Will a Chancellor ever be brave and fix the UK’s tax trap mess?
Two weeks ago, the Chancellor stood up in parliament to present his budget, which included a flagship policy to extend 30 hours of free childcare to all children over nine months old.
Jeremy Hunt acknowledged the skyrocketing cost of nurseries and child care in Britain compared to our European peers and said it was about boosting the workforce, productivity and prosperity.
It’s safe to say that this, along with changes to pension benefits, was a cornerstone of the Chancellor’s budget.
But it came with another huge pitfall in Britain’s increasingly bizarre tax system, added to the existing ones like the phasing out of child benefit and the abolition of the 60 per cent personal allowance.
Intended consequences? Jeremy Hunt happily rose to deliver a flagship child care budget policy that created one of the worst chasms ever seen in UK tax and welfare
There is already a catch to the 30 hours of free childcare system: if one parent earns more than £100,000, the family loses the 30 hours of free childcare entirely.
By extending that existing system, but refraining from repairing this abyss, Mr. Hunt has done the impressive feat of making an extremely unfair scenario even worse.
In its near-immediate analysis, the Institute for Fiscal Studies said, “The distortions this could cause are some of the most serious you’ll ever see within a tax-benefit system.”
It pointed out that, based on the average cost in England, a parent with a one- and three-year-old receiving full-time childcare would find their disposable income would fall by £14,500 if their pre-tax income exceeded the £100,000 mark.
The distortions this can create are some of the most serious you will ever see within a tax and benefit system
The IFS, on the childcare trap
Their disposable income would not make up for the loss in childcare until their pre-tax income reached £134,500.
For a parent paying average London costs, disposable income could fall by £20,000 if a pay rise cost them more than £100,000. They would not get their previous disposable income back until their salary reached £144,500.
It’s worth noting that £100,000 is a lot of money to make, but it’s also true that those with that kind of money pay a lot of tax.
Is it fair to treat them with such utter contempt that a respected and usually very measured think-tank like the IFS called the “distortions” they are affected by “absurd”?
Robert Joyce, of the IFS, commented: ‘A presumably unintended effect of today’s childcare announcements is to exacerbate one of the most serious distortions you will ever see within a tax and benefit system.’
But I think he’s being overly generous with the “unintended consequences” here.
The chancellor is a smart man, he has a lot of very smart people working for him in the Treasury, I can’t believe he didn’t know about it.
Still, he decided to plow through anyway and not fix it. That seems well intended.
Similarly, when Mr Hunt lowered the 45p tax threshold to £125,140 in the autumn statement, he chose not to scrap the 60p marginal income tax rate that preceded it.
This happens because when someone earns more than £100,000 their personal allowance of £12,570 starts to be removed, at a rate of 50p for every additional £1 earned – until it’s all gone at £125,140.
When Mr Hunt lowered the 45p tax threshold to £125,140, he chose not to remove the 60p marginal income tax rate that preceded it
This effectively adds 50 percent to their 40 percent income tax rate, raising it to a 60 percent marginal income tax rate (the tax paid on the next pound earned).
The abolition of the personal allowance is why the Chancellor chose such an oddly accurate figure as £125,140 for 45 pence of tax to kick in, rather than a nice round £125,000.
Again Mr Hunt knew that before they got to 45p tax people would have had a 60p tax rate. But instead of fixing this, he left it there.
Mind you, to be fair to him, so is every other Conservative chancellor we’ve had since 2010 – and they have the audacity to accuse Labor of being the party of high taxes.
This graph shows how marginal tax rates change through the income scale, with higher effective rates for those who see child support cuts and lose their personal allowance than paid by the highest earners with 45p tax (This is Money / Chris Sedgwick)
Osborne introduced another pernicious element of the tax system with his phasing out of child support
And, of course, it was George Osborne who introduced another pernicious part of the tax system further up the ladder, with his phasing out of child support.
This will begin to remove parents’ child benefit if any of their incomes exceed £50,000, until it all reaches £60,000. It creates a marginal tax rate of 51 percent for a parent with one child or 59 percent if they have two children.
It also managed to be such a spectacularly ill-conceived policy that it caused child support to wreak havoc on the state pension.
These are just three common examples of parts of the tax system where we treat people illogically and unreasonably. There are many more, as our article on tax cliffs explains.
Once you add in other things like losing personal savings or universal credit, you start getting edge cases of 96 percent marginal tax rates.
It is infuriating that there is also a major fiscal drag with the cliff edge thresholds.
If the £100,000 level for the removal of personal allowances had risen with inflation since 2010, it would be £159,500.
If the child benefit phasing out level of £50,000 had risen with inflation since 2013, it would be £70,000.
If the level of 30 hours of free childcare had increased with inflation since 2017, it would be £129,500.
But cutting out the unfair bits with inflation doesn’t really solve the problem, nor does it achieve the goal of building confidence in a tax system so that high earners – who often get even higher incomes – are encouraged to pay their wages. dues instead of feeling hard done.
A better move would be to do away with the below-the-belt parts of the tax system, but will we ever get a chancellor brave enough to fix that mess?
Some links in this article may be affiliate links. If you click on it, we may earn a small commission. That helps us fund This Is Money and use it for free. We do not write articles to promote products. We do not allow any commercial relationship to compromise our editorial independence.