The Treasury manages public spending within two ‘control totals’ of about equal size:

  • departmental expenditure limits (DELs) – mostly covering spending on public services, grants and administration (collectively termed ‘resource’ spending) and investment (‘capital’ spending). These are items that can be planned over extended periods.
  • annually managed expenditure (AME) – categories of spending less amenable to multi-year planning, such as social security spending and debt interest.

Social security and tax credits together are the biggest source of AME spending. Tax credits are one of the bigger elements of welfare spending (making up just over 10 per cent of the total). They comprise the working tax credit – payable to families with someone in work (typically for 16 hours or more a week) – and the much larger child tax credit – payable to families with children. The working tax credit also subsidises childcare costs. Awards are based on family circumstances and means-tested against family income.

Key determinants of spending on tax credits are household composition, employment/unemployment, and earnings. Tax credits are one of the elements of welfare spending that will be replaced by universal credit (UC) over the coming years. Currently, we produce our forecasts for all of the benefits affected by UC by first assuming a no-UC counterfactual (i.e. the legacy benefits continue as before) then adding the marginal cost of introducing UC. In outturn years, in order to enable monitoring of monthly spending against our forecasts, we switch to an ‘actual cost’ presentation of spending showing legacy benefit spending net of the impact of the UC rollout. These accounting switches appear as line breaks between the last actual cost and first no-UC counterfactual data points in the charts below. Our January 2018 Welfare trends report sets out how we forecast spending on UC and the legacy benefits in more detail.

In our latest forecast, outturn spending on tax credits is estimated to be £25.8 billion in 2017-18, with around £0.6 billion of spending having been ‘lost’ to UC. We expect tax credits spending in 2018-19 to total £26.0 billion (on a ‘no-UC’ counterfactual basis), with 3.6 million recipients paid an average of £7,170 each. That would represent around 3.2 per cent of total public spending and 1.2 per cent of national income.

  • Latest forecast

    Tax credits spending is set to fall by 0.4 per cent in cash terms between 2018-19 and 2022-23. Given the growth in GDP over the same period, this represents a fall of 0.14 per cent of GDP.

    This is mainly driven by our assuming incomes growing faster amongst tax credits claimants than average earnings, lowering tax credits entitlement and [recent] falls in inflows into tax credits. Elsewhere, the final two years of the uprating freeze between 2016-17 and 2019-20 means that average awards fall relative to average earnings, reducing spending on tax credits as a share of GDP. Cuts in support for first children and families with more than two children also reduce average awards.

    Our March 2018 forecast revised down spending on tax credits by £1.0 billion a year on average, with downward revisions increasing over the forecast and reaching £1.4 billion by 2022-23.

    Chapter 4 in our March 2018 Economic and fiscal outlook explained the changes made to our tax credits forecast relative to November 2017 in Box 4.3.

    The largest revisions to our welfare cap spending forecast relate to tax credits. This is dominated by two partly offsetting changes:

    • First, a large downward revision from assuming that income growth in the tax credits population will be higher relative to whole economy average earnings growth than had previously been assumed. This reduces spending by progressively larger amounts across the forecast, reaching £1.7 billion in 2022-23. The new assumption and the analysis the underpins it are described in a separate box.
    • Second, a correction to how rises in the disability benefits caseload affect the cost of disability premia in tax credits. This increases spending by progressively larger amounts, reaching £0.7 billion in 2022-23. These premia do not exist in universal credit (UC), so make up part of the saving from UC relative to the legacy system. Our UC forecast already factored in this saving, but the tax credits forecast had factored in the cost on an actual-cost basis rather than a ‘no-UC’ counterfactual basis, so in effect the UC saving was being double-counted.

    Tax credits: changes since previous forecast

    taxcredits

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  • Previous forecasts

    Our forecast for tax credits spending has been revised down repeatedly in most of our recent forecasts. Lower spending partly reflects caseloads being lower than expected. Higher-than-expected income growth among tax credits claimants appears to have been one factor behind these surprises, as discussed in our March 2018 EFO. This is an area where we will continue to work with HMRC forecasters to gain a fuller understanding. The sharp fall in spending in 2016-17 in our July 2015 forecast reflected the policies announced in Summer Budget 2015, which would have reduced the income threshold and increased the taper rate in tax credits. These announcements were reversed in the November 2015 Autumn Statement, before they had been implemented.

     

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  • Policy measures

    Since our first forecast in June 2010, the Coalition and Conservative governments have announced around 40 policy measures affecting our forecast for tax credits spending. The original costings for these measures are contained in our policy measures database and were described briefly in the Treasury’s relevant Policy costings document. For measures announced since December 2014, the uncertainty ranking that we assigned to each is set out in a separate database. For those deemed ‘high’ or ‘very high’ uncertainty, the rationale for that ranking was set out in Annex A of the relevant Economic and fiscal outlook.

    Some of the largest measures include:

    • Switching to CPI indexation from 2011-12 (June Budget 2010)
    • Freezing the basic and 30-hour elements of working tax credit for three years from 2011-12 (Spending Review 2010)
    • Increasing working hours requirement in working tax credit for couples with children to 24 hours (Spending Review 2010)
    • Removing over-indexation in child tax credits (Autumn Statement 2011)
    • Increasing tax credits by 1 per cent a year for three years from 2013-14 (Autumn Statement 2012)
    • Freezing tax credits for 4 years from 2016-17 (Summer Budget 2015)
    • Limiting child element of tax credits to 2 children for new claims (Summer Budget 2015)

     

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