How the Tax System Fails Families

A family may be paying up to five times as much tax as a single person with the same standard of living.

Families in poverty pay thousands in tax.

A single parent with two children renting a modest house may need to earn £40,000 to have a “decent” standard of living and pay £5,600 in tax.

A family living close to the poverty line pays the same tax as someone whose spouse has an £100,000 income.

Most people assume that income tax is a "progressive tax". The better off you are the more income tax you pay. This is only partly the case because income tax liabilities bear little relationship to how well off the taxpayer is. With two minor exceptions income tax takes no account of family responsibilities. A taxpayer with family responsibilities pays the same income tax as a single person without any dependents or someone married to a high-income taxpayer.

How well off people are depends on a number of factors. The three principal factors are income the number of people the income has to support and housing costs. Most economists say that when working out whether a family is in poverty housing costs need to be taken into account.

The income tax system, which we ave had for nearly thirty years, takes only income into account; it ignores the number of people the income has to support. Couples with two incomes pay less tax than couples with a single income. The result is that income tax liabilities are unrelated to how well off people are and as a result families bear a disproportionate share of the tax burden. Families who are less well off will often be paying more tax than people who are better off. Some may even be paying higher rate tax. Families who are in the less well off half of the population are subject to the High Income Child Benefit Charge whereas others who are in the top 10% of the population may escape the charge.

Case Study

To take the example of Gemma – the young hairdresser in the film – earning £24,000 (a good income in her area) and renting a small two bedroom house. Like so many young people today they haven’t been able to buy their own house, as they haven’t been able to find the deposit.  As a single person without any commitments she was reasonably well off even renting, like her twin Grace, a small house small two bedroom house.  Married with two children under 4 and living in the same two-bedroom house the picture is different.

Gemma and her family do get £73 per week in tax credits, £78 per week in housing benefit and £34 per week in child benefit. The family have £369 to live on. But their disposable income (what they have to live on) is just £22 above the poverty line in 2015/16.  The poverty line will almost certainly be higher in this (2017/18) tax year so the likelihood is that the family is either in poverty or very close to being in poverty even though they have what some might regard as quite a good income. As a married couple the family are paying £2,451 in income tax after claiming the marriage allowance.

Her twin, Grace, as a single person with no children paying rent of £686 per month she has £128 to live on. Her income would have been well above the poverty line. In 2017/18 a single person on £24,000 pays income tax of £2,497 -only £46 more than her married twin.

The highly respected Joseph Rowntree Foundation (JRF) say that this family who are not paying for child care needs £619 per week to have an acceptable minimum standard of living[1]

Some will say that the answer to family’s financial problems is for the non-working parent to go get paid work. This however is not an easy option. If both parents do paid work the childcare costs could be significant, not all of which will be covered by tax credits. Even if the non-working parent earned £11,5000 and as a result paid no income tax, the family would only be better off by only £93 per week as the extra income would reduce their benefits and increase income tax payments because the marriage allowance would no longer be due.  £93 is not much return for 30 hours work at the minimum wage. It does not bring the family’s income up to the £619 the JRF say they need for a decent standard of living. The answer surely is to take the family out of income tax together.

Case Study

To take another example – a bus driver married with three children and owing £1000 because tax credits were over paid after he worked overtime. He earns say £22,000 – £422 a week – a typical income for this type of work where he lives. The family probably would be getting about £140 per week in tax credits and £48 in child benefit. The amount they have to live on after tax, national insurance, rent and council tax was paid will be about £432 per week. This is just £35 per week above poverty line for at 5-person household in 2015/16. They are paying £2100 in income tax – almost the same amount as someone earning £22,000 in London married to an accountant earning a £100,000.

Because the family are getting tax credits they keep only 27p from every extra pound earned – their effective marginal tax rate is 73%. Income tax accounts for 20%, national insurance 12% and loss of tax credits 41%. To clear a £1000 debt the bus driver would need to earn £3,700. If, as may well be the case, the family were in private rented accommodation their effective marginal tax rate would be over 90%, which means that the driver would need to earn £10,000 to clear a £1000 debt.

There is nothing fair about a tax system which levies almost the same tax on an affluent second earner as it does on a struggling family of five burdened with an unrepayable debt which the State has in effect created. If Nigel Lawson’s original proposals for a system of independent taxation had been adopted the bus driver would not be paying any income tax. The income tax system may work well for the Government in that it is relatively easy to administer-and for high-income couples but it does not work well for the bus driver.

However, it is not only families with low incomes who find that the system does not work for them. As the tables below show even families with quite high incomes are adversely affected by the system of taxation that was introduced in 1990. All single income families – both couples and single parent families – have been disadvantaged. Couples who have two incomes are much better placed but even a two -child two -income family with an average  income (after housing costs) will have a tax burden which is 30% higher than that of a single person with an average income. 

The time has surely come when we need to rethink the way in which families are taxed. In the meantime any tax cuts that can be afforded should surely be focussed on families who are bearing a disproportionate share of then income tax burden. These families will almost wholly be in the poorer half of the population when tax and the number of people in the household is taken into account. We need to look at the way countries such as Germany, France and the USA tax families and see if there are any lessons to be learned.

Comparing tax burdens

There are three ways of comparing the income tax burden on households.  One is to look at the income they need to avoid being in “poverty” after tax and housing costs are taken into account. Another, is to look at the income they need for a “decent” standard of living” – JRF call this a “minimum acceptable standard of living”.  The third is to compare the tax burdens on households with an average income after housing cost. The figures will differ from part of the country to another because housing costs will differ.

Income needed to avoid being in poverty

For a household to be out of poverty the Government says its disposable income – the income available for living – needs to be greater than 60% of the median after tax and housing costs are deducted. For a couple with two children the amount needed in 2015/16 (latest available figure) was £347 per week.  For a single person the poverty line was £144 per week. The 2017/18 figures will be higher.

These official figures do not take account of childcare costs[3]. Where these are incurred the income required needs to be increased by these costs; they will only be only party covered by the childcare credit which forms part of the Working Tax Credit or the new Universal Credit.

Rents vary greatly from one part of the country to another. The table below shows our estimate of the gross income required by families in West Dorset for them to have a disposable income high enough to be out of poverty after their housing costs[4] are taken into account together with the income tax payable at that level of income.

Gross Income (and the income tax payable in 2017/18) required for a household paying rent of £658 per month to have disposable income in 2015/16 equal to 60% median 

For a lone parent able to work for 30 hours at the minimum age benefits are sufficient to lift the family income above the official poverty line. In reality this is unlikely to be the case, as childcare costs would normally have to be incurred.

Families who the Government regards as being in poverty in the sense that their free income is below 60% of median are paying thousands of pounds in tax. The family on the poverty line with one child is paying almost £4000 in tax – approaching three times the tax paid by a single person on the poverty line. Depending on how the income is split even some two earner couples may be paying substantial amounts in tax. In general it seems that two earner couples on the poverty line will be paying broadly the same amount of tax as single taxpayer on the poverty line.

For comparison the Table below shows the comparable figures for families in the London Borough of Barnet where we understand the current average rent for a 2-bed house would be  about £1462 per month.

Gross Income (and income tax payable in 2017/18 )required for a household paying rent of £1462 per month to have disposable income in 2015/16 equal to 60% median 

Because rents are higher the income required to lift a family is much higher and so also will be the tax paid. In an extreme case it may even be that a family paying higher rate tax has a disposable income below  60% of the median. All these households on the poverty line are paying thousands in tax.

Income required for a decent standard of living

Another way of comparing families is to measure the gross income need to give a family a “decent” standard of living.  The recent Rowntree Report on poverty says that a couple with two children need s £450 a week to have a basic minimum standard of living. The JRF figures are not comparable with the figures above as the figures in the tables above as JRF figures assume that the households are in social housing paying and that childcare costs have to be incurred where appropriate. The figures in the tables below are derived from JRF “minimum income calculator” substituting a rent of rent of £158 per week for the rent shown.

Gross Income (and the income tax payable ) required for a household to have sufficient disposable income to give it a basic minimum standard of living together with the income tax payable

On these figures, a single adult would need to earn only £17,934 on which the income tax would be £1182 to have a basic standard of living. A single parent with two children incurring child costs would need to earn £39,889 – more than twice as much and pay £5,678 – almost five times as much tax.  A single earner couple with two children and no child care costs needs to earn £33,602 on which the income tax bill would be £4,307 – over three and half times the singles tax.

Income needed for an average standard of living

The Government publishes annually an analysis of household incomes after tax benefits and housing costs are taken into account and adjusts the figures to take account of the number of people in the households and in the case of children their ages. The latest median (2015/16) figures are below:

Couple no children                                          £413

Single no children                                            £240

Single one child aged 2-14                              £322

Single two children aged 2-4                          £405

Couple one child aged 2-4                              £496

Couple two children aged 2-4                        £579

Income needed for an average standard of living

The following table shows our estimates of the gross incomes required (together with the income tax payable) to have an average disposable income and thus an average standard of living on the assumption that housing costs are £686 per month together with the tax paid.

Gross Income (together with the income tax payable in 2017/18) required for a household to have in 2015/16 an average disposable income after rent of £658 per month is taken into account 

The gross income required to give households an average disposable income varies from £25,,654 for a single person and no children to £49,754 for a one- earner couple with two children with the result that the tax burden varies from £2,831 to £8,598. A single earner couple with two children had to earn twice as much as a single person without children to have the same standard of living and pay three times as much tax. Even a two earner couple may have to earn 66% more and pay 38% more tax. Income tax liabilities bear little relationship to how well off taxpayers are.

To Sum Up

The picture that emerges from this data is that the income tax families pay bears little relationship to how well off they are. This seems to be the case for all family types, single parents, one-earner couples and also two-income couples. Even families whom the official Government statistics regard as being in poverty, after housing costs are taken into account, are paying thousands of pounds in income tax. This is particularly true in areas where rents are high and there is insufficient social housing. In other areas this may not be the case for two income families and single parents who are not paying childcare costs. If the poverty line were net of childcare costs some families who are classified as being in poverty would in reality be in poverty and yet paying significant income tax.

Successive governments have attempted to build a system of welfare support for families on top of an income tax system which takes no account of a family’s financial needs. This has proved increasingly costly and difficult to administer and is resulting in anomalies, which would seem increasingly difficult to support.  The question which surely needs to be asked is whether it makes sense to have an  income tax system which requires families who do not even have a basic standard of living to be paying thousands of pounds in the income tax – some of whom will end with income so low that they are judged to be in poverty.

Two exceptions to the General Rule

In general they income tax system looks only at the individual and takes no account of their families. There are, however, two exceptions.

The first is the High Income Child Benefit Charge, which was introduced in 2012. Any one who receives child benefit and has an income of £50,000 or more suffers a tax charge, which reduces the value of the benefit. The value of the benefit is wiped out if the income exceeds £60,000. This Charge applies not only to the individual who receives child benefit, but it applies also if his or her spouse or civil partner or cohabiting partner has an income of £50,000 or more. It is obviously disadvantageous to families.

The second exception is the Marriage Allowance. This does benefit families but it is not focused on families i.e. taxpayers with children. The Marriage Allowance was introduced in 2015 and allows a spouse or civil partner who cannot use their own personal allowance to pass 10% of the allowance it to their spouse or civil partner. The allowance can’t be claimed, however, if the recipient is a higher rate taxpayer. In 2017/18 the allowance is only worth only £230 and only 2.2 million couples have claimed it out of the 4.4 million eligible. The allowance can be claimed whether or not the couple have children. Many of those claiming the allowance are thought to be pensioners. Families who have not claimed the allowance for the current tax year can still do so and can also do so for past years. The allowance was extended in 2017 so that it can now be claimed where a partner has died.

[1] JRF minimum standard income calculator 2017

[2] Households Below Average Income 2015/16, DWP 2017

[3] We understand that the official figures do not take account of child care costs.

[4] In all assumed that the housing costs include rent of £658 per month for a two-bedroom house. The Local Housing Allowance is £593 per month.

[5] JRF Calculator produces a gross income figure of £42,900 on which the tax is £6,050 i.e. approximately 5 times the tax paid by a single with an average wage.   The calculator however assumes that the couple need to incur £155 per week child care costs