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Appendix 3: National Minimum Wage and the Tax and Benefits System

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1. In Chapter 3 we analyse the impact of the National Minimum Wage on incomes, the income distribution, the numbers of people living in poverty, and incentives to work. The impact of the minimum wage in these areas is influenced by the tax and benefits system. In this appendix we describe the main components of the tax and benefits system which are relevant to low-paid workers and the effect which they have on the incomes of these workers.

Tax and Benefits System

2. The main components of the tax and benefits system which affect low-paid workers are income tax, National Insurance contributions, and a number of tax credits and benefits payable to people in work. This section briefly describes each in turn. Unless otherwise noted, the rates and amounts shown are those applying from April 2001.

Income Tax and National Insurance

3. Income tax liability depends on the income and the allowances of tax-free income to which each person is entitled. Table A3.1 shows the allowances and the tax-free incomes which these allowances represent. The value of each allowance is a maximum, available only where the individual has sufficient tax liability to use the full allowance. Table A3.1 also shows the different income tax rates and the slices of taxable income to which they apply. In addition, families with at least one child under age 16 living with them can claim the Children's Tax Credit. This reduces their income tax by Ł10 per week or Ł520 per year (less for higher-rate tax payers). In the HM Treasury Budget 2001 report, the Government announced that, to recognise the additional costs of a new child in the first year, from April 2002 the Children's Tax Credit will be increased by Ł10 per week for families in the year of a child's birth, bringing it to Ł20 per week.

*Table A3.1*
Income Tax Allowances and TaxBands 2001/02
Allowance	Annual amount Ł	Weekly equivalent Ł
Personal allowance:
Age under 65	4,535	87.21
Age 65—74	5,990	115.19
Age 75 and over	6,260	120.38
Blind person's allowance	1,450	27.88
Income Tax Rate	Band of taxable income Ł per year	Band of taxable income Ł per week

Starting rate 10 per cent	Up to 1,880	Up to 36.15
Basic rate22 per cent	1,881 — 29,400	36.15 — 565.38
Higher rate 40 per cent	Over 29,400	Over 565.38
Source: Inland Revenue

4. Employees are liable to pay National Insurance contributions (NICs) on earnings between the primary threshold of Ł87 per week and the upper earnings limit of Ł575 per week. The contribution rate is 10 per cent of earnings between these amounts. The threshold for paying NICs has been increased to align it with the income tax personal allowance. Table A3.2 shows the income tax and NICs payable by workers earning the National Minimum Wage. Workers with at least one child under age 16 living with them and working for 35 hours per week for the minimum wage do not pay income tax.

*Table A3.2*
Income Tax and National Insurance Payable by a Worker Earning the National Minimum wage
A person of working age works for 35 hours per week for the National Minimum Wage (Ł3.70 per hour in April 2001, Ł4.10 per hour in October 2001).
	April 2001	October 2001
Income Tax: Ł per week
Worker with at least one child under age 16	Nil	Nil
Worker with no child under age 16	4.96	8.04
National Insurance: Ł per week	4.25	5.65
Source: Inland Revenue

In-work Support

5. People in work can, depending on their circumstances, receive a number of types of in-work financial support. The main types are Child Benefit, Working Families' Tax Credit, Disabled Person's Tax Credit, Housing Benefit and Council Tax Benefit. Apart from Child Benefit, these are all means-tested.

Child Benefit>

6. Child Benefit is payable to families — whether in work or not — who are bringing up at least one child under age 16; under age 19 and studying full-time up to A level, NVQ level 3 or equivalent; or under age 18 and registered with the appropriate agency, such as (in England) the Careers Service or Connexions. Child Benefit, which is non-contributory, non-means-tested and tax-free, is Ł15.50 per week for the first child and an additional Ł10.35 per week for each subsequent child.

Working Families' Tax Credit >

7. Working Families' Tax Credit is the main in-work support for families with at least one child on low or middle incomes where one or both partners work(s) for at least 16 hours per week. It is non-contributory and tax-free. The maximum Working Families' Tax Credit payable depends on the number and ages of children in the family, net income and savings, the number of hours worked and whether the family pays eligible childcare costs (childcare provided by, for example, registered childminders, nurseries or out-of-school clubs). Child Benefit, Housing Benefit, Council Tax Benefit and some other benefits are ignored when calculating entitlement to Working Families' Tax Credit.

8. Working Families' Tax Credit is built up from individual credits, as shown in Table A3.3. The maximum credit is payable where the family's net income does not exceed the Working Families' Tax Credit income threshold of Ł92.90 per week. For each Ł1 by which the family's net income exceeds Ł92.90 per week, the Working Families' Tax Credit payable is reduced by 55 pence.

*Table A3.3*
Working Families' Tax Credit 2001/02
	Ł per week
Basic tax credit	54 — increasing to 59 from June 2001
30 hour tax credit, where one adult works at least 30 hours per week	11.45
Tax credit for each child:
Under age 16	26
Age 16—18	26.75
Extra tax credit for each disabled child	30
Childcare tax credit:
For 1 child — 70% of eligible childcare costs up to a maximum	Maximum cost Ł100 — increasing to Ł135 in June 2001
For 2 or more children — 70% of eligible childcare costs up to a maximum	Maximum cost Ł150 — increasing to Ł200 in June 2001
Source: Inland Revenue

9. Example 1 shows that a two parent family with one child aged under 16 and with one adult working for 35 hours per week in April 2001 for the National Minimum Wage would receive Working Families' Tax Credit of Ł73.66 per week.

Example 1 — Working Families' Tax Credit
In a two-parent family with one child aged under 16, one partner works 35 hours per week in April 2001 for the National Minimum Wage (Ł3.70 per hour).
Gross pay Income tax National Insurance Net pay	Ł129.50 Nil Ł4.25 Ł125.25 per week
Maximum tax credit = basic tax credit (Ł54) + 30 hour credit + tax credit for the child = Ł91.45 per week.
Net income exceeds WFTC income threshold (Ł92.90) by Ł32.35 per week.
So WFTC payable = maximum credit (Ł91.45) less 55% of Ł32.35 = Ł73.66 per week.
Note: Any income from Child Benefit, some other social security benefits and maintenance payments is ignored when calculating entitlement to Working Families' Tax Credit. Assumes that net income taken into account comprises net pay only.

10. Working Families' Tax Credit includes a childcare credit to help with the cost of eligible childcare. To qualify, both partners in a couple, or a lone parent, must work at least 16 hours per week. Example 2 shows that a lone parent working for 35 hours per week in April 2001 for the National Minimum Wage and paying eligible childcare costs of Ł100 per week would receive Working Families' Tax Credit of Ł143.66 per week.

Example 2 — Working Families' Tax Credit
A lone parent with one child aged under 16 works 35 hours per week in April 2001 for the National Minimum Wage (Ł3.70 per hour) and pays eligible childcare costs of Ł100 per week.
Gross pay Income tax National Insurance Net pay	Ł129.50 Nil Ł4.25 Ł125.25 per week
Maximum tax credit = basic tax credit (Ł54) + 30 hour credit + tax credit for the child + 70% of the Ł100 childcare costs = Ł161.45 per week.
Net income exceeds WFTC income threshold (Ł92.90) by Ł32.35 per week.
So WFTC payable = maximum credit (Ł161.45) less 55% of Ł32.35 = Ł143.66 per week.
Note: Any income from Child Benefit, some other social security benefits and maintenance payments is ignored when calculating entitlement to Working Families' Tax Credit. Assumes that net income taken into account comprises net pay only.

Disabled Person's Tax Credit

11. Disabled Person's Tax Credit supplements low earnings of disabled people working at least 16 hours per week. Disabled Person's Tax Credit is non-contributory and tax-free. The calculation is similar to that of Working Families' Tax Credit, except that separate credits apply to single adults and to couples/lone parents (respectively Ł61.05 and Ł91.25 per week from June 2001). Additional credits for people working at least 30 hours per week, for children and for eligible childcare costs are the same as for Working Families' Tax Credit.

Housing Benefit and Council Tax Benefit

12. Housing Benefit and Council Tax Benefit are payable to people on low incomes — whether in work or not — to meet the cost of rented accommodation and council tax. They are non-contributory and tax-free. Entitlement is calculated on the same basis as for Income Support and Income-based Jobseeker's Allowance, which are the main means-tested benefits for people working below 16 hours per week or not in work. Housing Benefit and Council Tax Benefit also take account of childcare costs.

13. A significant feature of these benefits is that they take into account other tax credit and benefit income such as Working Families' Tax Credit and Child Benefit. For each Ł1 by which the household's net income exceeds statutorily-prescribed levels, the Housing Benefit and Council Tax Benefit payable are reduced by 65 pence and 20 pence respectively. Example 3 shows the Housing Benefit and Council Tax Benefit calculation for the two-parent family from Example 1. It indicates that — for a family paying average local authority rent and with one adult working for 35 hours per week at the minimum wage of Ł3.70 per hour — income from net pay, Working Families' Tax Credit and Child Benefit approaches the level at which entitlement to Housing Benefit and Council Tax Benefit will cease. The increase of Ł5 per week in the basic tax credit in Working Families' Tax Credit in June 2001 lifts such a family above entitlement to Housing Benefit and Council Tax Benefit altogether.

Example 3 — Housing Benefit and Council Tax Benefit
In a two-parent family with one child aged under 16, one partner works 35 hours per week in April 2001 for the National Minimum Wage (Ł3.70 per hour).
(a) The family is paying average private sector rent and council tax:
Average rent	Ł78.40 per week
Average council tax	Ł12.90 per week
Net income is: Net pay WFTC Child Benefit Total	Ł125.25 (see Example 1) Ł73.66 Ł15.50 Ł214.41 per week
Housing Benefit = Rent less 65% of income taken into account (see note) = Ł78.40 less Ł41.44 = Ł36.96 per week.
Council Tax Benefit = Council tax less 20% of income taken into account (see note) = Ł12.90 less Ł12.75 = Ł0.15 per week.
(b) The family is paying average local authority rent and council tax:
Average rent Average council tax	Ł43.32 per week Ł12.90 per week
Housing Benefit = Rent less 65% of income taken into account = Ł43.32 less Ł41.44 = Ł1.88 per week.
Council Tax Benefit = Council tax less 20% of income taken into account = Ł12.90 less Ł12.75 = Ł0.15 per week.
Note: Average rent and council tax figures are for 2000/01 financial year. Income taken into account is net pay, Working Families' Tax Credit and Child Benefit, less the first Ł10 of earnings, another Ł11.45 of earnings disregarded for working 30+ hours, any childcare costs up to a maximum of Ł70, and a statutorily prescribed amount based on household composition which for this family is Ł129.20 per week. Calculation assumes no other income.

New Tax Credits

14. In Budget 2001 the Government re-affirmed its intention to introduce two new tax credits from 2003. One will be a single new tax credit for families with children, whether or not someone is in work. This will bring together the different strands of support for children in Working Families' Tax Credit, Disabled Person's Tax Credit, Income Support/Jobseeker's Allowance and Children's Tax Credit, building on the foundation of universal Child Benefit. Budget 2001 indicated that this new credit, which will be assessed on the basis of household income, will be accompanied by a new Employment Tax Credit for people in work and without children, and that more details on these tax credits would be published in Summer 2001.

In-work Income

15. The tax credits and benefits described above supplement the incomes of many low-paid workers. The examples in Tables A3.4—A3.6 show the composition of the net incomes of illustrative households working for the National Minimum Wage and receiving tax credits and/or benefits.

16. Table A3.4 shows the minimum income guarantee for a family with one adult working for 35 hours per week: Ł214 per week in April 2001, rising to Ł225 per week in October 2001. Table A3.5 shows the minimum income guarantee for a family with one adult working for 16 hours per week: Ł154 per week in April 2001, rising to Ł166 per week in October 2001. And Table A3.6 shows the net income of a single person without children.

*Table A3.4*
In-work Income — Two-parent Family, with One Partner Working 35 Hours per week for the National Minimum Wage
Family has one child under age 16.		April 2001: Ł per week	October 2001: Ł per week
Net income before housing costs	Net pay WFTC Child Benefit Total = Minimum income guarantee	125.25 73.66 15.50 214.41	137.85 71.73 15.50 225.08
Per hour equivalent	Net	6.13	6.43
If paying average private sector rent Ł78.40 per week	HB CTB New total	36.96 0.15 251.52	30.02 0 255.10
Per hour equivalent	Net	7.19	7.29
If paying average local authority rent Ł43.32 per week	HB CTB New total	1.88 0.15 216.44	0 0 225.08
Per hour equivalent	Net	6.18	6.43
Note: Average rent and council tax figures are for 2000/01 financial year. Assumes average council tax of Ł12.90 per week. Net income increases part-way through this period due to the Ł5 increase in the Working Families' Tax Credit basic tax credit in June 2001, partly offset by reductions in any Housing Benefit and Council Tax Benefit payable.

*Table A3.5*
In-work Income — Lone Parent, Working 16 Hours per week for the National Minimum Wage
Family has one child under age 16. No childcare costs.		April 2001: Ł per week	October 2001: Ł per week
Net income before housing costs	Net pay WFTC Child Benefit Total = Minimum income guarantee	59.20 80.00 15.50 154.70	65.60 85.00 15.50 166.10
Per hour equivalent	Net	9.67	10.38
If paying average private sector rent Ł78.40 per week	HB CTB New total	58.45 3.76 216.91	51.04 1.48 218.62
Per hour equivalent	Net	13.56	13.66
If paying average local authority rent Ł43.32 per week	HB CTB New total	23.37 3.76 181.83	15.96 1.48 183.54
Per hour equivalent	Net	11.36	11.47
Note: Average rent and council tax figures are for 2000/01 financial year. Assumes average council tax of Ł9.90 per week. Net income increases part-way through this period due to the Ł5 increase in the Working Families' Tax Credit basic tax credit in June 2001, partly offset by reductions in any Housing Benefit and Council Tax Benefit payable.

*Table A3.6*
In-work Income — Single Person, Working 35 Hours per week for the National Minimum Wage
Family has one child under age 16. No childcare costs.		April 2001: Ł per week	October 2001: Ł per week
Net income before housing costs	Net pay	120.29	129.81
Per hour equivalent	Net	3.44	3.71
If paying average private sector rent Ł68.50 per week	HB CTB New total	28.05 0 148.34	21.86 0 151.67
Per hour equivalent	Net	4.24	4.33
If paying average local authority rent Ł39.56 per week	HB CTB New total	0 0 120.29	0 0 129.81
Per hour equivalent	Net	3.44	3.71
Note: Average rent and council tax figures are for 2000/01 financial year. Assumes average council tax of Ł8.80 per week and that the worker is age 25+.

When Earnings Increase 17. The impact of an increase in the National Minimum Wage on net income will vary considerably, depending on the circumstances of the individual worker, in particular whether the household receives Working Families' Tax Credit and/or Housing Benefit and Council Tax Benefit. The interaction between the 40 pence increase in the minimum wage adult rate — due to take effect in October 2001 — and the tax and benefits system is shown in Table A3.7 for workers with and without a child who work for 35 hours per week for the adult rate of the minimum wage. The table also shows the marginal deduction rates relating to particular combinations of in-work benefits and Working Families' Tax Credit. Marginal deduction rates show how much of every extra Ł1 in gross pay that a worker earns is lost as they pay more tax and NICs and have their benefits reduced.

*Table A3.7*
Interaction of October 2001 Increase in the National Minimum Wage with Tax Credits and In-work Benefits
In October 2001 a person working for 35 hours per week for the National Minimum Wage receives a gross pay increase of 40 pence per hour or Ł14 per week.
Tax credit/in-work benefits in payment	Income tax/NICs increases and tax credit/benefit decreases resulting from pay increase: Ł per week		Rise in net income: Ł per week	Marginal deduction rate:per cent
(a) Worker has at least one child under age 16 living with them
None	NICs (10% of Ł14) Total reduction	1.40 1.40	12.60	10
WFTC	NICs WFTC (55% of Ł12.60) Total reduction	1.40 6.93 8.33	5.67	60
WFTC and HB	NICs WFTC HB (65% of Ł5.67) Total reduction	1.40 6.93 3.69 12.02	1.98	86
WFTC, HB and CTB	NICs WFTC HB CTB (20% of Ł5.67) Total reduction	1.40 6.93 3.69 1.13 13.15	0.85	94
(b) Worker has no child under age 16 living with them
None	Tax (22% of Ł14) NICs (10% of Ł14) Total reduction	3.08 1.40 4.48	9.52	32
HB	Tax NICs HB (65% of Ł9.52) Total reduction	3.08 1.40 6.19 10.67	3.33	76
HB and CTB	Tax NICs HB CTB (20% of Ł9.52) Total reduction	3.08 1.40 6.19 1.90 12.57	1.43	90
Note: Marginal Deduction Rate = Total reduction as a percentage of Ł14 per week increase in gross pay. A worker who has at least one child under age 16 living with them and who works for 35 hours per week for the National Minimum Wage does not pay income tax (Table A3.2).

18. Table A3.7 shows that:

All such workers will pay Ł1.40 per week more in National Insurance, and workers without children will pay Ł3.08 per week more in income tax. But reductions in any Working Families' Tax Credit and/or Housing Benefit and Council Tax Benefit further reduce the increase in net income.
If the worker receives Working Families' Tax Credit, the increase in net income after the Ł14 per week increase in gross pay will be Ł5.67 per week, a marginal deduction rate of 60 per cent.
If the worker receives Working Families' Tax Credit, Housing Benefit and Council Tax Benefit, the increase in net income will be 85 pence per week, a marginal deduction rate of 94 per cent.
If the worker has no child and receives Housing Benefit, the increase in net income will be Ł3.33 per week, a marginal deduction rate of 76 per cent.
The workers who can be expected to gain most from the 40 pence increase in the minimum wage in October 2001 are those in households which do not receive any Working Families' Tax Credit or means-tested benefits. In such households, a worker with a child will receive an increase in net income of Ł12.60 per week and a worker with no child will receive an increase in net income of Ł9.52 per week, representing marginal deduction rates of 10 per cent and 32 per cent respectively.