Suggested alternative to treating tax credits as NRP's income

Reminder - "tax credits" & "reduced rates"

The reformed scheme has a protection mechanism for low earners. It has the concepts of a "flat rate" (£5) for people earning up to £100 net per week, and a "reduced rate" (lower percentages than 15% / 20% / 25%) for people earning from £100 to £200 net per week. So someone earning (say) £150 per week with 1 child pays £18 instead of the £23 which would be paid if the "basic rate" (15% formula) operated at this income level.

When low earners have a family, they will probably be entitled to WFTC, and the way the reformed scheme then treats WFTC as income for child support purposes means the NRP will pay more than the flat rate or reduced rate anyway. The reformed scheme is saying "yes, we've protected low earners - now we are going to get the money back"! It gives with one complication, and takes with another complication.

The "reduced rate" has its own problems. For example, the marginal rate of increase of child support as net income increases in this range is actually 25% / 35% / 45% of net income. The marginal rate of increase of all deductions (including tax and NI) can be as high as about 65%. These reduce the incentive to work harder - there will be a temptation for people to say "stuff it, why bother to try to earn more?"

The attempt to put WFTC into the formula makes matters much more complicated, and probably even worse.

Suggestion

The rule could be:

Don't attempt to treat tax credits as net income. (This would apply to all current & future tax credits).

But if the household receives any tax credits, operate the "basic rate" (15% / 20% / 25%) at all income levels. (So ignore the concepts of "flat rate" and "reduced rate" in these cases).

Then if & when tax credits become available for all low earners, even those without a family (perhaps 2003) - remove the concepts of "flat rate" and "reduced rate" for low earners from the child support formula entirely!

In other words, try to make the whole scheme vastly simpler than it is. The positive way of presenting this ("spin"!) would be: "the child support formula is 15% / 20% / 25% - but if the household doesn't receive a tax credit, there is a protection mechanism for low earners based on a "flat rate" or a "reduced rate"".

Consequences of this suggestion

The tables below compare what happens in the Case Studies as a result of the 2000 Act with the Alternative suggested here. They show the child support paid and the household's retained money.

Case Study 1 - Removing the incentive for the NRP to work

The child support liability is £15 for both cases where the NRP earns the same - an entirely predictable amount.

The incentives for the NRP to stop working are reduced (although not eliminated). If the NRP doesn't work:

• the household would be £9 worse off, not £7 worse off, compared with the case where both work
• the household is £15 better off, not £25 better off, compared with the case where it is the new partner who doesn't work

Case Study 2 - Bizarre child support changes as the new partner's income changes

The child support liability is a predictable £18 at all of stages 2 and 3 and 4 - the NRP earns the same throughout.

This is more predictable for the PWC and there is less incentive for the NRP and partner to play games.

Case Study 3 - No incentive for the NRP to earn more

The child support liability increases close to what would be expected - by about £3 for each extra £20 earned, close to 15% of the extra. (Note the immediate leap in child support when Anne moves in - this could be a disincentive for her to move in!)

The household retains about £6 or so of each extra £20 earned - not a lot, but better than £0 or £2!

Summary

It would not be necessary to know who is receiving the tax credit, or the earnings of anyone other than the NRP. There would be no "political" argument about whether component X (for example disabled child tax credit) or component Y of the tax credit should or should not be included. The new partner wouldn't be suspicious about her earnings being used. The PWC couldn't make predictions about the new partner's earnings based on the amount of child support received. In all, it would be much less intrusive.

This hasn't made everything perfect. But the residual problems, for example the incentive to become a single-earner household, are those introduced by WFTC and are not specifically child support problems.

In the long term this would all become simpler, because tax credits would be assumed to be available to all low earners. In the shorter term, it is necessary to know whether the household receives a tax credit. But it is already necessary to know this, and the Inland Revenue can supply the information if necessary.