Cancelling historical debt would improve the lives of Universal Credit claimants

When the budget is announced on Wednesday the immediate focus is likely to be on the chancellor’s fiscal rules and the emergency measures that he takes to tackle coronavirus. But one thing Rishi Sunak could do to address a longer-term problem concerns the huge amounts of debt – an eye-watering £10bn or so – that have built up in the social security system.

This debt – much of it decidedly historic – is now being reclaimed, with rather awesome efficiency, through Universal Credit (UC). And repayments are causing real hardship as more and more claimants are moved onto UC from the ‘legacy’ benefits it is replacing.

Debt repayments mean some claimants receive well below the standard allowance

Some 60% of all UC claimants – 1.5 million people – are currently repaying debt out of their monthly allowances. These deductions mean they are living on less than UC’s standard rate. Around half of this number receive deductions to repay advances – the loans new claimants can take out to tide them over the five-week wait for their first payment. For a 100% advance that equals an 8%-a-month deduction if paid back over a year. The other half are having larger deductions than that to repay various other forms of social security debt.

Around a fifth of all claimants currently have 30% or more of their standard allowance deducted each month. Given that the standard allowance for a single person is around £73 a week, and for a couple a combined £115, that is causing real hardship. This further damages UC’s reputation and undermines its effectiveness – at a time when its operation more broadly has been improving.

Tax credit overpayments make up £6bn of the historical debt total

The largest single element of the debt is some £6bn worth of past overpayments of tax credits.

Tax credits are based on previous estimated income and are paid for a year. But HMRC, which administers tax credits, only finalises the award at the year end. If a claimant’s income proves higher than expected, and so they are deemed to have been awarded too much, HMRC seeks to recover the overpayment. And overpayments can arise for other reasons, too, including the time it takes HMRC to process any in-year change of circumstances reported or to renew a claim, both of which can take weeks.

HMRC seeks to reclaim overpayments through the tax system – but if someone moves in and out of work repeatedly, or their income is too low to attract tax at all, the overpayment just sits there, on the government’s books.

The near doubling since 2010 of the income tax personal allowance to £12,500 has compounded the situation. The increase in the personal allowance has – as intended – helped very low earners. But an unintended side effect has been that those on earnings too low to pay income tax, but who have tax credit overpayments on the books, have not been paying any of that back.

Many are no longer aware that they even owe tax credit debt at all. Back in 2010, HMRC had around £650m of tax credit debt on its books. Today the figure is roughly 10 times that – some £6bn.

The issue arises the moment benefit recipients move on Universal Credit (as they are doing in ever greater numbers), when the debt crystallises. It becomes very real as UC starts to reclaim it – contributing to those very high deduction rates of 30% and more.

Cancelling tax credit debts would improve lives – and Universal Credit’s reputation

As last week’s Institute for Government paper, Universal Credit: Getting it to work better, argued: something must be done to tackle this. Much of this debt dates back years, and the temptation is to say to write all, or much, of it off. Certainly the more historic elements.

And there is a precedent for that. Initially, overpayments of £5,000 were ignored – that is, written off. But when the scale and size of overpayments in tax credits became clear, in the mid-2000s, the figure to be written off was raised to a mighty £25,000, before being cut back as an austerity measure, first to £5,000 and now to £2,500.

If writing all or much of it off is seen as a step too far, then the rate at which it is being reclaimed needs to be heavily reduced – from a maximum 30% deduction (the current limit for historical debt repayments) to, say, 10%.

That will raise its own issues, including more of the debt eventually being written off as unrecoverable (as is already the case for some tax credit and other social security debt). It would leave UC claimants living for longer – often much longer – on less than the nominal rate of UC. But it would at least prevent the big deductions currently being made that are hitting hard the living standards of some of the least well off in society.

Part of the task of Universal Credit is poverty reduction. Deductions on the scale that are currently being implemented are achieving the opposite of that.