A 'tax trap' could be on the horizon for tens of thousands of UK families. An expert has issued the warning saying that effective tax rates of at least 80%, and potentially as high as 96%, could be on the cards for some households in a benefits double-whammy.
This week, the Mirror reported that as the cost of living rises, around 50,000 families will be eligible for Universal Credit (UC) - despite one member earning over £50,000. It said that this will lead to a 'messy' situation where their UC and child benefit are both being withdrawn at the same time as they earn more money.
Of course, there will also be deductions for income tax, National Insurance, student loan repayments and pension on top of that. Think tank the Resolution Foundation warned this means that combined, between 80p and 96p of every extra £1 these people earn will never reach their bank account.
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News on the 'tax trap' gets worse. While the think tank says 50,000 families are currently in this trap, it estimates that around 90,000 could be caught up in it by 2030 as income tax thresholds are frozen.
The Resolution Foundation admits 'some may be surprised' that a family with a £50,000 earner could still be claiming UC, and 'this isn’t, of course, the typical position'. However, it adds: “For those with high housing rents, or with significant childcare costs, it is perfectly possible."
UC is a Government payment that is designed to help with living costs for those on a low income, out of work or who cannot work. Under UC, claimants lose 55p of benefits for every £1 they earn over a certain threshold.
Changes to the child benefit scheme mean that parents must may back 1% of their child benefit for every £100 they earn over £50,000. Once they hit £60,000, parents are not allowed any child benefit at all. The system has been criticised by many MPs, who point out a couple who each earn £45,000 get full child benefit, but a single parent on £60,000 gets no child benefit.
According to the think tank, the earning rules will lead to a collision between the two systems, which it warns has led to the 'highest marginal deduction rates in the UK'. It is 80% for families with one child, 83% for those with two children, and 87% for three children. Once student loan repayments and pension contributions are factored in, the rates could rise as high as 96% for three-child families, the think tank said.
Karl Handscomb is a senior economist at the Resolution Foundation. The expert said: "Freezing the child benefit threshold for over a decade has led to marginal tax rates rising to over 55% for 600,000 families.
"50,000 families will face tax rates of between 80% and 96%, where they are also seeing their UC 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."
The foundation did offer up some solutions, saying that the Government could raise or withdraw the child benefit withdrawal threshold. However, such a move would likely cost the Government up to £4billion. 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.
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 UC 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 eight million vulnerable."
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