Will you be squeezed by government cuts?

The government insists that we are all in this together. To heal a sickly economy and tackle the UK's £170 billion budget deficit we're told that all citizens must suffer their fair share of hardship, most obviously in the form of cuts to jobs, welfare and disposable income.

But new research shows that it's middle-income families who'll be hardest hit, with a shortfall this year of up to £4,250 as a result of public service cuts, wage freezes, inflation, higher taxes and benefit cuts.

So is it actually the case that Middle Britain has never had it so bad?

Hard times

Times are already hard in many households. The cost of living has increased dramatically in the last year, with a hike in VAT, rising food, clothing and petrol prices, and no extra money in the wage packet of the average earner to offset the pain.

But a first tranche of changes to the tax and benefits system started in April, including cuts to working tax credit and housing benefit, could push many middle-income families with kids towards the financial edge. And there are more cuts planned for coming years.

After the announcement of the cuts in last June's Budget and October's Spending Review, Prime Minister David Cameron said that those with the "broadest shoulders" would bear the greatest burden - but there's strong evidence of the financial burden falling disproportionately on middle-bracket families.

Those who fall bang in the middle of household earnings rely on the state for a fifth of their total income, according to the Office of National Statistics.

The Governor of the Bank of England, Mervyn King, has admitted that due to the most prolonged fall in wages since the 1920s, many households face a "squeeze in living standards".

Even Justice Secretary Ken Clarke admits that "Middle Britain hasn't quite taken on board the scale of the problem" and warns that these typical families will feel the pinch as the cuts begin to take effect this year.

Tax credit changes

From April the biggest blow to many middle-income families will be changes to tax credits, which will be means tested more aggressively.

In particular, only 70% of childcare costs will be met by the working tax credit, down from 80%; this will have a big impact on many families with younger children.

The Institute for Fiscal Studies (IFS) suggests that 175,000 families with an income of about £40,000 will be negatively impacted.

Brendan Barber, the Trades Union Congress (TUC) general secretary, says: "Women with very small children appear to have been singled out for some of the deepest cuts, which totally contradicts the family-friendly messages coming from the government.

"Altogether, the cumulative impact of these measures could have a devastating effect on household budgets, and they are likely to lead to an increase in child poverty."

April will also see a change to how most benefits and tax credits are calculated, using the consumer prices index (CPI) rather than the retail prices index (RPI). This will mean a reduction in the value of benefits over time, with support payments only increasing by 3.1% rather than the near 5% they would otherwise have done.

At the same time, a rise in the level at which income tax and national insurance must be paid will mean that a further 500,000 people will be let off paying any tax at all.

However, the bad news is that for those who are eligible to pay, the combined rate will be higher, plus the higher-rate tax threshold will drop to £42,475 from £43,875. According to the IFS, an extra 750,000 people will be pushed into the higher-tax bracket as a result.

The IFS has calculated that April's changes will cost households £5.4 billion, with each worse off to the tune of an average £200. There's greater pain to follow, however, with more reforms planned for April 2012 and later - which could cost families far more.

James Browne, the IFS's senior research economist, reinforces the message that working couples with children will be most hit by the reforms, while non-working couples and pensioners will lose relatively little.

"The very richest households are losing the most in terms of percentage of their income," he says. "But across the bottom 90% of income distribution, families with children are losing the most. Then you need to take into account that only a small minority of budget cuts will come into play in 2011 - they're going to continue over the next four years."

Universal credit: the real losers

For a start, from January 2013 universal child benefit, currently worth £20.30 a week for the first child and £13.40 a week for subsequent children, will be withdrawn from families where one or both parents are higher-rate taxpayers. For a family with three kids, the benefit is worth more than £188 a month.

Green points out that many people will lose their entitlement to child benefit because of the forthcoming tax changes pushing them into the higher-rate tax bracket. 

"The removal of child benefit will be a very important issue for those who are currently just on the boundary of basic and higher-rate tax bands, " he adds.

And then in April 2013, the current system of tax credits will be replaced by a universal credit; the TUC calculates working families could be £2,700 a year worse off as a result. Browne believes the new system will also have a negative impact on the ability of women with children to work.

"Universal credit will probably act as an incentive for one person in a household to be earning rather than none," he says.

"But it will weaken the incentive for a second person to work, leaving the couple to decide who should stay at home."

The government has also abolished the Health in Pregnancy grant, which gave £190 per child to expectant mothers, while the Sure Start Maternity grant of £500 per child for those on lower incomes will now only be paid for the first child.

The same group will also lose out most from the loss of the child trust fund, which contributed two vouchers of £500, plus another £500 to each child's savings if they were from a lower-income family. Child benefit will also be frozen for three years.

Who is in the middle?

But who makes up this "squeezed middle"? The Resolution Foundation, a think tank that analyses the plight of middle earners, identifies it as roughly 11 million adults in the UK who live in households deemed too rich to qualify for significant state support, but who still struggle to pay bills.

This group, it says, is particularly exposed to changes to tax credit entitlement and the rising cost of living - particularly childless couples on between £12,000 and £30,000 a year, and families with three children earning up to £48,000.

Katherine Green, spokesperson for the foundation, says: "It's perfectly possible to be earning £45,000 but have three or four kids - that's enough to tip a family below median household income."

These tax and benefit changes are occurring against a backdrop of high inflation (currently 4%), low wage rises and growing unemployment.

The hike in VAT alone - from 17.5% to 20% in January - has increased the annual shopping bill of the typical household by an estimated £200-plus, with those on lower incomes suffering most.

Andrew Goodwin, Ernst & Young's ITEM club economic adviser, says: "We've been used to an increase in pay in real terms of 2% each year, but wages have been declining for several years, which puts a significant strain on many households.

"There's also the added pressure of the rising cost of oil, food and clothing. Then there's the impact of the VAT rise, plus the weakness of the labour market. We're in the middle of a perfect storm, caught between externally generated pressures on commodity prices and the government's austerity measures."

TUC head Barber adds: "It's unfair to make young families shoulder such a large proportion of the welfare cuts. When ministers talk about a ballooning welfare budget they say that the main problem is people who choose not to work. But the fact is these sweeping cuts will affect working families with children."

Key tax credit changes

• A freeze in the basic element and 30-hour element of working tax credit for three years from April.
• The couple and lone parent elements will increase annually by CPI rather than RPI.
• A reduction in the amount of eligible childcare costs that will be met by working tax credit from 80% to 70% from April.
• Above-RPI increases in the child element of the child tax credit of £180 from April this year and £110 in April 2012.
• A reduction in the second-income threshold, after which the family element is tapered, to £40,000 from April.
• The family element will also be tapered immediately after the child element from April 2012

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