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Punitive Deduction Rates Are Unsustainable, U.K. Think Tank Says

Posted on Dec. 29, 2022

The combined result of U.K. child benefit and universal credit withdrawals is a “truly punitive” effective tax rate of at least 80 percent that is affecting a growing number of families, the Resolution Foundation said.

Families with two children face an effective rate of 83 percent, those with three children face a rate of 87 percent, and even higher rates can apply to people making student loan repayments or pension contributions, the think tank said in a December 28 report.

“The separate systems for withdrawing child benefit (when one parent is earning over £50,000) and universal credit (when the household earns from as little as £4,548 next year) were originally designed to affect two distinct parts of the population,” the foundation said in a release accompanying the report. But a “decade-long cash freeze” in the £50,000 threshold at which the child benefit starts to be withdrawn via the high-income child benefit charge “means that 50,000 families will see their child benefit withdrawn at the same time as their universal credit is tapered away next year,” it added.

Families receiving universal credit often pay high marginal deduction rates, the foundation noted. “While the vast majority of those on universal credit are low-income families, it is possible for families to be entitled to universal credit on earnings above £50,000 if they have high housing costs or receive help with childcare costs,” it said. “The collision of these two systems has led to the creation of the highest marginal deduction rates in the United Kingdom.”

‘A Tax on Work’

The universal credit taper “withdraws support as people work more hours,” Rishi Sunak, then chancellor of the Exchequer, noted in his October 2021 budget. “Let us be in no doubt: This is a tax on work, and a high rate of tax at that,” he said while announcing an increase in universal credit work allowances and a reduction in the taper rate from 63 percent to 55 percent.

But the foundation has warned that exceptionally high marginal deduction rates are “set to affect increasing numbers of families over the next decade," rising from 50,000 in 2022 to around 90,000 by 2030, with another 250,000 people earning £40,000 to £50,000 at risk of being pulled into those high tax rates if they receive a pay raise. It will become “increasingly unsustainable” for the two policies to continue in their current format as rising numbers of families become “trapped in a high tax rate which presents a significant disincentive to seek higher earnings,” it said.

“It is not the super-rich that have the highest effective tax rates in the U.K., but some families with children,” said Karl Handscomb, the foundation’s senior economist. He recognized, however, that the government “faces significant challenges in fixing this problem, as the solutions are either expensive or deal a major blow to families’ finances.”

People may ask why growing numbers of families are in this position, foundation Chair Gavin Kelly said in a December 28 blog post. “Universal credit is generally thought of as a benefit for those on ‘low’ incomes, whereas child benefit is supposed to be withdrawn from ‘higher-income’ families,” he said. “In reality, there has always been a degree of overlap because some middle and upper-middle-income families face very high costs (living in high-rent areas and/or [incurring] high childcare costs) that require support.”

The extent of that overlap is growing fast for two reasons, Kelly added. The high-income child benefit charge threshold has not been increased since the charge was introduced in 2013, and the recent changes to universal credit meant that “more middle and upper-middle-income” households became eligible, he noted.

“The combination of these two effects generates a slow-motion car crash for work incentives in this £50,000 to £60,000 zone as each year more families lose their child benefit while still being on universal credit,” Kelly wrote.

“Anomalously high marginal tax rates” could plausibly be holding back economic growth, and “any government serious about fixing the tax system should start here,” Dan Neidle, founder of Tax Policy Associates, said in an October 4 blog post.

Tax Arrears

At least 45,000 families who are liable to pay the high-income child benefit charge could be at risk of building up tax arrears, accountancy firm BDO said in a December 21 release.

HM Revenue & Customs “urgently needs to focus its efforts” on raising awareness of the charge, particularly among those whose income exceeds the threshold for the first time, BDO tax partner Paul Falvey said.

HMRC published an update on the high-income child benefit charge in a December 15 Freedom of Information Act release. On December 20 it tweeted a reminder that taxpayers liable to pay the charge need to file self-assessment tax returns. The normal deadline for tax returns for 2021-2022 is January 31, 2023.

More than 3,000 tax returns were filed on Christmas Day, HMRC said in a December 28 release.

Subject Areas / Tax Topics
Magazine Citation
Tax Notes Int'l, Jan. 2, 2023, p. 127
109 Tax Notes Int'l 127 (Jan. 2, 2023)
Institutional Authors
Tax Analysts
Tax Analysts Document Number
DOC 2022-40722
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