Working tax credit: Wikis

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Working tax credit (WTC), in the United Kingdom, is a payment from the state for people who work on a low income. It is a part of the current tax credits system - part of the system of means-tested social security benefits. As well as Working Tax Credit, people may also be entitled Child tax credit (CTC) if they are responsible for a child or children. Tax credits were introduced in their present form in April 2003. They replaced Working Families Tax Credit (WFTC), which operated from April 1999 until March 2003. WFTC was a transitional system from the earlier benefit for working families known as Family Credit (FC) which had been in operation from 1986. 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.

Despite their name, tax credits are not linked to a person's tax bill. WTC can be claimed by working individuals, childless couples and working families with dependent children. 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 WTC.

Application for both CTC and WTC is made to Her Majesty's Revenue and Customs (HMRC), where the initial award of tax credits is based on previous year's income with current circumstances and a provisional amount is awarded. Some people choose to ask HMRC to based their tax credits on an estimated current year income, but this carries some risks.[1] This is paid in monthly or weekly instalments to the claimant via bank account until the end of the tax year, 5 April. 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. Once the claimant can confirm the actual income for that tax year the final calculation is made on the award. Sometimes people will have received more than they are entitled. This means they will have an overpayment. Any overpayment, known as Tax credit overpayment, is expected to be repaid. If a claimant has been underpaid, HMRC will make a lump sum payment. For those who do not have actual income figures available, they must provide an estimate to HMRC by 31st July and confirm this by the following 31st January. The deadline for the return of the renewal forms to HMRC is for 2008-2009, 31st July 2008.

Contents

Elements of tax credits

Both Working Tax Credit(WTC) and Child Tax Credit(CTC) are themselves made up of components referred to as "elements". These elements are related to individual circumstances that form the maximum award of tax credit. Each claim for WTC consists of a basic element of £1,890 (in 2009/10) and, if applicable, a couple and lone parent element (£1,860). In addition, claimants can receive a 30 hour [working week] element (£775), a disabled worker element (£2,530), a severely disabled worker element (£1,075) and/or a 50+ return-to-work payment (at one of two rates: £1,300(16-29 hours) or £1,935(30 hours+) ).[2]

Withdrawal of tax credits

Being an income-related payment, a tax credit initially reduces (much like an earned income is reduced by the effect of income tax) under a so-called withdrawal rate as gross annual income exceeds a predetermined first threshold of £6,420 (in 2009/10). For WTC and CTC 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. This high effective rate of tax falling on the recipients of tax credits is an inescapable feature of any scheme whose main purpose is to raise the 'take home pay' of low and modest earners whilst seeking to remain affordable in terms of total public expenditure.

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2008/09 Income Tax changes

In tax year 2008/09, the basic rate of income tax was reduced from 22 percent to 20 percent and the starting rate of 10 percent abolished for earned and pension income. At the same time, the main tax credits withdrawal rate increased from 37 to 39 percent. This left the effective marginal rate exactly where it had been - at 70 percent (11 plus 20 plus 39). However the first threshold was also raised above normal indexation - from £5,220 to £6,420 - in part to compensate for the loss of the 10 percent rate.

Interaction of tax credit components

Under withdrawal, entitlement to WTC is gradually reduced first until 'exhausted' at an income level which 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.

Where CTC is claimed, its components similarly combine to form the basic award. This award is subject to withdrawal from the point at which WTC entitlement would be zero, however.

In 2009/10, this First threshold for those entitled to Child Tax Credit only is set at £16,040.

Tax credits (WTC and CTC) are thus designed as a seamless allowance that is steadily reduced as family income rises. But unlike WTC, CTC does not continue to reduce to nothing. Once CTC has been reduced to the level of family element of £545, it remains fixed there until the household reaches a second income threshold of £50,000. Thereafter it starts be reduced again - but at a much more modest rate of 6.67% (1 in 15).

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

Tax credits (both WTC and CTC) for the current year will need to be paid on the previous tax year's gross household income as an interim award, as only this information will be available at the time of application or renewal . As incomes rarely if at all remain the same from one year to the next nearly all 'finalised' awards would need to be adjusted in subsequent years to allow for any change and the result of so many revisions would be undesirable. When first introduced, therefore, broad allowance was made for this (at the price of making the scheme less closely resemble 'true' tax credits) 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 would need to be taken into account in establishing a final award. Overpayments could be recovered by adjustment over the same period (12 months) in 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. Even when reported, however, the long time required by the system of administration to take such circumstances into account will add to any overpayment generated and shorten the time available for their recovery. One result has been significant levels of overpayments - only a proportion of which have been or may ever prove to be recoverable - even allowing for the scope of the income disregard to ignore changes. Probably in part to reduce significantly the problems of further such overpayments in subsequent years, the income disregard was raised tenfold from £2,500 to £25,000 with effect from 2006/07.

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?"[3]

Assessment of income

Income for tax credit purposes is assessed similarly in principle to how UK income tax would be determined. Thus 'income' (c/f 'taxable income') will consist of what the individual has received from gross earned and unearned sources - less certain allowances for 'expenditures' that would reduce that income. Unlike income tax however, tax credits measures income is based on a family 'household', rather than the individuals within it. The presence of the income disregard - to mask large annual increases in resources - however weakens the (direct) link between the income of the person (or couple) and what tax credits they may actually receive over a number of years.

By comparison with remaining means tested benefits, of which the tax credits scheme is an example, the income treatment of claimants is especially generous in that it permits them to deduct the full gross amount of any personal pension contributions and any Gift aid payments they may make. Since increases in income (in the initial range) are subject to withdrawal at 39 percent, any offsetting 'reductions' allowed are effectively subject to 'rebate' at the same rate. Thus, whilst a pension (or Gift Aid) contribution of £100 would result in direct cost to the employee of £80 after basic rate tax relief, it will attract an additional £39 in total tax credit awarded and so will reduce the direct cost to just £41 instead.

Other concessions with regard to the assessment of income (in contrast to means testing used elsewhere) include:

- disregarding the first £300 of 'other' income (rent, interest or dividends etc).

- disregarding any 'other' income deriving from tax-free savings and investments

- having no explicit limit on capital resources (as it is only income from capital that is declarable) to the making of a claim.

Level of take-up

Around 2 million of those entitled do not claim Working Tax Credit or its companion Child Tax Credit, despite there being around 7 million people in the UK entitled to do so. The levels of Tax Credit take-up in the UK have not risen in recent years, despite a recent increase - according to official Treasury figures [4] - of 100,000 (from 2004-05) of children living in households classed as "below the poverty line".

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 paied out in tax credits in 2004, £1.9bn consisted of overpayments.[5] In addition, computer problems led to delays in many receiving payments, causing significant financial hardship for those on low incomes, and resulting in EDS 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[6] and being asked whether she had "lost control" of her department. [7] Prime Minister Tony Blair also apologised to Parliament over the incident.[5]

The problem of overpayment has continued on a massive scale since inception leaving millions of claimants in debt. The causes of overpayment is many and complex at times, please see here for further information; tax credit overpayment.

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.[8][9]

Further information

HMRC Rates and Allowances - Tax Credits/Child Benefit

also see Tax Credit Casualties

References

External links


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