Tax credit cuts that escaped Osborne's U-turn to hit 800,000 workers

About 800,000 people will still be hit by tax credit cuts from April because of a little-noticed change that survived the government’s controversial U-turn on the policy last year.

Labour said the scale of those affected by the cut would come as a surprise to those who thought the chancellor had abandoned attempts to reduce tax credits under pressure from the opposition and some Tory MPs.

Osborne was forced into the humiliating climbdown over tax credits in his autumn statement in November following a defeat for the proposed measures in the House of Lords. The defeat prompted a clash between the government and the upper chamber over whether the Lords could block a measure with such large implications for the government’s finances.

John McDonnell, the shadow chancellor, is now planning to table an urgent question seeking more details about how people will be affected by the cut.

“The chancellor said he was reversing his cuts to tax credits only two months ago, but like many announcements he makes he says one thing in public and does another when he thinks no one is looking,” McDonnell said. “It’s completely shameful when you consider that 800,000 working people, almost the equivalent of a city the size of Leeds, face losing money when the Tories are cutting taxes for a wealthy few.”

The Treasury is proceeding with a cut to the so-called “income-rise disregard”, which could cost affected households £200 to £300 a year on average, despite the measure being among those blocked by the House of Lords in October.

Under the changes, laid out in a draft statutory instrument, people will have their tax credits cut sooner when their employment income rises by more than £2,500 in a year, reducing the incentive to take on extra work or responsibilities, and raising the risk of overpayments.

It means people benefiting from the rise in Osborne’s “national living wage” will be particularly vulnerable to seeing their tax credits cut or clawed back if they happen to take on more hours or get a promotion.

McDonnell called on Osborne to use next month’s budget to reverse the cuts, which are due to save the Treasury £170m next year and £250m by
2018-19.

“There will be many Tory MPs who’ll have told their constituents that their chancellor was not cutting their tax credits who’ll now be left looking silly,” McDonnell added.

The details of numbers affected by the cut have only emerged because the Treasury was forced to give the data to a Lords committee examining draft legislation. The secondary legislation scrutiny committee had highlighted the absence of any impact assessment and demanded to know how many people would be affected by the proposed change and what would be the likely financial impact on those people.

However, the government declined to give information to the committee about how much each claimant was due to lose in tax credits, merely saying people would not be worse off overall because they would be earning more from elsewhere.

The Treasury told the committee: “HM Treasury has released the estimated number of people that will be affected by the new income-rise disregard in tax credits, of £2,500, compared to a situation where the disregard had remained at £5,000.

“A tax credit award will only be adjusted in response to a claimant earning more money. Next year there are expected to be 800,000 claimants with a reduced award as a result of their income increasing – none will be cash losers because their income will have increased.”

The “income-rise disregard” was raised as high as £25,000 under Labour to stop a crisis of overpayments in the tax credit system. This happened because tax credit entitlements are paid based on predicted earnings for the year ahead, calculated on the basis of the previous year’s earnings.

Before the limit, tax credits were often overpaid and then clawed back if a claimant’s income turned out to be higher than expected, causing “debts” to Revenue & Customs for millions of people.

A briefing from the Children’s Society charity says the main purpose of income disregard is to “avoid overpayments caused by estimated income for the coming year being lower than finalised income at the year end” as well as helping to provide additional support to those returning to work at key points of financial strain, such as following maternity leave or illness.

“The income-rise disregard gives a year of grace for those whose earnings rise, allowing people to adjust to their new circumstances and avoid having to pay back tax credits.”

A Treasury spokeswoman said: “It is a simple matter of fairness and
common sense that tax credit awards are reviewed as people’s incomes change. It isn’t right that someone earning significantly more should do just as well in terms of tax credits than someone earning less.

“Lowering the maximum annual pay rise that is disregarded to £2,500 will simply return the system to the same level as when tax credits were first introduced. By definition there will be no losers because people’s increase in income will outstrip any reduction to their tax credit award.”