Observations

Child benefit withdrawal will mean some worse off after a pay rise

Date: 04 October 2010
Authors: Mike Brewer and James Browne

Chancellor George Osborne announced today that child benefit will be withdrawn from families containing a higher-rate taxpayer from April 2013. This move is expected to affect around one-in-six (1.2 million) families with children, and save the Government £1 billion per year.

The Government intends to claw back the amount of child benefit paid to a family from higher-rate taxpayers through the income tax system. Higher-rate taxpayers who receive child benefit, or whose partner receives child benefit, will have to make additional payments through income tax self-assessment equal to the amount of child benefit they receive.

This form of means-testing has a number of implications.

First, child benefit will continue to be paid in full to all who claim it. Instead of reducing the payment of child benefit, the Government's proposed reform would increase tax payments by those on high-incomes; in a stereotypical couple with children where the higher-rate tax-payer is a man, and the woman receives child benefit, then the Government's proposed reform would mean that the father effectively pays for the mother's child benefit.

Second, some may think the proposed scheme is unfair because child benefit is withdrawn where an individual in a couple is a higher-rate taxpayer, regardless of the joint income of the couple. To give an extreme example, the Government's proposed reform implies that a one-earner couple with an income of £45,000 would lose all their child benefit, but a much better-off couple where each has an income of £40,000 would keep all their child benefit.

A third implication, and the most serious from an economic point of view, is that this reform seriously distorts incentives for some families with children. In particular, adults with children whose income places them below the higher-rate income tax threshold might be find themselves considerably worse off from a small rise in income. This is because such a family would effectively lose all their child benefit as soon as the adult's income rose just above the higher-rate income tax threshold.

A family with two children currently receives £1,750 a year in child benefit, so a one-earner couple with two children with a gross income between £43,876 and £46,850 would be worse off than if their income were £43,875. Equivalently, a one-earner couple with an income of £43,875 would need a pay rise of £2,975 or more to ensure they were no worse off after paying income tax and national insurance and losing child benefit.

The Government might argue that using the income tax system to means-test child benefit is cheaper for it to administer than devising a brand-new means-test, and can be done more quickly. But there is already a system of means-testing support for families with children through the tax credit system, and the Government could have straightforwardly reduced spending on child benefit by combining it with the child tax credit in some way. Using the means-test in tax credits could be considered fairer to single earner couples, and would not distort incentives so dramatically. But this proposed means-test of child benefit might be just a stop-gap measure; Iain Duncan Smith, the Secretary of State for Work and Pensions, said today that his proposed universal credit system - which he hopes will be fully in place by the end of the next Parliament, and would replace all existing benefits - would taper away child benefit 'more fairly' from higher income families.