Institute for Fiscal Studies – The NEN

Without reform, the two-child limit will affect an additional 670,000 children by the end of next parliament

What impact has the ‘two-child limit’ in universal credit had, and what policy choices does the next government face? – a report by Institute for Fiscal Studies

Low-income families typically receive an additional £3,455 a year of universal credit (or child tax credit) for each child they have¹ . But the ‘two-child limit’ means that claimants do not receive an additional amount for third or subsequent children born after 5 April 2017.

This policy has been the subject of controversy, and the Liberal Democrats and Green Party have both committed to abolishing the limit in their manifestos, while the Labour Party have said they will abolish it ‘when fiscal conditions allow’.

In this comment, we (IFS) outline the impact of the two-child limit on household incomes and work incentives, and the public finances.

To illustrate the impact of the policy, take a lone parent with three children who lives in social rented accommodation costing £500 per month² , and not working.

Their universal credit entitlement will be made up of the basic £4,721 per year in universal credit for single adults; £6,000 to cover the cost of their housing; and – in the absence of the two-child limit – £10,365 for their children³ .

On top of this, they receive £3,102 a year in child benefit, which is unaffected by the two-child limit, giving them a total income of £24,188 (without the two-child limit); they would also generally have support to cover most or all of their council tax bill. The two-child limit means they receive £3,455 less each year in universal credit, representing a 14% cut to their income and putting them into relative poverty.

Turning to the impact across the population, we find that, when fully rolled out, on average affected households will lose £4,300 per year, representing 10% of their average income and 22% of average benefit income⁴ .

These losses are concentrated among 790,000 households (10% of working-age households with children) and would affect nearly one in five children (2.8 million).

As things stand, the policy affects only 550,000 households. The difference is because there are families with three children all of whom were born before 6 April 2017; as time passes, more and more large families will have children born after that date.

We estimate that 250,000 extra children will be affected by the policy next year and 670,000 extra children will be affected by the end of the next parliament. HMRC statistics show that in 2023, 50% of families affected by the two-child limit were single parents and 57% had at least one adult in paid work.

Figure 1 shows where in the household income distribution households that are affected by the two-child limit sit. For comparison, we also show the equivalent for all households with children and all households with children receiving universal credit.

Unsurprisingly, the two-child limit disproportionately affects poorer households, but the figure shows that affected households are also more likely to have low income than are all universal-credit-receiving families with children.

76% of households affected by the two-child limit are in the poorest 30% of working-age households. In comparison, 63% of households eligible for universal credit with children are in the poorest 30% of working-age households.

Figure 1. Distribution of households affected by two-child limit; universal credit claimants with children; and all households with children, by equivalised income decile

_{Note: Assumes full take-up of benefits and full roll-out of universal credit and the two-child limit. Only includes households where all adults are under 66.}

_{Source: Authors’ calculations using the Family Resources Survey 2022–23 and TAXBEN, the IFS tax and benefit microsimulation model.}

The two-child limit has an (even more) outsized impact on children living in low-income households, as, by definition, a household affected by the two-child limit has at least three children. It affects 23% of households with children in the poorest fifth of the income distribution, but 38% of children in the poorest fifth of the income distribution.

The two-child limit also has varied impacts across families of different ethnicities. We estimate that 43% of children in households with one adult of Bangladeshi or Pakistani origin (400,000 children) would be affected by the policy when fully rolled out, compared with 17% of children in other households (2.4 million children). This reflects both these families having more children and them being more likely to be on low income.

The two-child limit would be even more targeted at the poorest households if it was not for a separate policy: the benefit cap. The benefit cap limits the total amount that a family with no adults in work can claim to £22,020 a year outside London and £25,323 a year inside London (lower amounts are applied for single adults without children). 110,000 households are not directly affected by the two-child limit as the benefit cap already limits their entitlements. Almost all these households are in the poorest fifth of households.

Figure 2 shows relative child poverty rates, defined as being in a household with an income (after housing costs) below 60% of median income, split by the number of children in the household.

Since 2014–15, relative poverty rates have declined for families with one or two children, but they have increased for families with three or more children⁵ .

Absolute poverty rates have also diverged: they have fallen for small families but remained unchanged for large families. So, in absolute terms, low-income large families are about as well off as they were in 2015, but their incomes have fallen further behind relative to other households, including small families.

Figure 2. Relative child poverty rates after housing costs, 2008–09 to 2022–23

_{Note: The fall in poverty rates in 2020–21 is at least partly due to benefit expansions in that year, including raising maximum housing support and a temporary £20 per week uplift to universal credit.}

_{Source: Authors’ calculations using}_{Family Resources Survey}_{, 2008–09 to 2022–23.}

The two-child limit is likely one driver of this recent increase in relative child poverty rates for larger families. However, it is not the only explanation. Other benefit cuts are likely to affect larger families more as they on average receive more of their income from benefits (the benefit cap also disproportionately affects larger families); and broader economic trends may also play a role.

Nevertheless, removing the two-child limit would certainly go some way to reversing the recent increase in poverty rates for large families. We estimate that removing the two-child limit would reduce relative child poverty by approximately 500,000 (4% of all children)⁶ .

The two-child limit has a relatively small effect on work incentives. One statistic that helps explain work incentives is replacement rates: the household’s income if an individual was out of work as a percentage of their in-work household income. The lower someone’s replacement rate, the more incentive they have to remain in work.

With the two-child limit, an average working parent with three or more children has a replacement rate of 62.1%; without it, they would have a slightly higher replacement rate of 63.0%.

This average difference is small for two reasons. First, 28% of these workers are unaffected entirely, as they would not be able to claim universal credit even if they lost work, due to having more than £16,000 in assets or their partner having a sufficiently high income.

Second, for 22% of these workers, the two-child limit actually increases their replacement rate, as it decreases their income when in work but does not affect them when they are out of work, as they would be benefit capped if out of work.

For those who when out of work are eligible for universal credit but not benefit capped – 50% of working parents with three or more children – their replacement rate falls by 4 percentage points.

Naturally, removing the two-child limit would come at a cost. We estimate that removing the two-child limit would cost the government about £3.4 billion a year. For a sense of scale, this is equal to roughly 3% of the total working-age benefit budget; it is also approximately the same cost as freezing fuel duties for the next parliament, or cutting the basic rate of income tax by half a penny.

The indirect fiscal impacts of the two-child limit are more uncertain. Previous research has found that investments in young children can sometimes partly or even entirely pay for themselves by causing better outcomes for those children in later life.

If the same is true of benefit spending in the UK, removing the two-child limit may be less costly in the long run than its up-front cost suggests. However, there is very little evidence on this issue in the UK, though ongoing IFS research is looking to study it.

Institute for Fiscal Studies: Scottish Government faces major medium- and long-term budget challenges

New analysis by IFS researchers shows the stark funding challenges facing the Scottish Government, and the public services it is responsible for, over the next five years and beyond.

In the next two financial years, the budget for day-to-day non-benefit spending looks very tight:

After taking account of in-year funding top-ups this financial year, which under current plans will not be available in 2023–24, funding will fall by 1.6% in real terms in 2023–24 compared with this year. Even after adjusting for major one-off costs this year, such as council tax rebates, the reduction will still be 0.8%.
Official projections imply that funding will fall by a further 1.6% in real terms in 2024–25, and then grow only modestly over the next three years. This means that funding is set to be almost 2% lower in 2027–28 than in 2022–23.

Such cuts would imply difficult trade-offs for the Scottish Government. Increasing spending on health to meet rising costs and demand, and boosting spending on net zero policies could require cuts of around 13% to other public service spending between 2023 and 2027.

These are among the key findings of two pre-released chapters from the inaugural IFS Scottish Budget Report, focusing on the Scottish Government’s funding outlook and devolved income tax revenue performance. Other key findings include:

Medium-term outlook

The baseline projections above rely on Scottish Fiscal Commission (SFC) forecasts of a significant improvement in income tax revenues. This largely reflects faster expected growth in Scotland’s underlying income tax base relative to the rest of the UK, rather than the effects of tax rises announced in the Scottish Budget last month. If this faster growth doesn’t materialise, then the Scottish Government’s choices would be harder still, with funding for non-benefits spending in 2027–28 still 5% below 2022–23 levels.
The faster growth in Scotland’s tax base forecast for the next few years follows a period during which the tax base has grown more slowly than in the rest of the UK. Because of this, SFC forecasts imply that even by 2026–27, almost one-third of the yield from Scotland’s higher income tax rates will be offset by slower tax base growth since the devolution of income tax in 2016–17. This would still be a substantial improvement from this financial year though, for which the SFC estimates that revenues from Scotland’s income tax policy changes since devolution will be more than fully offset by slower underlying growth in the tax base.

Long-term outlook

While the Barnett formula used by the UK government to allocate funding is often thought to benefit Scotland, in the long term it is likely to lead to relatively smaller increases in funding for Scotland than for England. The speed of this ‘Barnett squeeze’ depends on the rate of growth in spending in England (both real-terms growth and that which merely offsets inflation), and the rate of population growth in Scotland relative to England.
Using long-term projections for inflation and GDP growth from the Office for Budget Responsibility, assuming public spending is held constant as a share of GDP, and taking into account population projections from the Office for National Statistics, we project Scottish Government funding per person would increase by an average of 1.2% per year in real terms over the 30 years between 2027–28 and 2057–58. This compares to an average of 1.4% in England over the same period. Under this scenario, spending per person in Scotland would fall from 124% of English levels in 2027–28, to 121% in 2032–33, and to 115% in 2057–58.
Faster real-terms spending growth in England to meet the rising costs of health and social care (which are expected to grow faster than GDP) would result in bigger absolute increases in funding for the Scottish Government, making it easier for it to meet these costs in Scotland. However, it would increase the Barnett squeeze on funding levels relative to England – making it harder for the Scottish Government to maintain enhanced levels of service provision over and above those in England.

Bee Boileau, a research economist at the IFS and an author of the report said: “Additional funding from the UK government and a forecast boost to devolved tax revenues mean the outlook for funding has improved a little since last May’s Resource Spending Review.

“But the picture is far from rosy. Official projections imply that funding for non-benefit spending is set to fall over the next two years and then grow only slowly over the following three years. Indeed, it would still be close to 2% below 2022–23 levels in 2027–28. And that assumes a significant improvement in the performance of Scotland’s devolved income tax revenues – without that, this funding would be close to 5% lower than this year in 2027–28.

If either of these scenarios were borne out, the Scottish Government would likely need to make significant cuts to a range of public services. Further big increases in devolved tax rates would be one way to avoid such cuts.

“The Scottish Government will instead be hoping for additional funding from the UK government – which may not be in vain as the UK government would also need to make cuts to many services if it sticks to the plans for spending it has pencilled in.’

David Phillips, an associate director at the IFS, and another author of the report said: ‘The Scottish Government’s long-term funding outlook beyond 2027–28 will also be determined, to a large extent, by UK government spending decisions via the Barnett formula.

“This formula is often seen to benefit the Scottish Government, by providing it with a much higher level of funding per person than is available for comparable services in England.

But this is a misunderstanding of the nature of the formula and its purpose. Because it provides the Scottish Government with a population-based share of funding changes planned for England, and Scotland starts with a higher-than-population share of funding, it delivers a smaller percentage increase in funding for Scotland than England.

This so-called Barnett squeeze will make it more difficult for the Scottish Government to meet rising costs and the demands on public services associated with an ageing population, and to maintain enhanced service provision relative to England, such as free personal care and free university education, in the longer term.”

The-overall-funding-outlook-The-Institute-for-Fiscal-Studies Download

The long shadow of deprivation

Research highlights England’s local councils with the lowest social mobility opportunities

The effect of deprivation in dozens of English local authorities is now so persistent that some families face being locked into disadvantage for generations unless the right action is taken, a new report shows today.

In the most detailed study of regional social mobility ever conducted in the UK, the report from the Social Mobility Commission identifies local councils with the worst and the best social mobility in England.

In the “coldest spots” those from disadvantaged backgrounds, entitled to free school meals, have little chance of making a better life for themselves or their children. They also earn much less than their more affluent peers.

These areas, which range across England, include:

Chiltern
Bradford
Thanet
Bolton
Wolverhampton
Kingston-upon-Hull
Fenland
Mansfield
Walsall
Gateshead
Kirklees
St Helens
Dudley
Bolton
Wigan

Individuals aged 28 from disadvantaged families in these councils earn on average just over half the amount of those from similar backgrounds in the most mobile areas. They also earn much less than those of the same age from more affluent families living nearby.

Steven Cooper, interim co-chair of the commission said: “These findings are very challenging. They tell a story of deep unfairness, determined by where you grow up. It is not a story of north versus south or urban versus rural; this is a story of local areas side by side with vastly different outcomes for the disadvantaged sons growing up there.“

Areas with high social mobility, where those from poorer backgrounds earn more and the pay gap with those from affluent families is smaller include:

Forest Heath
West Oxfordshire
South Derbyshire
Cherwell
Kingston upon Thames
South Gloucestershire
Tower Hamlets
North Hertfordshire
Eden

The research, carried out by the Institute for Fiscal Studies (IFS) and UCL Centre for Education Policy and Equalising Opportunities (CEPEO), links educational data and HMRC earnings for the first time to identify young sons from disadvantaged families – those entitled to free school meals. The sons who were born between 1986 and 1988 and went to state schools in England, were followed from aged 16 to 28.

The results, covering around 320 local councils in England and 800,000 young adults, show a postcode lottery for disadvantaged people. In areas with high social mobility, disadvantaged young adults earn twice as much as those with similar backgrounds in areas with low social mobility – on average, over £20,000 compared with under £10,000. Annual earnings from this group range from £6,900 (Chiltern) to £24,600 (Uttlesford).

Councils with the lowest earnings for disadvantaged individuals include:

Bradford
Hyndburn
Gateshead
Thanet

But they also include:

West Devon
Sheffield
Malvern Hills
Kensington and Chelsea.

Those with the highest earnings include:

Broxbourne
East Hertfordshire
Forest Heath
Havering
Uttlesford
Wokingham

But those from poor backgrounds also face unfairness on their doorstep. Pay gaps between the most and least deprived individuals in local authorities with the poorest social mobility are 2.5 times higher than in areas of high social mobility.

Education, often blamed for social mobility differences, is only part of the answer. In areas with high social mobility, gaps in educational achievement account for almost the entire pay difference between the most and least advantaged sons. On average it accounts for 80% of the difference.

However, in local authorities where social mobility is low it is much harder to escape deprivation. In such areas, up to 33% of the pay gap between the highest and lowest earners is down to non-education factors, like local labour markets and family background.

Disadvantaged workers are restricted by factors including limited social networks (fewer internships); inability to move to more prosperous areas; limited or no financial support from family; less resilience to economic turbulence due to previous crisis such as 2008 financial crash and less developed soft skills.

The commission is now urging regional and community leaders to use the findings to help draw up tailored, sustained, local programmes to boost social mobility, building on the approach in some Opportunity Areas.

The commission will also ask the government to extend its current Opportunity Areas programme – which gives support to 12 councils – to include several more authorities identified as the areas with the most entrenched disadvantage.

Professor Lindsey Macmillan, Director of CEPEO at UCL and Research Fellow at IFS said: “This new evidence highlights the need for a joined up-approach across government, third sector organisations, and employers.

“The education system alone cannot tackle this postcode lottery – a strategy that considers the entire life experience, from birth through to adulthood, is crucial to ensuring fairer life chances for all.”

Laura van der Erve, Research Economist at IFS and co-author of the report, said: “Not only do children from disadvantaged backgrounds have considerably lower school attainment and lower adult earnings than their peers from more affluent backgrounds, we also find large differences in the outcomes of children from disadvantaged backgrounds across the country.

“This highlights that children’s opportunities in England are still defined by both the family they were born into and the area they grew up in.”

Key findings

Social mobility in England is a postcode lottery, with large differences across areas in both the adult pay of disadvantaged adults, and the size of the pay gap for those from deprived families, relative to those from affluent families.
Disadvantaged young adults in areas with high social mobility can earn twice as much as their counterparts in areas where it is low – over £20,000 compared with under £10,000
Pay gaps between deprived and affluent young adults in areas with low social mobility are 2.5 times larger than those in areas with high social mobility.
In areas of low social mobility, up to 33% of the pay gap is driven by family background and local market factors, over and beyond educational achievement.
Characteristics of the coldest spots: fewer professional and managerial occupations; fewer outstanding schools; higher levels of deprivation and moderate population density.

The Social Mobility Commission is an independent advisory non-departmental public body established under the Life Chances Act 2010 as modified by the Welfare Reform and Work Act 2016. It has a duty to assess progress in improving social mobility in the UK and to promote social mobility in England.

Independence IFS and buts

Think Tank report warns of spending cuts and tax hikes

An independent Scotland would have to cut spending or increase taxes for its finances to be sustainable in the long-term, a leading think tank has warned. The Institute for Fiscal Studies (IFS) said Scotland would face a ‘fiscal gap’ of 1.9% of national income, more than double that of the rest of the UK (0.8%).

The report says that significant spending cuts or tax increases would be necessary to balance the books.

Better Together campaigners say the report leaves the economic argument for independence ‘in tatters’ but Scottish Finance Secretary John Swinney believes the report actually underlines the case for an independent Scotland.

The 69 page ‘Fiscal sustainability of an independent Scotland’ (attached below) concludes:

‘An independent Scotland would have the freedom to make its own decisions about spending priorities and the appropriate design of the tax system, but it would be constrained by the necessity to deliver a significant cut in spending and/or increase in tax revenues in order to put its public finances in a sustainable long-term position’.‘

Speaking after the publication of the report earlier today, Alistair Darling, leader of the pro-Union Better Together campaign, said: “This sober and impartial analysis by the IFS leaves the SNP’s economic case for independence in tatters. SNP ministers pretend that in an independent Scotland there would be more money to spend, but that notion has been comprehensively demolished by the analysis from this respected institution. Today’s report is clear that an independent Scotland would need big cuts to things like pensions, benefits and the NHS or a big increase in tax.”

Not so, say supporters of independence. Commenting on the IFS report, Mr Swinney said: “This report actually underlines the case for an independent Scotland with full control of its own economy and the ability to take decisions that can secure a stronger and more prosperous future for the country.

“It is no surprise that projections based on the UK’s economic position show a long-term deficit when the OBR state that the UK’s economic strategy is “unsustainable” and that the UK will run a fiscal deficit in each of the next 50 years.

“The IFS themselves admit their projections in this report are ‘inherently uncertain and could evolve differently if Scotland were independent rather than part of the UK; in addition they could be substantially effected by the policies chosen by the government of an independent Scotland’.

“The whole point of independence is to equip Scotland with the competitive powers we need to make the most of our vast natural resources and human talent and to follow a better path from the current Westminster system which stifles growth and which is responsible for the damaging economic decisions which this report – and its projections – are based on.

“Scotland has strong financial and economic foundations, and even without a single penny from oil and gas, both output and tax revenues per head in Scotland are virtually the same as for the UK.

“Next year’s independence referendum will give people in Scotland a choice between staying with a broken Westminster system that has created one of the biggest gaps between rich and poor in the western world, which concentrates far too many jobs in London and the South-East of England, has accumulated vast amounts of debt and which neglects manufacturing and trade – or using the full tools of independence to rebalance the economy, improve equality and support public services.

“Between 1977 and 2007, smaller independent European countries similar to Scotland grew their economies faster than ours, and if we had matched those rates that greater output would now be the equivalent of around £4.5 billion.

“Tomorrow the Scottish Government will publish detailed analysis of the economic security, growth and job opportunities that come with the powers of independence and by taking Scotland’s future into Scotland’s hands.”

IFS report