Increasing proportions of families with children faced effective tax rates of at least 80% and as high as 96% in 2019, when two systems for supporting children (Universal Credit and Child Benefit) clash.
Originally, the different procedures for withholding Child Benefit (when one parent earns above £50,000) and Universal Credit (when the household earns from as low as £4,548 per year) were supposed to effect two distinct populations.
However, due to a decade-long financial freeze in the £50,000 threshold at which Child Benefit begins to be removed (through the High Income Child Benefit Charge), 50,000 families will see their Child Benefit taken at the same time that their Universal Credit (UC) is tapered away in 2019.
Frequently, families receiving UC pay high marginal deduction rates. Three million working individuals pay effective tax rates of 69 percent or more as a result of paying Income Tax and National Insurance contributions, as well as having their UC withheld when their wages increase.
Since 2013, freezing the Child Benefit level has caused 1 in 13 families with children, or 600,000 people, to face comparably high tax rates.
As Child Benefit is withheld according to a sliding scale for individuals earning between £50,000 and £60,000, households in which the higher earner earns between £50,270 and £60,000 may be subject to marginal deduction rates of 55% for one child, 63% for two children, and 71% for three children.
While the great majority of UC recipients are low-income families, it is feasible for families with incomes exceeding £50,000 to qualify if they have significant housing costs or need assistance with childcare expenses. Consequently, an estimated 50,000 families with incomes between £51,720 and £60,000 are eligible for UC, but also liable to the High Income Child Benefit Charge.
The collision of these two systems has produced the greatest marginal deduction rates in the United Kingdom, at 80% for families with one kid, 83% for those with two children, and 87% for those with three children.
Taking into account student loan repayments and pension contributions, these rates jump to 89 percent for one kid, 93 percent for two children, and 96 percent for three children. A hypothetical employee in this group, with a £50,000 salary and two children, would only receive an additional £800 if they obtained a £10,000 wage increase.
The number of families affected by these exceptionally high tax rates is projected to rise over the next decade, from 50,000 in 2022 to approximately 90,000 by 2030, with an additional 250,000 people (earning between £40,000 and £50,000) at risk of being pulled into these rates if they receive a pay raise.
The Foundation observes that it will become more untenable for these two policies to continue in their current shape, as an increasing proportion of families get locked in a high tax rate that creates a substantial disincentive to pursue higher wages.
But resolving this predicament also presents the government with difficult trade-offs. Raising or even eliminating the Child Benefit withdrawal barrier is one answer, but it may cost the government up to £4 billion since it would make Child Benefit available to families with high incomes.
Alternately, the government could integrate Child Benefit into UC, but this would risk cutting vital support for some low- and middle-income families that aren’t eligible for UC and eliminate a relatively secure and easily accessible income stream for adults who are the primary carers for children.
Karl Handscomb, Senior Economist at the Resolution Foundation, said: “It is not the super-rich that have the highest effective tax rates in the UK, but some families with children.
“Growing numbers are facing effective tax rates of 80 per cent and above next year, as the UK’s two policies for supporting children collide.
“Freezing the Child Benefit threshold for over a decade has led to marginal tax rates rising to over 55 per cent for 600,000 families.
“But 50,000 families will face tax rates of between 80 and 96 per cent where they are also seeing their Universal Credit payments reduced with each extra pound they earn.
“The number of families affected by this double whammy are set to almost double by the end of the decade.
“This ‘children’s benefits mess’ needs cleaning up as it creates huge complexity and disincentives for these workers to seek higher pay.
“But the Government faces significant challenges in fixing this problem, as the solutions are either expensive, or deal a major blow to families’ finances.”