Monday, January 23, 2012

No child benefit for higher rate taxpayers - A political car crash in slow motion

Its been a while since the Conservatives announced that families where one parent is a higher rate taxpayer would loose child benefit payments. Since then, despite some signs from David Cameron that the Conservatives were about to row back on the policy, the chancellor and others have indicated it is still the government's intention to stop families with a higher tax paying parent from claiming child benefit.

Watching this unfold is like watching a political car crash in slow motion. There has been every opportunity to turn off the road, and no shortage of warning signs of the trouble ahead, but the politicians journey continues apace towards a catastrophic collision with the brick wall representing the reality of a policy rapidly approaching its intended introduction date that is utterly and inexcusably dreadful.

Its not so much that a Conservative lead government is putting narrow political imperatives to be seen to be kicking high earners above rational policy making - although that is obviously a problem, it is that the policy is so deeply, obviously and in fundamental respects flawed. To be more specific, the policy makes the child benefit claims of one party dependent on the tax status of another, relies on an eligibility test for benefit that can only be carried out some time after the benefit needs to be claimed, has a horribly complex effect on marginal tax rates (including marginal rates in some instances over 100%), and is desperately unfair on families with only one wage earner.

To illustrate the problems better, here is some extracts from an email I wrote to an MP in the Chancellor's treasury team.


"what has been touted as an administratively simple way to generate £1bn in revenue looks actually to be deeply flawed. I'm not particularly interested in a response - certainly not of the political justification type - just hope you can look into the issues raised below and try to avoid a nightmare.

I think there are three intrinsic features of the proposed scheme that will cause problems:

1) The plan will introduce a discontinuity in effective marginal tax rate, including a marginal rate of more than 100% around the threshold.

The size of the impact, potentially £2k or more on post-tax income will make tax planning essential for those near the threshold. At the margins, tax could completely drive economic decisions, such as whether or not to seek a promotion, or to work harder, and act as a strong disincentive to economic activity, which can't be a good thing.

There will need to be many complex anti-avoidance rules around artificially reducing income for those just above the threshold or in the first year of the change, and opportunities for professional advisors to have a field day, at a time when the tax system is crying out for simplification.

The last time something with an effect on marginal tax rates as crazy as this was tried was Labour's anti-avoidance rules around restrictions on pension tax relief for high earners. The system was ludicrously complicated, understood by very few taxpayers, slated as a complete dogs breakfast (e.g. http://www.economist.com/node/15580725), and rapidly reviewed. The child benefit proposals probably affect a much larger group, who are much less able to deal with the financial consequences than those in the £130k+ income bracket.

2) The tax charge on one person could depend on the child benefit claims of another.
This makes anti-evasion and anti-avoidance measures extraordinarily difficult to frame and enforce. Some habitual benefit claimants are already adept at disguising from the authorities when they are in a relationship or living with someone who actually earns some money if it affects their benefit. I thought the party was trying to move away from this type of nonsense, not introducing the regime to an entirely new part of the population.

For example:
One assumes where parents live apart/are no longer in a relationship - the higher earner cannot possibly have to repay child benefit, as they won't necessarily even know if it is being claimed.

This will leave a whole range of opportunities for some people to avoid the charge. If parents separate during the year - will subsequent child benefit claims be clawed back? How will the authorities determine who is in a relationship (if they aren't married)? What if a family lives together, but owns two homes - with one parent registered at each - how does the government intend to police when repayment of child benefit is required in this instance, or will it just be an honesty box?

Why is the party increasing the 'couple penalty', rather than reducing it?

3) The test for the trigger can only be performed at the end of the tax year, at which point tax is assessed on the benefit claims during the period, so it will be unclear what the tax effect of an action might be until some time afterwards.
This increases the burden of tax planning, and could result in some nasty cashflow problems around tax return time for people with already stretched financial resources. There are two problems scenarios, failing to claim child benefit then suddenly losing income, and claiming child benefit and unexpectedly hitting the threshold. How would you respond to the following scenarios created by these plans in a surgery situation:

- I thought I was going to be under the limit, but I forgot about the dividends on a few shares I own. If I had of remembered, I would have asked my employer to pay me less in March(!!!), but that £500 now means the taxman wants to reclaim £2,000 from me for the child benefit claimed by my wife, and I can't find that type of cash - I'm the only earner, my wife stays at home looking after the children.

- My husband was earning £50k a year, but he lost his job just before Christmas. The Chancellor said it was sensible for me not to claim child benefit, so I didn't, even though there will no longer be a higher rate taxpayer this year. Now we are in real hardship, and they won't let me backdate a claim for child benefit.

This makes a nonsense of the Chancellor's claim that higher rate taxpayers shouldn't claim child benefit. At the very least they would be advised to claim the benefit and put it in the bank.

The points above are mostly applicable to people near the margins, but looking at the policy politically, there will be a major hit on all higher tax rate families. Working people, particularly in London and the South East have been absolutely hammered under Labour - they pay higher marginal tax rates, higher stamp duty, and I think the reason why we have a Conservative prime minister is that in constituencies across the south voters like this were fed up with a bloated and ever increasing state, squandering taxpayers money and mortgaging their children with its borrowing, leaving them picking up a grossly disproportionate share of the bill. If you wanted to devise a magic bullet carefully targetted to do maximum damage to Conservative core support, I don't think you could do much better than attacking families with one parent working on the high tax threshold, the other staying at home looking after children."

The email was acknowledged with a response indicating that the points would be considered. But that was in 2010 shortly after the policy was first announced, and still the car moves on towards the brick wall.

As someone who was a public face for the Conservatives in Cambridge, I know several people who have raised concerns about the effect of this proposed policy with me - in an 'apoplectic with rage' kind of way. The response if the policy is actually implemented doesn't bear thinking about for the government.

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