Briefing Note (BN175)

An assessment of the potential compensation provided by the new ‘National Living Wage’ for the personal tax and benefit measures announced for implementation in the current parliament

Date: 09 September 2015
Publisher: Institute for Fiscal Studies
ISBN: 978-1-909463-97-4
DOI: 10.1920/bn.ifs.2015.00175

This briefing note, prepared for the House of Commons Treasury Select Committee, documents the estimated distributional impact of the tax and benefit changes that have been announced for implementation in the current parliament. It then considers the extent to which households might expect the net losses from these changes to be offset through increased wages as a result of the large increase in the minimum wage for those aged 25 and over that was announced in the July 2015 Budget. 

Executive summary

  • A package of changes to the tax, tax credit and benefit system has been announced for implementation in the current parliament as part of the government’s deficit reduction programme. These will reduce household incomes significantly, particularly for those towards the bottom of the income distribution. The July 2015 Budget also announced a substantial increase in the national minimum wage for those aged 25 and over, which the Chancellor described as a new “National Living Wage” (NLW).

  • If the NLW were to have no effect on GDP, employment or hours of work it would offset 27% of the drop in household incomes from the impact of net tax and benefit reforms. In fact, as the Office for Budget Responsibility stresses, the NLW is likely to depress GDP and employment, and the money for it has to come from somewhere so this can be taken as a “better case” scenario, at least in the short term.

  • The new NLW offers such little compensation because the boost to gross wages is smaller than the announced fiscal tightening and almost one-third of the increase in gross wages goes to the Treasury in higher tax receipts and lower benefits and tax-credit entitlements.

  • Among the 8.4 million working age households who are currently eligible for benefits or tax credits who do contain someone in paid work the average loss from the cuts to benefits and tax credits is £750 per year. Among this same group the average gain from the new NLW, is estimated at £200 per year (in a “better case” scenario). This suggests that those in paid work and eligible for benefits or tax credits are, on average, being compensated for 26% of their losses from changes to taxes, tax credits and benefits through the new NLW.

  • The average losses from tax and benefit changes in deciles 2, 3 and 4 of the household income distribution are £1,340, £980 and £690 per year, respectively. These same groups are estimated to gain £90, £120 and £160 from the new NLW (again on a “better case” scenario). This suggests that a “better case” estimate of the compensation these groups are receiving is 7%, 13% and 24% respectively, on average.

  • There may be strong arguments for introducing the new NLW, but it should not be considered a direct substitute for benefits and tax credits aimed at lower income households.