A fortnight ago the Chancellor rose in Parliament to present her budget, including a flagship policy to extend 30 hours of free childcare to all children over nine months old.
Acknowledging the exorbitant cost of nurseries and childcare in Britain compared to our European peers, Jeremy Hunt said it was about boosting labour, productivity and prosperity.
It’s safe to say that along with the changes to retirement allowances, this was the cornerstone of the Chancellor’s budget.
But this has been accompanied by another massive trap in the increasingly bizarre UK tax system, on top of existing ones such as the cut in child benefit and the 60% tax rate of the cut in benefit personal.
Desired consequences? Jeremy Hunt stood up happily and presented a landmark childcare budget policy that has created one of the worst cliff edges ever in UK taxation and welfare
There is already a catch to the 30 hour free childcare scheme: if either parent’s income exceeds £100,000 the family loses 30 hours of free childcare entirely.
By expanding this existing system but refusing to fix this cliff edge, Mr. Hunt has achieved the impressive feat of making a grossly unfair scenario even worse.
In its almost immediate analysis, the Institute for Fiscal Studies said: “The distortions this can create are some of the most severe you will ever see in a tax and benefit system.”
He pointed out that a parent with a one- and three-year-old child in full-time childcare, based on average fees in England, would find their disposable income would drop by £14,500 if their pre-tax income crossed the £100,000 mark.
The distortions this can create are some of the most serious you will see in a tax and benefit system
The IFS, on the childcare trap
Their disposable income would not recoup the childcare loss until their pre-tax income reached £134,500.
For a parent paying average London costs, disposable income could drop by £20,000 if a pay rise takes them past £100,000. They would not regain their previous disposable income until their wages reached £144,500.
It’s worth noting that £100,000 is a lot of money to earn, 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 such a respected and generally very measured think tank as the IFS has called the “distortions” that hit them “absurd”?
Robert Joyce of the IFS commented: “A likely unintended effect of today’s announcements on childcare is to exacerbate one of the most serious distortions you will see in a childcare system. tax and benefits.”
But I think he’s being overly generous here with the “unintended consequences” track.
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 that.
Yet he decided to go ahead regardless and not fix it. Sounds well intentioned to me.
Similarly, when Mr Hunt reduced the tax rate threshold from 45 pence to £125,140 in the autumn statement, he opted not to remove the marginal income tax rate of 60 pence which precedes it.
This happens because when someone earns over £100,000 their personal allowance of £12,570 starts to be phased out, at a rate of 50p for every additional £1 earned – until it’s all increased to £125 £140.
When Mr Hunt reduced the 45p tax rate threshold to £125,140, he opted not to remove the 60p marginal income tax rate that precedes it.
This effectively adds 50 percent to their 40 percent income tax rate, bringing it to a marginal income tax rate of 60 percent (the tax paid on the next pound earned).
The scrapping of the personal allowance is why the Chancellor chose such a bizarrely accurate figure of £125,140 for a 45p levy, rather than a nice round £125,000.
Again, Mr Hunt knew that before arriving at a 45p tax, people would have had to face a 60p tax rate. But rather than fix it, he left it there.
Mind you, to be fair to him, so have every other Tory chancellor we’ve had since 2010 – and they have the temerity to accuse Labor of being the high tax party.
This graph shows how marginal tax rates change across the income scale, with higher effective rates for those who see child benefits cut and lose their personal allowance than those paid by the highest earners with a tax of 45p (This is Money / Chris Sedgwick)
Osborne introduced another pernicious part of the tax system, with his reduction of child benefits
And it was George Osborne, of course, who introduced another pernicious part of the tax system further down the scale, with his reduction in child benefits.
It starts removing parents’ Child Benefit if any of their incomes exceed £50,000, until it’s all down to £60,000. It creates a marginal tax rate of 51% for a parent with one child or 59% if he has two children.
It is also such a spectacularly ill-conceived policy that it has caused child benefits to cause chaos in state pensions.
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 the edges of the tax cliff explains.
Once you add other things like loss of personal savings allowances or universal credit, you start to get extreme cases of 96% marginal tax rates.
Infuriatingly, there’s also a major budget drag with the cliff edge thresholds.
If the £100,000 level for the personal allowance cut had risen with inflation since 2010, it would be £159,500.
If the child benefit taper level of £50,000 had risen with inflation since 2013, it would be £70,000.
If the 30 hour free childcare tier had increased with inflation since 2017 it would be £129,500.
But lifting the unfair elements with inflation doesn’t really solve the problem, nor does it achieve the goal of building trust in a tax system, so that high earners – which often become even higher earners – are encouraged to pay their dues rather than feel bad about it.
A better move would be to get rid of the below-the-belt elements of the tax system, but will we ever have a chancellor brave enough to fix this mess?
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