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Briefing: Means-testing Child Benefit

4 January 2013

4:04 PM

4 January 2013

4:04 PM

George Osborne’s removal of child benefit from high-earners kicks in on Monday, but what exactly does it entail?

Who loses what?

Initially, Osborne’s plan was ‘to remove child benefit from families with a higher rate taxpayer’, as he announced in the Spending Review of October 2010. (This year, that’d be anyone earning over £42,475.) But after criticism that this would hit too many people, and that it would create a ‘cliff-edge effect’ (whereby someone earning £42,475 would keep all their Child Benefit but someone earning £42,476 would lose it all, so the lower-earner would end up better-off), Osborne changed his mind.

In his Budget of March 2012, the Chancellor announced that only families with at least one parent earning more than £50,000 would lose out, and that the removal would be tapered. Families will lose 1 per cent for every £100 their highest-earner earns over £50,000 — up to 100 per cent for those earning £60,000-plus.

HMRC estimates that this will affect around 1.2 million families, with 70 per cent of them losing all their child benefit (because at least one parent earns £60,000 or more). Those 1.2 million families will lose an average of roughly £1,300 each per year. (Child Benefit is currently £1,056 a year for one child, and an extra £697 per additional child.)

How will it work?

Somewhat bizarrely, the affected families will actually carry on receiving Child Benefit, but will face an extra ‘income tax charge’ to reduce their net income by the appropriate amount. So a family with two children whose highest earner has an income of £60,000 will receive £1,752 in Child Benefit (as now) but will also have to pay a new tax of £1,752.

How much will it save the government?

The Treasury estimates that the change will save the government around £1.5 billion in 2013-14, rising to £2.5 billion a year by 2016-17.

Criticism 1: Unfairness

One criticism of the original plan that Osborne didn’t address with his changes is that a family where both parents earn, say, £40,000 (so the total income is £80,000) gets to keep all of its Child Benefit, whereas a lone parent earning £60,000 loses all of it. On the plus side, the policy does not hit the 85 per cent of families where both parents earn less than £50,000 at all.

Criticism 2: High marginal tax rates

The gradual reduction in Child Benefit means that families whose highest earner’s income is between £50,000 and £60,000 will effectively face much higher marginal income tax rates. At the moment, for every extra pound they earn, they keep 60p, but from Monday — if they have kids — they’ll keep less. How much less depends on how many children they have:

Robert Joyce of the Institute for Fiscal Studies has put together the below graph to show how the change will distort the income tax system, warning that this will raise the incentives for those in this band ‘to reduce their taxable income by, for example, working less or contributing more to a private pension’.

Criticism 3: Ignoring inflation

As Joyce notes, the government does not plan to raise the £50,000 and £60,000 thresholds — which has two knock-on effects. First: as wages rise, more families will find themselves losing their Child Benefit. Second, as Child Benefit rises to keep up with the cost of living, the marginal tax rates facing those in that range will rise even further.

Criticism 4: More paperwork

HMRC predicts that, as a result of the policy, an extra 500,000 people will have to fill in self assessment forms.

Criticism 5: What happened to simplifying the benefits system?

‘Perhaps the biggest concern is the incoherence it creates in the welfare system’, Joyce says. He notes that on the one hand the government is simplifying benefits by combining six means-tested benefits into one (the Universal Credit), but at the same time is turning Child Benefit into a new one. With Council Tax Benefit also becoming more complicated, Joyce warns that ‘It is unclear whether the net effect of all this will be to improve the welfare system.’

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