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Hounding the poor

Hounding the poor

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The Independent reports that the UK Government is using debt collection agencies to recover overpaid tax credits from some of Britain's poorest families. In many cases the debts are due to errors by HMRC. And in many more cases they are due to fundamental flaws in the design of the system. Some are due to errors on the part of the claimants. Few, if any, are due to fraud.

The tax credits system is complex. But the fundamental problem is simple. The design of the system does not match the reality of people's lives.

The tax credits system is principally designed for people who are in stable long-term employment with a single employer. But these are the very people who least need tax credits. This is because, in these days of highly flexible labour markets, people in stable long-term employment tend to be well paid. If someone's skills and abilities are scarce enough for an employer to accept the costs of employing them, the employer is also likely to pay them well. The poorly-paid tend to be the least secure. Many of them are part-time: some of the poorest people in the country are single mothers working part-time. Many are self-employed, because increasingly employers do not want the costs or responsibilities of employment for unskilled workers. Many are on temporary or zero-hours contracts. The picture is not one of a stable workforce of very low-paid workers helped on a long-term basis by a benevolent government. It is a fluid dynamic of people moving in and out of short-term and casual jobs, and a tax credits system that can't keep up with the changes and therefore ends up hurting the very people it is supposed to help. 

The most unstable income is that of the self-employed. The picture most people have of self-employment is a “man with a van”, who earns a very comfortable living doing some kind of trade. And indeed, that is how self-employment used to be. But not any more. At the same time as self-employment has vastly increased, self-employed incomes have crashed in the last five years. The median income for the self-employed is now less than half median employment income. It is probably fair to say that the majority of self-employed now depend on tax credits and other benefits. But the system cannot even begin to cope with them.

Tax credits, like self-employment taxation, are based on estimated earnings. Your tax credit entitlement is calculated based upon your income for the previous tax year. But that may or may not bear any resemblance to your actual income in the current tax year. HMRC say that they should be told about changes of income – but they are thinking of someone in stable employment receiving a pay rise or changing jobs. How is someone whose self-employed income varies from week to week supposed to report “changes of income”? HMRC does not have the resources to staff the phones, or the IT capacity to handle the website traffic, if self-employed people or people doing short-term temp or contract work reported to them the income change arising from every new job or every jobless period.

What happens in practice, therefore, is that when the self-employed and people with unstable income report their actual income at the end of the tax year, it differs significantly from the estimate. This means that they have either been underpaid tax credits, or they have been overpaid. If they have been underpaid, then they have struggled on unnecessarily low incomes throughout the year, but they do receive a year-end top-up payment. But if they have been overpaid, then the benefits have to be clawed back. This is usually done by deducting the overpayments from tax credit payments in the following tax year, which are of course also reduced because the income has increased. If the income increase is large enough to end eligibility for tax credits, then the claimant must pay back the overpayment out of their earnings. In what way is this an incentive to people to work hard and earn more? And of course, the following year's tax credits entitlement is estimated.....what if their income from earnings goes down? Far from relieving stress, benefits themselves are a source of uncertainty and worry for those with unstable income.

The tax credits system simply is not designed to cope with the constant change that is the reality of many people's lives. But in part because of its ineffectiveness, it is extremely complex. Mistakes by administrative staff are common. When these lead to underpayments, the poor struggle on unnecessarily low incomes, but they do in the end receive payments. But when these lead to overpayments, claimants who have previously been told they are receiving the right amount are suddenly told not only that the amount was wrong, but that they have to pay it back. And HMRC are not kind to benefits recipients who are unable to repay overpaid benefits – I speak from experience. They treat overpaid benefits as debts, even if the overpayment was due to HMRC's error. And they hound these “debtors” with unpleasant letters, phone calls, SMS texts. They pursue them through the courts, and they send in bailiffs to seize assets.

Just to remind you, the people they are chasing for payment are among the poorest in the country. Repaying these overpaid benefits causes real hardship. These people are being made even poorer, and what little creditworthiness they have is being destroyed, by a tax credit system that is not fit for purpose coupled with an overly harsh regime for dealing with involuntary indebtedness. 

Leaving aside the questionable morality of pursuing the poor in this manner, the economics of such a tax credit system make no sense. Tax credits should be counter-cyclical: as the economy improves and wages rise, so tax credit payments should fall. But when entitlements are estimated on the past year's income, overpayments are inevitable in an improving economy. If you then claw them back by deducting from future claims and/or earnings, you depress claimants' real incomes. Since benefits claimants are poor, they are likely to spend rather than save any income increase. Hitting their incomes in the name of “keeping benefits bills down” is not clever if your main economic problem is lack of aggregate demand.

But worse than that, a tax credit system based upon weak estimates and riddled with unforced errors creates serious disincentives to work. Consider someone, registered self-employed, who is doing around 25 hours a week of casual work at the minimum wage. They are offered the opportunity to do an additional 15 hours a week for a month. Should they accept this work? Arguably, no they should not. They will lose nearly all of the extra income in benefits clawback, most likely accompanied by unpleasant hounding by debt collection agencies because HMRC won't get round to noticing the extra income for several months and by that time will have paid quite a bit too much. Where is the incentive to work hard and improve earnings, if virtually all of it goes in benefit clawbacks and there is the added distress of involuntary indebtedness?

If the purpose of the tax credits system – and its replacement Universal Credit – is to provide stability and work incentives to those with low unstable income, it manifestly fails. And if anyone thinks that Universal Credit will make things better, they are dreaming. The IT infrastructure for Universal Credit is simply not going to deliver the flexibility required, and the punitive treatment of people who have been overpaid is set to continue. Indeed it may even get worse, especially for the self-employed. 

Under Universal Credit, self-employed people will have to report their net earnings monthly to HMRC. Tax credits will adjust automatically in the FOLLOWING month based upon the earnings in the previous month. Presumably, then, if tax credits one month were massively overpaid due to a spike in earnings that month, the following month they will be clawed back. Once again, where is the incentive for people to work hard and grow their businesses? Indeed, how are they supposed to invest profits in growing the business if benefits are always clawed back when earnings rise? Self-employed people are faced not only with unstable income, but unstable benefits too.

Originally there was an income buffer, which allowed people's incomes to vary within limits without incurring a benefits penalty. But that was wiped by the Coalition government in the name of cost-cutting. Yet the income buffer removed the disincentives to work that sharp clawbacks create, and it massively reduced the incidence of over- and under-payments. And there is now a new restriction, presumably introduced to reduce abuse of "self-employment" status to get people off the unemployment statistics. Self-employed people on Universal Credit will lose their "income floor" after a year. If their business then suffers a downturn, tax credits will no longer support their income to minimum wage full-time equivalent. The effect will be that self-employed people will be forced to close down businesses experiencing temporary downturns.  This is no way to encourage enterprise. 

I doubt if removing the income buffer has saved any money at all. The extra administration needed to deal with all those overpayments may even have increased the cost. And harsh treatment of honest people who end up in benefits debt through no fault of their own is both distressing and counterproductive. It's a disgrace.

We must do better than this. We need a benefits system that is simple and cheap to administer, does not cause involuntary indebtedness and does not penalise hard work and enterprise. Personally I think a universal basic income would come closest to meeting this need. But at the very least, we need to restore the income buffer and ensure that the income floor does not leak for anyone, especially the self-employed. And stop this merciless hounding of the poor. 

Related reading:

Categorising the poor

Never mind the welfare reform anecdotes, feel the MPA - Anna Hedge

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