing used elsewhere) include:
The levels of Tax Credit take-up in the UK have not risen in recent years, despite an increase of 100,000 children living in households classed as "below the poverty line" between 2004 and 2005.
losing its contract to provide the Inland Revenue
with computer services.
These problems led to considerable political fallout. Dawn Primarolo
, who as Paymaster General was the minister responsible for the implementation of tax credits, having to apologise to parliament and being asked whether she had "lost control" of her department. Prime Minister
Tony Blair
also apologised to Parliament over the incident.
David Blunkett
, former Cabinet minister has criticised the system stating, "The tax credit system is a shambles — such a shambles that I've had to help out one of my constituents financially, only the second time that I ever have done this, and the first was for a child....
what else can you do when the tax credit system is such a total mess?"
Despite its flaws, however, the tax credit system has proven itself to be an effective mechanism in tackling poverty, with 2 million children lifted out of absolute poverty and almost 1 million out of relative poverty by 2007 as a result of this benefit.
Welfare
Welfare refers to a broad discourse which may hold certain implications regarding the provision of a minimal level of wellbeing and social support for all citizens without the stigma of charity. This is termed "social solidarity"...
in the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
made to people who work on a low income. It is a part of the current system of refundable (or non-wastable) tax credits introduced in April 2003 and is a means-tested social security
Social security
Social security is primarily a social insurance program providing social protection or protection against socially recognized conditions, including poverty, old age, disability, unemployment and others. Social security may refer to:...
benefit. In addition, people may also be entitled to the Child Tax Credit
Child tax credit
A child tax credit is the name for tax credits issued in some countries that depends on the number of dependent children in a family. The credit may depend on other factors as well: typically it depends on income level. For example, in the United States, only families making less than $110K per...
(CTC) if they are responsible for any children.
Despite their name, tax credits are not linked to a person's tax bill. The WTC can be claimed by working individuals, childless couples and working families with dependent children. The WTC and CTC are assessed jointly and families remain eligible for CTC even if where no adult is working or they have too much income to receive the WTC.
In 2010 the coalition government
United Kingdom coalition government (2010–present)
The ConservativeLiberal Democrat coalition is the present Government of the United Kingdom, formed after the 2010 general election. The Conservative Party and the Liberal Democrats entered into discussions which culminated in the 2010 coalition agreement, setting out a programme for government...
announced that the Working tax credit will, by about 2016, be integrated into and replaced by the new Universal Credit
Universal Credit
The Universal Credit is a proposed new benefit which will replace six of the main means-tested benefits and tax credits in the United Kingdom.-Background:...
.
History
The WTC replaced the Working Families Tax Credit (WFTC'), which operated from April 1999 until March 2003. The WFTC was itself a transitional system from the earlier benefit for working families known as Family Credit (FC), which had been in operation since 1986.The WFTC shared its assessment of means and period of renewal (6 months) with FC but moved towards a tax credit approach styled on schemes in other countries, which used an annual declaration of income to assess entitlement for a whole year. Tax Credits also replaced the child elements in means tested benefits, the Children's Tax Credit in the tax system, and disabled persons tax credit.
How it works
The basic operation of the tax credit is broken down into the following steps:- An individual makes an application for WTC to HM Revenue and Customs (HMRC).
- HMRC calculates a provisional amount of tax credit to be awarded. It is based on the previous tax year's income and current circumstances. The tax credit is then paid in monthly or weekly instalments to the claimant via bank account until the end of the tax year, 5 April. It is possible to ask HMRC to base their calculations on the estimated current year's income, but this does carry some risks.
- After the end of the tax year, HMRC send claimants forms (TC603R and TC603D commonly called renewal or declaration forms) asking them to confirm their actual income for the year just ended. For those who do not have actual income figures available, they must provide an estimate to HMRC by 31 July and confirm this by the following 31 January. The deadline for the return of the renewal forms to HMRC for 2010–2011 is 31 July 2010.
- A final calculation of the WTC is made using the confirmed income. This final amount might be greater, equal to or lower than the provisional amount received the previous year.
- If someone received more than the final WTC calculation, this is an over paymentTax credit overpaymentIn the tax law of the United Kingdom, tax credit overpayment occurs when a claimant has received more Working Tax Credit or Child Tax Credit than HMRC’s final end of year calculations awards them. This can be caused by official or claimant error or neglect, or simply because the provisional...
and must be repaid to HMRC. Similarly, if someone received less than the final WTC calculation, this is an underpayment in which case HMRC will make a lump sum payment back to that person.
Calculation of the annual award
The amount of the award is calculated from two separate amount as follows:- WTC award = Elements minus Withdrawal
The component called Elements is based on circumstances whilst the Withdrawal component is income based. The following sections describe how each component is arrived at.
Elements
The Working Tax Credit (WTC) and the Child Tax Credit (CTC) are made up of "elements" related to individual circumstances. Examples of elements are:- a basic element of £1,890 payable to everyone (in 2009/10)
- a couple and lone parent element (£1,860)
- a 30 hour [working week] element (£775)
- a disabled worker element (£2,530), or a severely disabled worker element (£1,075)
- a 50+ return-to-work payment (at one of two rates: £1,300(16–29 hours) or £1,935(30 hours+)
Each element that applies to a claimant's circumstances is added together to determine the maximum award of tax credit (before any withdrawal is considered). For example, a couple would have elements calculated as
- Elements = £1,890 + £1,860 = £3,750
Withdrawal
The withdrawal rate is the amount that is deducted from the Elements described above. If the gross annual income exceeds a predetermined first threshold of £6,420 (in 2009/10) then the first (and main) withdrawal rate is 39 percent (but see Income Tax changes, below). This means that for every £1 earned above the threshold, 39p of the WTC entitlement is withdrawn.As withdrawal of tax credits is based on 'gross' rather than 'net' income, however, the claimant is also subject to Class 1 NIC national insurance contributions at 11 percent and UK income tax at 20 percent—making an effective marginal tax rate of 70 percent.
For example, if one person in a couple earns £10,000 pa, then the amount of withdrawal is
- Withdrawal = 39% times (10,000 - 6,420) = £1,396.20
Under withdrawal, entitlement to WTC is gradually reduced first until 'exhausted' at an income level that can be calculated from the first threshold and the basic award. For a couple, for instance, this would be:
£6,420, plus (£1,890 + £1,860) divided by 39%. That is £16,035 in rounded figures.
Amount of WTC
In this example, the award is then calculated as follows:- WTC = Elements - Withdrawal = £3,750 - £1,396.20 = £2,353.80
Interaction of WTC and CTC
WTC and CTC are designed to be a seamless allowance that steadily reduces as family income rises.If they are claimed together, both combine to form the basic award. This combined award is subject to withdrawal from the point at which WTC entitlement would have been zero (called the First threshold for those entitled to Child Tax Credit only). In 2009/10 this threshold was £16,040.
However, unlike WTC, CTC does not continue to reduce to zero. It reduces only until it reaches the "basic family element" of £545pa. Thereafter it remains fixed until the household reaches a second income threshold (£50,000 in 2009/10). After that it reduces again at a rate of £1 for every £15 of income.
Recipient households of combined WTC/CTC awards thus fall into three categories
- those on a 'main-rate' reduction of 70 percent (i.e. marginal tax + 39%) receiving > £545pa
- those on an income of up to £50,000 in receipt of the small flat rate family element (i.e. marginal tax only) receiving £545pa
- those with incomes between £50,000 and £58,170 (i.e. marginal tax + 6.67%) receiving <£545pa
Awards and disregards
WTC and CTC for the current tax year year are considered to be an interim award because they are based on the previous tax year's gross household income. Final awards would need to be adjusted in subsequent years when the actual income is known.Since large fluctuations from year to year would be undesirable, broad allowance is made for this by disregarding the first £2,500 of any increase in the final income from one year to the next. Only changes in excess of this income disregard are taken into account in establishing a final award. Overpayments are recovered by adjustment to the amount of the following years' interim award.
Tax credits have not proved to be nearly as robust or well administered as the initial design envisaged. Claimants have not always recognised the need to report any change of circumstances immediately. The time taken by the system of administration to then take these into account adds to any overpayment generated and shortens the time available for their recovery. This led to significant levels of overpayments. In order to reduce the overpayment problem, the income disregard was raised tenfold from £2,500 to £25,000 with effect from 2006/07.
Assessment of income
Income for tax credit purposes is in principle assessed similarly to UK income tax. Thus 'income' (c/f 'taxable income') consists of what the individual receives from gross earned and unearned sources—less allowances for 'expenditures' that would reduce that income. But, unlike income tax, tax credits measure income based on family 'household', rather than the individuals within. Also the effect of income disregard —to mask large annual increases in resources from reassessment— weakens comparisons with a true income tax still further.By comparison with other means test
Means test
A means test is a determination of whether an individual or family is eligible for help from the government.- Canada :In Canada means tests are used for student finance , and "welfare" . They are not generally used for primary education and secondary education which are tax-funded...
ed benefits
Welfare
Welfare refers to a broad discourse which may hold certain implications regarding the provision of a minimal level of wellbeing and social support for all citizens without the stigma of charity. This is termed "social solidarity"...
, the income treatment of claimants of tax credits is especially generous; it permits deduction of the full gross amount (rather than 50% net)of any individual pension
Pension
In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...
contributions and any Gift aid
Gift Aid
Gift Aid is a UK tax incentive that enables tax-effective giving by individuals to charities in the United Kingdom. Gift Aid was originally introduced in Finance Act 1990 for donation from 1 October 1990, but was originally limited to cash gifts of £600 or more...
payments. Since increases in income are subject to withdrawal at 39%(in the initial range), such reductions are effectively 'rebated' at the same rate through the tax credits received. Thus, while a pension (or Gift Aid) contribution of £100 will cost the employee £80 (after basic rate tax relief) directly from net pay, it attracts an additional £39 in tax credits; so the true cost is only £41.
Other concessions with regard to assessment of income (in contrast to means testing used elsewhere) include:
- disregarding the first £300 of 'other' gross income (rent, interest or dividends etc.).
- disregarding 'other' income derived from tax-freeIndividual Savings AccountAn Individual Savings Account is a financial product available to residents in the United Kingdom. It is designed for the purpose of investment and savings with a favourable tax status. Money is contributed from after tax income and not subjected to income tax or capital gains tax within a holding...
savings and investments
- having no explicit (ineligibility) limit for capital resources (as only actual income derived from capital is taken into account)
Level of take-up
Around 7 million people in the UK are entitled to claim Working Tax Credit or the companion Child Tax Credit, although around 2 million people do not do so.The levels of Tax Credit take-up in the UK have not risen in recent years, despite an increase of 100,000 children living in households classed as "below the poverty line" between 2004 and 2005.
Implementation difficulties
The introduction of the Working Tax Credit scheme was marred by implementation issues and large scale overpayments. The Office of National Statistics estimated that of the £13.5bn paid out in tax credits in 2004, £1.9bn consisted of overpayments. In addition, computer problems led to delays in many receiving payments, causing significant financial hardship for those on low incomes, and resulting in EDSElectronic Data Systems
HP Enterprise Services is the global business and technology services division of Hewlett Packard's HP Enterprise Business strategic business unit. It was formed by the combination of HP's legacy services consulting and outsourcing business and the integration of acquired Electronic Data Systems,...
losing its contract to provide the Inland Revenue
Inland Revenue
The Inland Revenue was, until April 2005, a department of the British Government responsible for the collection of direct taxation, including income tax, national insurance contributions, capital gains tax, inheritance tax, corporation tax, petroleum revenue tax and stamp duty...
with computer services.
These problems led to considerable political fallout. Dawn Primarolo
Dawn Primarolo
Dawn Primarolo is a British Labour Party politician who has been the Member of Parliament for Bristol South since 1987. She was Minister of State for Children, Young People and Families at the Department for Children, Schools and Families from June 2009 to May 2010 and is now a Deputy Speaker of...
, who as Paymaster General was the minister responsible for the implementation of tax credits, having to apologise to parliament and being asked whether she had "lost control" of her department. Prime Minister
Prime Minister of the United Kingdom
The Prime Minister of the United Kingdom of Great Britain and Northern Ireland is the Head of Her Majesty's Government in the United Kingdom. The Prime Minister and Cabinet are collectively accountable for their policies and actions to the Sovereign, to Parliament, to their political party and...
Tony Blair
Tony Blair
Anthony Charles Lynton Blair is a former British Labour Party politician who served as the Prime Minister of the United Kingdom from 2 May 1997 to 27 June 2007. He was the Member of Parliament for Sedgefield from 1983 to 2007 and Leader of the Labour Party from 1994 to 2007...
also apologised to Parliament over the incident.
Criticism
The Working Tax Credit scheme has been subject to much criticism, particularly in the wake of the difficulties surrounding its implementation. Criticism has focused on the way that credits are calculated on an annual basis, leading to overpayment, followed by large demands for repayment, which those on low income may find difficult to meet. David Harker, chief executive of Citizens Advice commented "This is an untenable system. An annualised system doesn't provide the stability of income required by low income families". In addition, the scheme has been accused of being over complicated and difficult for claimants to understand, and of underestimating the extent to which the incomes of low-earners can fluctuate over a year.David Blunkett
David Blunkett
David Blunkett is a British Labour Party politician and the Member of Parliament for Sheffield Brightside and Hillsborough, having represented Sheffield Brightside from 1987 to 2010...
, former Cabinet minister has criticised the system stating, "The tax credit system is a shambles — such a shambles that I've had to help out one of my constituents financially, only the second time that I ever have done this, and the first was for a child....
what else can you do when the tax credit system is such a total mess?"
Despite its flaws, however, the tax credit system has proven itself to be an effective mechanism in tackling poverty, with 2 million children lifted out of absolute poverty and almost 1 million out of relative poverty by 2007 as a result of this benefit.