Here we look at the OBR’s update to see whether the Chancellor’s spending plans are on track, we examine the Living Wage announcement and see how this interacts with changes to tax credits, we look into the changes to Higher Education funding and apprenticeships, and consider the government’s green paper on pension and savings tax relief.
NOT QUITE THE END OF AUSTERITY
The usual politics of elections might dictate promising lots of goodies during the campaign and tightening the purse strings once safely in Government. George Osborne appears to have somewhat turned this upside down. The Conservative manifesto promised to eliminate borrowing by 2018-19. Today’s budget speech pushed back the deadline to 2019-20.
Annual day-to-day departmental spending is to be cut by just under £18 billion by 2019-20, or around 5%. That doesn’t sound too bad: the OBR says that no year will see cuts as severe as in 2011-12 and 2012-13. However, not all is rosy. Where public spending goes is still seeing big changes. Promises for some public services will mean difficult choices for others. The NHS is to receive an extra £10 billion in real terms by 2020-21, and the MoD budget is to rise by 0.5% in real terms a year. Prior to the election, promises were made on schools funding. Taken together, this could mean day-to-day spending rising by around £10 billion by 2019-20 in some areas. So overall, the cut to other departments, could be closer to around £27 billion. That is a substantial amount, albeit slightly less than the Conservative manifesto targets suggested, which was around £30 billion.
Social Market Foundation (SMF) Chief Economist, Nida Broughton said:
“Austerity isn’t over everywhere. Public services will still need to make substantial savings to pay for money going to the NHS, schools, aid and defence. However, departments will have more time to find the full savings needed, with the deadlines now pushed back. That’s important because after the last Parliament, the easiest savings will have already been made. In our pre-Budget publication, One More Time, we argue that Government will need to take more time in trying to identify the next tranche of savings. Most likely, big reforms will be needed that look ahead to the longer-term challenge of an ageing population, as pointed out in the OBR’s Fiscal Sustainability Review. Giving departments breathing room to do this will ensure that big reforms are not rushed through at a higher price later on.”
THE LIVING WAGE AND TAX CREDITS
The Chancellor announced dramatic changes to tax credits. The income threshold beyond which tax credits are withdrawn will be reduced from £6,420 to £3,850; whilst the taper rate at which they are withdrawn will be increased from 41% to 48%. This will result in a large cut in tax credit income for working families. All working-age benefits will be frozen for four years. In addition, tax credits – and their equivalent under Universal Credit – will be limited to two children, with larger families receiving no increase beyond that for the second child. Multiple birth will, however, be exempt.
The Chancellor’s announcement on the new Living Wage was even more dramatic. Over 25s will be entitled to a compulsory National Living Wage of £7.20 from April 2016, with the Low Pay Commission being asked to ensure it reaches at least 60% of median earnings – expected to be over £9 per hour – by 2020.
SMF Researcher Ben Richards said:
“The Living Wage announcement was extremely bold – certainly much bolder than expected. The policy goes far beyond some of the other policies being mooted to raise wages for low paid workers, such as tax breaks for companies paying the Living Wage. It reinforces the Government’s commitment to drive up earnings from low paid work through wages rather than tax credits; and the remit of the Low Pay Commission, to increase pay to 60% of median earnings, represents a substantial change to the previous remit of raising the Minimum Wage only when there was no impact on employment. The Government now appears willing to accept a small rise in unemployment in return for higher wages for low paid workers.
However, the tax credit cuts are huge, and will be have a very noticeable effect on the incomes of many families. A two child family with one full-time earner on the Minimum Wage will receive £1,612 less in tax credits under the new system. The big question is: will the wage increases under the new Living Wage be enough to offset these cuts? The new £7.20 Living Wage will increase gross income by nearly £1,300 for the same family with a full-time earner, but the difficulty is that increases in gross income are offset by payments in National Insurance and Income Tax, and decreases tax credits. This will mean that the family’s net income will not increase by nearly as much – by only around £255, for those not claiming housing benefit. And work incentives will be hit by the increased taper of 48%.”
The government has set the target of delivering 3 million new apprenticeship starts during this Parliament. As we argued in our recent paper (Fixing a Broken Training System: The case for an apprenticeship levy), under current funding arrangements, 3 million new apprenticeships would leave funding of only £2567 available per apprentice. Only 2 apprenticeship frameworks, out of more than 200, receive government support below £3000 at the moment. This means that, without a change to funding, increasing apprenticeship numbers will reduce the quality of what is on offer.
The new levy announced by the Chancellor provides the opportunity to improve funding and hence the quality of apprenticeships. No information has been given at this stage on the rate of the levy. Our work estimates that a levy set at 0.5% of payroll for large companies will raise somewhere in the region of £2bn per year.
A big question for employers will be how the levy is administered. The Chancellor has not proposed so far that the levy is funded on a sector basis, with the funds retained within that sector. This will raise questions for employers in service sectors – where apprenticeships are often lower cost – that their levy payments will be used to help fund apprenticeships in manufacturing or engineering firms. Though this may be the right choice for achieving higher productivity.
One issue that arises following the Budget is that, once the new National Living Wage is introduced for employees aged over 25, then the gap between the wages employers must pay this group versus the lower minimum wage that they can pay to people on an apprenticeship will widen. This may lead to more growth in apprenticeships among the over-25s rather than among younger people.
Social Market Foundation (SMF) Director, Emran Mian said:
“The funding available per apprenticeship was about to nosedive with the Government determined to grow the number of apprenticeships very significantly. By contrast the new levy will mean that the funding available per apprenticeship can potentially be increased beyond current levels. This will support higher quality training and productivity improvements. There may however be winners and losers among employers with those in manufacturing and engineering sectors potentially standing to gain a lot more funding for training while those in service industries see less of the money from the levy coming back to them.”
HIGHER EDUCATION FUNDING
The switch from offering grants to loans to help students pay for the cost of living during higher education was expected. However, there are a number of additional changes here that mark a major shake-up of the student finance system. The first is that the total level of support for the cost of living is going up, by around £1,000 for students living away from home. While this will all now be in the form of a loan, the increase in support is positive.
The terms for repaying the loans though are about to get tougher. The income threshold for repayment is currently £21,000. Graduates pay 9% of their income above this level towards the loans. This threshold due to go up every year but the Chancellor has announced today that the Government will consult on freezing it for 5 years. This is what is known as ‘fiscal drag’ and it operates the same way as when income tax thresholds are frozen or rise by less than inflation. Freezing the threshold will mean that more graduates will enter repayment earlier in their careers and they will repay more than previously planned. This reduces the cost to Government of loans.
A more technical measure reduces that cost further. Government currently calculates the cost of student loans on the basis of an old measure of its own cost of borrowing the money that it lends out. The Budget announces that Government will update that figure to reflect the current very low cost of borrowing in sovereign debt markets.
While this is a technical change, significantly it creates the fiscal room for the Government to allow universities to charge higher fees without the Government facing prohibitively high costs on the loans that students take out to pay those fees. However, universities will only win the freedom to charge higher fees – rising in line with inflation – if they can prove that they provide excellent teaching. This raises the stakes for the new Teaching Excellence Framework that the Government plans to introduce. Universities suddenly have a strong financial incentive to get a strong rating.
Social Market Foundation Director, Emran Mian commented:
“This is a big shake up of the current student finance system. The cost of going to university is going to rise. Students will have to take out loans to meet their cost of living without any offer of grants from the Government. This means the total amount that they owe at the end of their course will go up by something like £12,000 for students living away from home. The terms of repayment will get tougher too, with the repayment threshold likely to be frozen for 5 years. On top of this, tuition fees may rise. Though universities that want to raise fees will first have to prove that they are providing high quality teaching.”
The Government’s Green Paper Strengthening the incentive to save asks whether the UK has the right policy of pensions and savings tax relief and whether we should adopt an approach more similar to ISAs. It comes on the back of the Freedom and Choice reforms announced in Budget 2014 and introduced in April 2015, by which pensioners can choose how to spend their pension saving.
SMF Research Director, Nigel Keohane said:
“The Government’s Green Paper today opens up the prospect of one of the most radical reforms to pensions in a century – second only perhaps to last year’s Budget.
It diagnoses problems in the pensions system that have been avoided for too long, particularly the fact that high earners receive a very large and growing share of the relief. Our research shows that the public support the idea of redistributing tax relief so that a higher proportion is directed to those on middle and lower earnings, and a lower proportion to higher earners, the latter who in any case are more likely to set money aside. This would be likely to increase levels of savings across the population for the same or less Treasury expenditure.
But, we need to be careful that we do not sleepwalk away from the primary purpose of a pension, which is for retirement income. The Government has already deregulated how retirees spend their savings pots through the pension flexibilities, and if we take away the special treatment and regulation of pension saving, there may be nothing for them to spend come retirement.”