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Childcare costs in universal credit

6 August 2013
Benefits and tax credits evidence cover

A better way to allocate the additional money committed in the 2013 Budget

Childcare costs in universal credit [ 170 kb]

Update 28 November 2013: for our current proposals and recommendations: Support for childcare costs in universal credit

Summary

Universal Credit as it currently stands, provides support with 70 per cent of childcare costs for all parents whether they work just a few hours a week or full time. This will make it much easier for parents to move into work for just a few hours, as under the current system help with costs is only available when working for more than 16 hours a week. However, analysis by Citizens Advice, the Joseph Rowntree Foundation and others, has found that it will be difficult for parents on a low income and with high childcare costs, to make work pay as they increase their hours. This is especially, but not exclusively true, when they start to earn enough to pay tax. Currently, those on a low income receive financial support for 20 per cent of their childcare costs from increased housing benefit in addition to the 70 per cent support they receive from tax credits.

To help address this situation, the Government announced that it would increase funding for childcare in Universal Credit by an extra £200 million from 2016. The Government proposes to target the additional funding on parents earning enough to pay tax. The support that they will get with childcare costs will be raised to 85 per cent which will mean that parents earning over £10,000 a year will pay half the proportion of their childcare costs (15 per cent) than their lower earning counterparts, who will still have to pay 30 per cent.

Our analysis finds that the extra money distributed in this way will indeed make it easier for parents working full time to make work pay. But it does nothing to improve the poor work incentives of parents who earn at or near the minimum wage and choose or are not able to work full time - currently two thirds of lone parents work between 16 and 29 hours a week. In fact, if the current proposal is not changed, Universal Credit will also have a surprising and perverse consequence; many low income parents will find that increasing their hours of work actually decreases their net income, unless they can work full time. Those who earn significantly more per hour then the minimum wage do not have difficulty in making extra work pay. They will however, gain from this proposal even if only working part time.

Not only does the proposal only help the minority of low income lone parents and second earners who work full time, but the introduction of a second tier of support adds significant extra complexity which will make it very difficult for parents to assess whether taking on more hours will actually make them better or in fact worse off. This situation risks forcing parents on a low income into a position where they will have to turn down work and/or reduce their hours and earnings potential.

This paper argues that the extra £200 million would better meet the Universal Credit objectives of simplifying the system and making work pay, if it were distributed evenly by increasing support for all parents, rather then creating a second higher rate of support to claimants earning enough to pay tax.

Providing support for 78 per cent of childcare costs for all Universal Credit claimants would be the simplest and most effective solution that keeps closest to the allocated budget of £200 million.

However, it is also clear from the analysis that £200 million would be insufficient to really improve work incentives for all parents with low incomes and high childcare costs. Gains from work would still be much lower than under the current system where some families get up to 90 per cent of their costs met. We recommend that the Government reconsider the split of new funding between the –750 million new funding for childcare vouchers for parents earning too much to be entitled to Universal Credit and the £200m extra in Universal Credit.