Some families could end up facing effective marginal tax rates of at least 80% next year due to a “collision” between Universal Credit (UC) and child benefit, according to a think tank.
The Resolution Foundation's analysis found a growing number of families with children will find their pay packets hit hard, due to a clash between the two welfare systems.
According to the think-tank, the two systems for withdrawing child benefit and UC were originally intended to support distinct parts of the population.
But a decade-long cash freeze in the £50,000 threshold at which child benefit begins to be withdrawn will mean that around 50,000 families will see the support withdrawn at the same time as UC is also withdrawn.
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% 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 in place in England, Wales and Northern Ireland, families on Universal Credit often pay high marginal deduction rates, with the Resolution Foundation estimating that 3 million working adults pay effective tax rates of 69% or higher due to paying income tax and national insurance contributions alongside having UC withdrawn as their earnings increase.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 notes: “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.”
The think tank is warning that a collision between the two systems has led to the “highest marginal deduction rates in the UK” – 80% for families with one child, 83% for those with two children, and 87% for three children.
It warns that accounting for student loan repayments and pension contributions, the rates could rise as high as 96% for three-child families, with fears that around 90,000 families could be caught up a high-tax-rate situation by 2030.
One solution would be to raise or withdraw the child benefit withdrawal threshold, according to the Resolution Foundation.
But that 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.
“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,” Mr Handscomb said.
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.”
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