Is self-employment compatible with Universal Credit?

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Published date
16 Feb 2018
The complexity and hardship with which Universal Credit (UC) threatens to engulf self-employed workers is one of the underreported stories of the design of UC.

In UC, they will face in-work benefit cuts if they do not meet the ‘Minimum Income Floor’ (MIF), which requires them to earn the equivalent of 35 hours a week at the National Minimum Wage. There is no such requirement for employees.  In addition, the monthly income assessments in UC are expected to be problematic for the self-employed, as they are more likely to have unpredictable and fluctuating earnings.

The new self-employed

Self-employment has grown significantly since the recession. There are now almost an extra million self-employed workers, increasing the self–employed workforce to just under five million and 15 per cent of the total workforce.  Part time self-employment has seen the biggest expansion, rising by 55 per cent to reach around 1.5 million people.  

Earnings data for the self-employed indicate that they are more likely to be on lower earnings compared to employees. The Family Resources Survey shows that median earnings for the self-employed are around 60 per cent of those of employees. The Social Market Foundation (SMF) estimates that in 2016 there were 1.7 million self-employed workers paid below the National Living Wage. This group accounts for 45 per cent of the self-employed in the UK.

The SMF also estimates that around a fifth (19 per cent) of families with an individual whose main job is self-employment are claiming in-work benefits such as tax credits and housing benefit that will be replaced by Universal Credit.

The Minimum Income Floor 

In 2015, during a Parliamentary debate, Lord Freud explained the reasoning of the MIF:

The welfare system is not there to prop up unproductive or loss-making businesses. The minimum income floor is there to incentivise individuals to increase their earnings from their self-employment. Those subject to the minimum income floor are exempt from having to search for or carry out any other work, allowing them to concentrate on making a success of the business…the other thing that the minimum income floor does is address a loop-hole in the tax credits system whereby individuals can report little or zero income but still receive full financial support, which is neither a desirable or sustainable situation to maintain.”

However, the MIF only applies to those who are considered gainfully self-employed’ by the Department for Work and Pensions (DWP). So those who are doing odd jobs and not in a sustainable business have already been sieved out by the system. Those who fail the test would be subject to benefit conditionality.

While there is a grace period of 12 months for a new business before the MIF applies, this period is considered too short for a new business set up, as large numbers of the self- employed earn very little at the outset of their business.

Such a short start-up period in the MIF could close businesses with the potential to become sustainable and profitable.  And these rules could discourage people from starting self-employment in the first place. Self-employment can sometimes be the only option for single parents, carers and groups that find traditional employment difficult to access.

The OBR in its recent welfare trends report  confirms that the low-income self-employed face a much tougher benefits system under UC. It estimates that the MIF in 2022-23 will overwrite the actual income for around two thirds of self-employed UC claimants. And on average, those affected are assumed to lose around £3,000 relative to what they would receive if the MIF were not in place.

In effect, the saving of £1.2bn to the Exchequer of introducing the MIF is coming out the pockets of the low paid self-employed.

Fluctuating Incomes

As the self-employed are more likely to have fluctuating earnings, and UC is assessed on the previous month’s income, you can have a situation where a self-employed claimant (above the level of the current minimum income floor) receives substantially less UC than an employed claimant earning a similar annual income.  In one example modelled by the independent Low Incomes Tax Reform Group (LITRG), the self-employed person received £2,600 less UC than their employed counterpart.       

Universal Credit is designed around monthly assessment periods, and while this may work well for the employed with steady hours and income, it does not adapt well to the self- employed. 

There is also further disparity between the employed and self-employed in Universal Credit, on pension contributions. The LITRG points out employed claimants can deduct pension contributions from their declared income, therefore increasing their UC payments. A self-employed claimant can also deduct pension contributions, they can only do this down to the level of the MIF; below that level, they do not receive any recognition for pension contributions.

Self-employed claimants could be discouraged from saving into a pension. There is already a clear divide between employees and the self-employed, who are far less likely to be saving into a pension.

From April 2018, the UC system will become even more complicated with the introduction of surplus earnings rules for both the self-employed and employed. The basic idea is if a UC award is terminated (e.g. as income goes up) a calculation will be done to work out ‘surplus earnings’ for that month and the following five months. Surplus earnings are essentially the amount of income you have above the point at which your UC would reduce to nil plus a £300 de minimis. If a new claim is made within that period, the surplus earnings for those months will be applied to their new claim as income. In the above example by LITRG where the self-employed claimant loses £2,600, under surplus earnings they would lose a further £455. 

For a system designed to be simple and streamlined, it has ended up being complex and bureaucratic.  In addition, the self-employed as well as providing earnings information to the DWP, still have to report to HMRC for tax obligations.

In April 2017, the Work and Pensions Committee concluded that the MIF fails to get the balance right between supporting entrepreneurship and not subsidising long term, unprofitable self-employment.

The existing Minimum Income Floor in UC does not get this balance right and risks stifling viable new businesses. The incoming government should commission an independent review of the MIF with a view to improving its sensitivity to the realities of self-employment. Until this is complete, the MIF should not apply to self-employed UC claimants.’

The TUC endorses this recommendation. The Government has frequently said that it wants to support self-employment, however the UC credit system is a serious deterrent for this type of work.