UK tax system tightens the screw on ‘squeezed middle’, warns major new report from social policy charity

CARE is publishing its fifth annual review by independent consultants of the taxation of families – The taxation of families 2010/11. This is one of the most comprehensive reviews of the tax burden on families that anyone has yet made.

Like its predecessors, it examines the tax burdens on various households, and compares the position of families with that of taxpayers without family responsibilities. It includes comparisons with families in other OECD countries. Whereas previous reviews have focused mainly on families with an ‘average’ wage, this year’s looks at incomes ranging from 50% to 150% of an average wage.

The report’s key conclusions are:

• Politicians who have warned of the additional burdens faced by the “squeezed middle” have a point. Commonly taken to mean families with children on incomes between £20,000 and £45,000 a year, this new analysis suggests they are right to be feeling the pinch. It says there has been a gradual shift in the tax burden from single people and others without children to middle income families with children.
• Tax as a percentage of income paid by a one-earner married couple with children on an average income has doubled since the mid-1960s as part of a gradual trend in which tax reliefs such as the married couples allowances and child tax allowances have been phased out. But low income families have seen their tax bills fall.
• Increasing the tax threshold is not a cost efficient way of helping the least well off middle income families, many of whom will be basic rate one-earner couple families. Most of the benefit of a threshold increase goes to taxpayers in the top half of the income distribution, many of whom will be in two income families and/or without family responsibilities.
• A transferable allowance, as envisaged in the Coalition Agreement, would be a good way of reducing the tax burden of those families whose budgets are under the greatest pressure. It would not involve abandoning independent taxation. It would be a cheaper option than threshold increases, and would result in a more equal sharing of the national tax burden. 70% of the benefit of transferable allowance would go to families in the poorer half of the population. It should be confined to married couples.
• There has been a lack of consultation about the withdrawal of child benefit from households with a higher rate taxpayer. The report demonstrates that, because of the failure of the tax system to have regard for family responsibility, the withdrawal of child benefit from those just inside the higher rate threshold will actually have the effect of pushing some families already in the lower half of the income distribution further inside and take others into the lower half of the income distribution for the first time. In the House of Commons on 6 March 2012 the Chancellor of the Exchequer said: “I think it is fair to ask those in the top 15 per cent of the income distribution to make a contribution to the fiscal consolidation.” If that is his intention, then a measure which will adversely affect families in the bottom half of the income distribution is exceptionally badly targeted. The report also points out that the proposal is likely to discriminate against marriage because of the administrative difficulties of withdrawing benefit from many cohabiting couples.
• The switch from tax credits to Universal Credit should reduce child poverty and the couple penalty for low income couples, but many families will still find the return from paid work very low. A quarter of all families seem likely to face an effective marginal rate of over 76%, much higher than in any other OECD country. The loss of passported benefits and reductions in Council Tax Benefit could make that rate even higher. If a transferable allowance were introduced, it would reduce the marginal rate for middle income families and improve the return from work. Some families would see their marginal rate reduced from 76.2% to 32%.

In a comment on the report, Nola Leach, chief executive of CARE, said: “This report demonstrates clearly that the United Kingdom is out of step with its international counterparts in the way it taxes families.

“Concern about the plight of the “squeezed middle” is entirely valid. The detailed analysis in the report shows that single-earner middle income families with children, earning around the median national household income of £34,ooo a year are facing a gradually growing tax burden compared with single people and two-earner families.

“This is because the UK taxes people on an individual rather than a household basis and because tax reliefs such as the married couples allowance have been phased out. Our tax system takes no account of having many dependants (such as spouses and children) rely on a single wage.

“The most recent proposal for an increase in the income tax threshold to £10,000 would not, as is commonly supposed, help hard-pressed middle income families. Most of the benefit would go to taxpayers in the top half of the income distribution and widen the growing gap between two-earner families and their one-earner neighbours.”

These conclusions are based on the report’s key findings:

• The burden on UK taxpayers without family responsibilities is not out of line with that in other countries, or with what it was in the 1960s. Nor does the tax burden on two income families seem to differ much from that in other countries. The tax burden on very low income families compares favourably with the OECD average.
• However, one-earner families on a middle income pay much more. In 2010 (the latest year for which figures are available) a one-earner married couple with two children and an income of £35,000 had a tax burden that was 52% more than the OECD average. At £26,000 (close to the median wage), the family paid 85% more than the OECD average.
• The tax burden on that family was twice what it would have been in the 1960s. This is because in those years there was a married tax allowance and child tax allowances on top of the (comparatively low) threshold.
• As well as paying more tax, these middle income families face an effective marginal tax rate of over 70%. No other comparable country has a marginal rate on middle income families as high as this. Canada (58%), Australia (55%) and Italy (53%) are the only other OECD countries with rates above 45%. The OECD average for this type of family is 39%.
• The unfair treatment of some families is evident from the position of different households in the distribution of income. Pre-tax income is a poor guide to how well off taxpayers are, because it takes no account of the number of adults or children in the household.
• The failure by successive governments to take the number of people in a household into account when making tax changes explains why the tax burden on some families has been allowed to rise much faster than that on other households, why the tax burden on these families is often much higher than that in other countries, and why some families on low and middle incomes are now so hard pressed.
• Except at the lowest incomes, one-earner families are much lower in the income distribution than singles and couples without children. A single person without dependents earning around £34,000 is in the ninth decile (i.e. he or she would be better off than between 80% and 90% of the population), whereas a single one-earner married couple with two children and the same pre-tax income is in the fourth decile (i.e. between 30% and 40% in the distribution).