Thousands of families could be hit by effective tax rate of up to 96%

Tens of thousands of families could be hit by an effective tax rate of up to 96 per cent next year because of a ‘clash’ between Universal Credit and child benefit, think tank says

• Growing number of families with children will find pay packets hit due to clash
• Collision will take place between income levels at which they are withdrawn
• Child benefit and Universal Credit created to aid distinct parts of population
• But decade-long cash freeze in the £50,000 threshold will see support halted
• Around 50,000 families could be impacted, rising to 90,000 by 2030 

Tens of thousands of families could face an effective tax rate of up to 96 per cent next year due to a ‘collision’ between Universal Credit and child benefit.

Analysis by think tank Resolution Foundation has warned that a growing number of families with children will find their pay packets hit due to a clash between the income levels at which of the two welfare systems are withdrawn.

The two systems for withdrawing child benefit and Universal Credit were originally drawn up to support distinct parts of the population. 

But the decade-long cash freeze in the £50,000 threshold, the figure at which child benefit begins to be halted, means around 50,000 families will see their support withdrawn at the same time Universal Credit is also stopped.

Chancellor Jeremy Hunt pictured outside Downing Street last month ahead of his Spring Budget statement

A growing number of families with children will find their pay packets hit due to a clash between the income levels at which Child Benefit and Universal Credit are withdrawn

This could rise to 90,000 families by 2030 if the rules are not amended, the think tank added.

Only one parent has to be earning more than £50,000 for the threshold to be met under the ‘high income child benefit charge’. Despite Universal Credit being designed for low-income families, households which earn more than the threshold but have high housing or childcare costs are also eligible for the support.

Karl Handscomb, senior economist at the Resolution Foundation, said: ‘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 is set to almost double by the end of the decade.’

Under the current system impacting England, Wales and Northern Ireland, families on Universal Credit often pay high marginal deduction rates, with the Resolution Foundation estimating that three million working adults pay effective tax rates of at least 69 per cent.

This is due to families paying income tax and national insurance contributions – alongside having Universal Credit withdrawn as their earnings increase.

The think tank has said that the freeze on the child benefit threshold since 2013 has led to one in thirteen families with children, or around 600,0000, facing similarly high tax rates.

The report adds: ‘Some may be surprised that families containing someone earning over £50,000 can receive UC. 

‘This isn’t, of course, the typical position of most families on UC but for those with high housing rents, or with significant childcare costs, it is perfectly possible.’

Prime Minister Rishi Sunak leaves 10 Downing Street to attend Prime Minister’s Questions in the Houses of Parliament earlier this month

It warns a collision between the two systems has led to the ‘highest marginal deduction rates in the UK’ – 80 per cent for families with one child, 83 per cent for those with two children, and 87 per cent for three children.

The think tank also says that, accounting for student loan repayments and pension contributions, the rates could rise as high as 96 per cent for three-child families.

That has led to fears that around 90,000 families could be caught up a high-tax-rate situation by 2030.

One solution suggested would be to raise or withdraw the child benefit withdrawal threshold.

However, such a move would likely cost the Government up to £4 billion.

Another option would be to integrate child benefit into UC, but the think tank warned that it risks cutting support for some lower and middle-income families.

Mr Handscomb added: ‘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.’

A Treasury spokesperson said: ‘We are committed to supporting families with children, which is why we increased both child benefit and child tax credits in line with inflation this year and made changes to Universal Credit so that working families can keep more of what they earn.

‘We also have a plan that will help to more than halve inflation next year, bearing down on the financial pressures that households face, and have already lifted millions of people out of paying tax altogether by raising the tax-free allowances for both income tax and National insurance by more than inflation since 2010.

‘This is on top of substantial support with the cost of living, with everyone benefiting from energy bills being held down this winter and more than 8 million vulnerable.

It comes after new research from the Office for Budget Responsibility also found that middle-class families could be £40,000 worse off over the next 10 years after Jeremy Hunt hiked taxes to plug a £50billion hole in public finances.

In the autumn statement the Chancellor announced he would freeze income tax thresholds until 2028 at the earliest.

This means that thousands more families will end up paying increased amounts of tax, while earnings fail to keep pace with inflation.

The OBR previously estimated 3.2 million people will be dragged into paying the 20 per cent basic rate of income tax due to the freezing of the personal allowance at £12,571.

An estimated 2.6 million people are predicted to be pulled into paying the 40 per cent higher rate, which has a threshold of £50,271.

The Times reported that research from the House of Commons Library showed a family with two earners on £60,000-a-year each will be £40,880 worse off over the next decade compared to if income tax thresholds had risen in line with inflation.

Mr Hunt froze the income tax personal allowance, as well as the threshold for paying higher rate income tax, in an attempted to fill the blackhole in the nation’s finances.

However experts think it could lead Britain to a continuous cycle of higher taxes.

The Times found that a worker earning £60,000 a year will pay an estimated more than £134,000 in income tax during the next decade.

This equates to an 18 per cent higher tax bill than it would have been had thresholds not been frozen.

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