Can you solve the Child Benefit conundrum?

15 January 2012 - Ian Mulheirn

As the Government grapples with the political and financial complexities of its pledge to remove child benefit from higher earners, Ian Mulheirn weighs up the options available and invites your views on how to solve the child benefit conundrum.

Last week the politically fraught issue of Child Benefit cuts for higher rate taxpayers reared its ugly head. The government is in a bind because of the perceived unfairness of taking the benefit away from families with a higher rate taxpayer. As a result, dual earner families with annual incomes up to £85,000 could continue to receive the benefit after April next year, while those with a single earner on £43,000 would have it withdrawn. The Treasury has pencilled in £2.4bn of savings from the change, so it’s a big deal.

In an interview last week, the Prime Minister hinted that something might be done to address the ‘unfairness’ of the measure and/or - it wasn’t entirely clear - to smooth the ‘cliff-edge’ by which all the benefit money is taken as soon as a person crosses the higher rate threshold. That’s intriguing, but when you think about the available options, it's hard to see a solution that's both politically and financially viable.

Is Universal Credit the answer?

At one extreme, the Government could roll the benefit into the Universal Credit, a ready-made system for allocating benefits fairly, according to total family income. It could also save something like another £3bn per year. But of course it would mean cutting the benefit for millions more families on even lower incomes than the current plan, so that won’t fly (even though it probably should, as we've argued before).

The nuclear option

At the other extreme the Chancellor could scrap the whole plan. But, apart from the embarrassment, dropping the idea would leave a gaping hole in his spending plans, so that’s a no-no.

The trouble with means testing

For anything in-between, the trouble is that it’s not possible to withdraw Child Benefit gradually. The creaking old system pays fixed amounts, based on simple rules, for 19 years after a child is born. So the only way to means test it is to recover the cash by raising income tax on the recipient family above a certain income. So far, so sensible. But since the late 1980s, the tax system has been based on individuals’ earnings, so establishing total family income for higher income families is all but impossible without some expensive, intrusive and politically suicidal new IT system (another non-starter).

Variations on a theme

That leaves variations on the idea of raising tax on one member of the family to recover the Child Benefit payment. Some have suggested that the Chancellor could decide to claw back the benefit from individuals earning above, say, £50,000 instead. Trouble is, it would cost hundreds of millions and wouldn’t address either of the two problems identified by the PM. Households with two earners could get more than a single earner family on a much lower income; and the problem of losing hundreds of pound of benefits for a small rise in earnings would remain.

An alternative would be to try to taper the benefit away more gradually. That would tackle the cliff-edge at a cost, but not the unfairness point – and it would introduce a whole bunch of other problems. Who should pay if both parents are higher rate payers? How much paperwork will be involved? And can the state require a parent to tell her/his higher rate paying partner that she/he gets Child Benefit?

All this is mind-numbingly complicated. And all the more baffling for the fact that elsewhere in the benefits system a massive upheaval to the tax credits system is underway at a similar cost in the name of simplicity. Can anyone think of a better way out of the Child Benefit conundrum? Please post your plan below.

Please add a comment

Posted by Chris W Drew on Jan 17th, 2012

1. Bring back joint tax allowances, instead of separate for each partner

2. Actually INCREASE Child Benefit

3. Double-tax it, but ignore any consequential tax allowance that might go negative - i.e. treat as nil.

Consequence of a (say)£40 total of Child Benefit is £40 to a non taxpayer, £24 to a 20% taxpayer, £8 to a 40% taxpayer and £0 for 50%, with automatic smooth gradations arising where the CB itself is pushing people up into the next tax-band.

As income increases, the marginal cost od each £ is still only at the highest tax-rate, on any income other than the CB itself.

Posted by Tim Leunig on Jan 18th, 2012

Why can't we add it in to universal credit and alter the taper point and rate to achieve what he wants to achieve?

Posted by Ian Mulheirn on Jan 18th, 2012

Chris - that's certainly one way to do it, but a whole new tax system and junking the principle of individual taxation just for this? Expensive and controversial

Tim - Think you're right that Universal Credit is the simplest answer. But to give full Child Benefit to any family earning less than £43k under that system would mean giving lots of families more in tax credits. Would add several billion to the bill.

Posted by Tony Orhnial on Jan 19th, 2012

HI Ian

As you know, this is a very familiar policy conundrum so I'd be very surprised indeed if anyone came up with a solution to the fairness problem which did not involve joint assessment of couples' incomes. Realistically, that rules out the tax system and leaves only the tax credit/universal credit mechanism. Given the Government's already very "challenging" plans and timetable for the move from the tax credits to the universal credit system, piling Child Benefit assessment onto the challenge would seem very risky indeed. So, unless the Government junks the Child Benefit change altogether, the unfairness issue won't go away.

That leaves the cliff-edge issue which can be alleviated by some sort of tapering mechanism. Although not without its problems, the short-lived Children's Tax Credit provides a useful precedent: where the income of a single parent or a person in a couple exceeded the higher rate threshold they lost £2 of the allowance for every £3 of income above the threshold until the CTC was withdrawn completely. I can't remember how the two higher rate earners issue was addressed in the CTC, but in a Child Benefit clawback mechanism you could allow such a couple to elect which partner would take the hit, or allocate the liability to the higher earner of the two. Not simple, but also should be workable if HMRC are still able to do what they were able to 10 years ago when the CTC was around. Not cheap though.

Tony

Posted by Tim Nichols on Jan 19th, 2012

For any family with a single earner just above the threshold, it is the equivalent to a 5% hike in income tax. For any further children, you can add another 2% (e.g. with 5 children it is equivalent to an 11% hike in income tax).

Only around 3 in 10 higher rate tax payers have children in the household, so this is effectively a tax targeted to children which leaves the majority of higher earner households untouched.

A similar amount could be raised by the Treasury if they simply put up the higher rate of income tax by 1%. This approach would be progressive because it doesn't take away thousands of pounds from mid earner families at once, but does so proportionately to earnings above the threshold at a much lower rate. It is also fairer because it applies to all higher rate tax payers, rather than just those with children in proportion to how many children they have.

So the fairest, is the cheapest, simplest and most obvious. The only problem is the irrational taboo that has gripped the WEstmisnter village in recent years around making use of progressive taxation. Once you remember that there is really no reason why this option should not be on the table, it is a no brainer!

Posted by Lord Lindley on Jan 19th, 2012

Only payable where the gross income to the household is less than 40k & only payable on first 2 children.

Posted by Rob on Jan 19th, 2012

Continue to pay child benefit to those who choose to claim - as at present - but claw back from those above the threshold in the following year's tax - as proposed by Osborne in October 2010. Instead of clawing back the whole amount, claw back only to the point so that the person is no worse off by earning just above the threshold. Better still, taper the clawback so that the recipient receives at least 30p in the pound after deduction of tax, NI and clawback of child benefit.

As for solving the unfairness between a couple with one earner on £44K and one with two earners on £42K... [shrugs]

Posted by Tim Leunig on Jan 19th, 2012

Ian - I am not sure I follow. You could taper it away fairly rapidly if you wanted to, starting at £40k. A 40% on post tax income would mean that the first child would be tapered away over income £40k - £44k, with subsequent children £44-£47k, £47k-£50k. My guess is that starting at £40k would give you savings in the right ballpark, although I have not done the maths.

Remember it is done on household income, so it will catch the two earner @£30k family who would not lose under the original plan. Catching them, while being more generous to those with one earner @£50k is the way to make it revenue neutral.

Posted by Ian Mulheirn on Jan 19th, 2012

Tony - you know where all the bodies are buried on this one... Thanks for your comment. The old Children's Tax Credit is an intriguing idea, but ChB is claimed by the mother so how can HMRC taper someone else’s income to recover it? And how could it identify them as a couple without a joint tax or joint ChB claim?

Posted by Tony Orhnial on Jan 20th, 2012

Ian - thanks. What bodies? I agree with both your objections: on the first, that's why I suggested some kind of election; and, on the second, some form of joint identification arises whatever scheme you adopt to withdraw CB from higher earners, whether or not you taper it, doesn't it? Really messy whatever you do: what price "simplification"? Tony