Universal Credit and Hour Credits

The move in the UK to combine multiple forms of benefit payments into one Universal Credit is a very sensible idea in theory. Delivering it has proven difficult, however, and I suggest that my hour credit proposal would resolve a lot of these problems.

The problem with having lots of independent forms of benefit is that they can interact in undesirable ways that discourage people from working. The worst situation is that in which people are actually better off if they work fewer hours. But even having high effective marginal benefit withdrawal rates is undesirable.

High marginal rates mean that working an extra hour will not bring nearly as much in net income as it does in gross income. Add the fact that people’s time off work (to do work in their home, caring for others or simply for leisure) is also valuable and people may not take up additional work even if it is available to them.

A recent report by the Resolution Foundation has highlighted that the aim of making work pay is not currently going to be achieved in all cases. Single parents, second earners with children and the disabled in particular are picked out as being provided with insufficient incentives to take up work and increase their hours.

I wanted to highlight the advantages of calculating support in a way that takes account of the amount of hours worked, as my proposed hourly averaging tax system does. The basic idea is that people are given an hour credit for every hour they work for a recognised employer and this is used to calculate their lifetime tax rate. Each person’s tax rate is based on their lifetime average income per hour worked – calculated by dividing lifetime income by lifetime hour credits.

Those who work long hours at a low wage will receive a more generous tax rate than those who earn the same amount of income while working fewer hours. The incentive to work full-time is therefore built into the system.

What has a tax proposal got to do with the Universal Credit benefit system reform? Put simply – you can use the hourly tax system simultaneously for benefits and taxes. Hour credits can be seen to work in one of two ways—that they bring down your tax rate or alternatively that each one brings you additional income at the rate of your hourly net income.

The hour credit system can provide people with additional hour credits instead of the cash benefits they would receive at present. So someone might get five hour credits a week instead of child benefit, 4 hour credits a week as a result of their disability and so on. These hour credits will bring additional income as a result.

The hour credit system therefore puts all benefits into the same currency—additional hour credits. The value of the hour credits relate to the person’s lifetime income statistics, but will be worth at minimum the effective net hourly minimum wage.

We can be sure that additional hour credits will not produce a disincentive to work because people who receive these can still work and get hour credits for this. Working more hours will always generate more income, irrespective of the additional hour credits that each person receives (up to the maximum weekly or monthly limit for work-based hour credits).

The additional-hour-credit system that replaces existing benefits would sit alongside the regular-hour-credit tax system and the two together will encourage people to work while providing generous benefits to those who qualify according to the relevant criteria.

Hourly averaging works by providing earning subsidies to those with a low lifetime hourly average income. We could alternatively call this a negative hourly tax-rate for low earners. People who are economically unfortunate will get their income topped up. However, working will make them better off as they will be able to qualify for more hour credits as well as receiving the income from these.

The aim of a generous benefit system that retains strong incentives to work is very difficult to achieve unless you build incentives to work longer hours into the entire system. Hourly averaging does just this.