Universal Credit - Incomes, Incentives And The Remaining Roll-out

14th July 2024

What has been the impact of universal credit on incomes and work incentives?.

The introduction of universal credit (UC) has been the most significant reform to the working-age benefits system since the reforms following the post-war Beveridge Report.

When fully rolled out, around 8 million families - 29% of all working-age families - will be entitled to the benefit. UC is an integrated means-tested benefit that is replacing six ‘legacy' benefits, combining out-of-work support with support for housing costs, incapacity and children.

This report assesses the impact of the UC reform on households' incomes and their financial incentives to work, as well as the practical experience of applying for and getting means-tested benefits. We then briefly review the issues around the rest of UC's roll-out.

Key findings
Nearly half (47%; 3.7 million) of all households affected by the UC reform gain at least £200 per year. One-fifth of affected households (21%; 1.7 million) see their income change by less than £200 per year, while nearly a third (32%; 2.5 million) are worse off by at least £200 per year.

Many see considerably more substantial income changes. 25% (2.0 million) of affected households are better off under UC by at least £2,000 per year, with half of those better off by more than £4,000 per year. Conversely, 21% of affected households (1.6 million) are worse off under the legacy system by at least £2,000 per year, with close to half of those worse off by more than £4,000.

Couples with children are the most likely to gain under UC compared with the legacy system. 72% gain by at least £200 a year, compared with just 22% who lose out by at least that much. Households in work and renter households also tend to gain as benefits are typically withdrawn more slowly as earnings rise under UC.

Most households with one adult above and one adult below state pension age are significantly worse off under the UC system than under legacy benefits. Because the reform means they are entitled to UC - rather than the much more generous pension credit - 70% of these households (180,000) lose out by more than £4,000 per year under the UC system. Households with over £16,000 of assets and the self-employed can also lose out significantly under the UC system.

Households receiving health-related benefits also see big differences in their benefit income under UC compared with legacy benefits. Depending on the exact combination of disability and incapacity benefits they receive, a household could be either better or worse off by thousands of pounds per year.

Taken as a whole, UC represents a net giveaway of about £2½ billion compared with the legacy system. Households in the second to fourth income deciles benefit most on average, while middle-income households are worse off.

A key motivation for introducing UC was to strengthen work incentives, and for many workers it does so (often significantly). Under the legacy system, claimants could see multiple benefits withdrawn at once as their earnings increased, leading to very high effective tax rates. For example, about a quarter of workers lost at least 70% of their earnings in higher taxes and lower benefit entitlements when they moved into work. Under UC, almost no one sees an effective tax rate that high.

Similarly, UC induces substantial falls in the share of workers who are strongly disincentivised from increasing their earnings (e.g. by working an extra hour). However, by extending entitlements to benefits further up the income distribution, UC brings more workers into means-testing and hence weakens work incentives for many who under the legacy system had a low effective tax rate. While the incentive to move into paid work has been strengthened, there has been almost no change in the incentive to move from part-time to full-time work.

While UC has made significant strides in rationalising the benefit system, there is still room for improvement. In particular, integrating council tax support into UC would mean practically no workers facing a marginal tax rate above 75% (down from 6%).

UC also changes the practical experience of getting the benefit. For many, it eases the burden of applying and allows the system to respond more flexibly to changes in families' circumstances. It also results in fewer over- and under-payments than the legacy system. However, various factors likely make budgeting harder: it can (usually) only be received monthly, payments cannot be split between couples nor paid directly to landlords, and when applying for the benefit claimants face a ‘five-week wait' for the first payment, which applicants must cover either through their own resources or a loan (‘advance') from the Department for Work and Pensions (DWP) that must be repaid.

The roll-out of UC is now planned to be completed by the end of 2025. There are still around 1.2 million claimants of legacy benefits who must be migrated. This requires them to make an application for UC after receiving a ‘migration notice’ telling them to do so. 32% of tax credit recipients who received a migration notice in 2023-24 did not apply in time and saw their benefit payments terminated. If this rate persisted for the remaining migrations, then 400,000 claimants would see their benefit payments stop.

The largest group left to be migrated are claimants of employment and support allowance (ESA), a particularly vulnerable group who may face even more acute difficulties with putting in a UC claim. DWP has already pledged additional support to help these claimants, but getting this assistance right will be a critical issue for the next government - or large numbers of disabled claimants, often receiving over £10,000 a year in means-tested benefits, may suddenly end up without any of that financial support.

These propositions were first introduced under the earlier Conservative government. However, the current Labour administration asserts it will scrutinise these proposals along with the feedback procured post-consultation closure on 22 July 2024. The administration has signalled its intention to "support more disabled people and those with health conditions into work."

Read the full IFS report HERE