Working tax credit
Working tax credit (WTC), is a component of the current
tax creditsscheme in the United Kingdom - part of the system of means-tested social security benefits. The related component of the scheme is the Child tax credit(CTC). Tax credits were introduced in their present form in April 2003. Previously these allowances were combined in a single payment for low-income family and single-parent households called Working Families Tax Credit (WFTC), which operated from April 1999 until March 2003. WFTC was transitional from the earlier benefit for working families - Family Credit (FC) (since 1986) - whose assessment of means and period of renewal (6 months) it shared - and a "tax credit" approach styled on schemes in other countries, which used an "annual" declaration of income to assess entitlement for a whole year.
WTC and CTC are "non-wasteable" credits - the actual payments may exceed and are not limited by the amount of annual
income taxpayable by the claimant. 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 are they have too much income to receive WTC.
Elements of tax credits
Both WTC and CTC are themselves made up of components (referred to as "elements") related to individual circumstances that form the "maximum" award of tax credit. Each claim for WTC consists of a "basic element" (of £1,620 in 2006/07) and (if applicable) a "couple and lone parent element" (£1,595). In addition, claimants can receive a "30 hour" [working week] "element", a "disabled worker element" (£2165), a "severely disabled worker element" (£920) and/or a "50+ return-to-work payment" (at one of two rates: £1,110 or £1,660) - depending on which secondary characteristic applies to them. These secondary entitlements 'overlap' - meaning where two (or more) circumstances apply together such "elements" will be added to the "basic element"
A full list of available Tax credit elements and rates can be found at the HMRC website: http://www.hmrc.gov.uk/rates/taxcredits.htm
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 £5,220 in 2006/07). In the case of WTC (and also CTC) this "first" (and main) "withdrawal rate" for tax credits is 37 percent. This means that for every £1 earned above the £5,220 threshold, 37p of the WTC entitlement is withdrawn. As withdrawal of tax credits is based on their 'gross' and not 'net' income, however, the claimant is actually subject to three simultaneous forms of reduction: "Class 1 NIC" national insurance contributionsat 11 percent, UK "income tax" at 10 percent (or 22 percent) and the "tax credit", itself - at 37 percent – making an effective marginal tax rate of up to 70 percent. This high effective rate of tax falling on the recipients of WTC 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.
From the financial year 2008/09, the main withdrawal rate will increase from 37 to 39 percent. At the same time the basic rate of income tax reduces from 22 percent to 20 percent and the starting rate of 10 percent withdrawn for earned and pension income. This leaves the effective marginal rate at 70 percent (11 plus 20 plus 39). The first threshold has also been raised above normal indexation to £6,440 - in part to compensate for the loss of the 10 percent rate.
Interaction of tax credit components
Under withdrawal, entitlement to WTC is first reduced and finally 'exhausted' at an annual income level which can be calculated straightforwardly from the level of the "first threshold" and knowing the basic amount payable. For a couple, for instance, this would be:
£5,220, plus (£1,620 + £1,595) divided by 37%. That is £13,909 in round figures.
Where CTC is claimed, its components similarly combine to form the basic amount payable just like WTC. For a family of two children aged 4 and 7, for instance, this would consist of: a "family element" (in 2006/07) of £545 and a "child element" of £1,690 for each child, making a total of £3,925. This basic amount is then subject to withdrawal at the same initial rate - 37 percent - as WTC, but only from a higher, predetermined "threshold" set just above the point at which WTC would have become exhausted. In the case of CTC for 2006/07, this threshold has been set at £13,910. Tax credit components are thus designed to form an integrated, seamless allowance that is steadily reduced as family income rises. But unlike WTC, CTC does not continue to reduce steadily to nothing. Once CTC has been reduced to the level of "family element" of £545 (at annual income of £23,045 in this example), it remains fixed there until the household reaches a "second income threshold" of £50,000. Thereafter it will start to reduce again - but at a much more modest rate of 6.67% (1 in 15). Recipient households of WTC and CTC payments thus fall into two broad categories - those on a main-rate reduction of 70 percent (marginal tax) and those in a wide range of income up to £50,000 in receipt of small flat rate "family element" only and subject to normal marginal taxation.
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. For instance, if a couple in the above example were awarded £2,815 WTC/CTC in 2006/07 based on their income from the previous year (2005/06) of £16,910 but subsequently turned out to have received £21,450 in the current year - a rise of £4,540 - then only £2,040 of that increase would need to be taken into account and lead to a smaller reduction to the following year's award of £754 (£14.50pw).
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?" [http://www.publications.parliament.uk/pa/cm200607/cmhansrd/cm070315/halltext/70315h0006.htm]
Assessment of income
Income for tax credit purposes is assessed similarly in principle to the way income for payment of UK income tax would be determined. Thus 'income' (c/f 'taxable income') will consist of what the individual has received by way of gross earned and unearned sources - less certain allowances for 'expenditures' that would reduce that income. Unlike income tax however, the tax credits' measure of income is based on a 'household', which will consist of the pooled resources from both adults in any couple or in any family with dependent children. The distorting presence of the "income disregard" - to weaken the link between the income of a person (or couple) and what tax credits they may finally receive - cannot be ignored altogether, but to a first approximation the parallel with the operation of a
negative income taxremains valid.
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 pensioncontributions and any Gift aidpayments they may make. Since increases in income (in the initial range) are subject to withdrawal at 37 percent, any offsetting 'reductions' allowed are effectively subject to 'rebate' at the same rate. Thus, whilst a pension (or Giftaid) contribution of £100 would result in direct cost to the employee of £78 after basic rate tax relief, it will attract an additional £37 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 [http://business.timesonline.co.uk/tol/business/economics/budget_2007/article1582431.ece official Treasury figures] - of 100,000 (from 2004-05) of children living in households classed as "below the poverty line".
The introduction of the Working Tax Credit scheme was marred by implementation issues and large scale overpayments. The
Office of National Statisticsestimated that of the £13.5bn payed out in tax credits in 2004, £1.9bn consisted of overpayments. [http://news.bbc.co.uk/1/hi/business/4112480.stm] 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 Revenuewith computer services.
These problems led to considerable political fallout.
Dawn Primarolo, who as Paymaster Generalwas the minister responsible for the implementation of tax credits, having to apologise to parliament [http://news.bbc.co.uk/1/hi/programmes/working_lunch/2966030.stm] and being asked whether she had "lost control" of her department. [http://news.bbc.co.uk/1/hi/business/3036006.stm] Prime Minister Tony Blairalso apologised to Parliament over the incident. [http://news.bbc.co.uk/1/hi/business/4112480.stm]
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 large demands for repayment, which those on low income may find difficult to meet, particularly if they have not budgeted for these repayments. David Harker, chief executive of
Citizens Advicecommented "This is an unteneble 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. [http://www.prospect-magazine.co.uk/article_details.php?id=9615 Prospect Magazine - Tax Credits: The Success and Failure (Subscription Content)] [http://www.prospect-magazine.co.uk/article_details.php?id=6967 Prospect Magazine - David Harker: Tax Credits - Labour has overpaid poor families by £2 billion, but this is no cause for celebration (Subscription Content)]
For rates of all main UK social security benefits (including WTC and CTC)see:
2006/07: [http://www.hm-treasury.gov.uk/pre_budget_report/prebud_pbr05/press_notices/prebud_pbr05_press02.cfm (UK Treasury - 2006 Pre-Budget Report)]
2007/08: [http://www.hm-treasury.gov.uk/budget/budget_07/press_notices/bud_bud07_press02.cfm (UK Treasury - 2007 Budget)]
2008/09: [http://www.hm-treasury.gov.uk/newsroom_and_speeches/press/2007/press_109_07.cfm (UK Treasury - Press notice, 2008 Budget)]
* [http://www.publications.parliament.uk/pa/cm200708/cmselect/cmpubacc/300/300.pdf House of Commons Public Accounts Committee report into Tax Credits and Overpayment]
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