The Citizen’s Income Trust has suggested replacing Child Tax Credits and Child Benefit with a higher flat rate Child Benefit and merging the income tax-free personal allowance, the National Insurance-free Lower Earnings Limit and Working Tax Credits into a Citizen’s Income.
These proposals have been criticised on the basis that Working Tax Credits include a Childcare Element to subsidise childcare costs (registered nursery or child minder), which are supposed to be targeted at lower earners.
This article addresses those concerns (the Childcare Element of working tax credits is only four per cent of total Tax Credit payments, and only one-quarter of total government subsidies for childcare costs) and looks at how these overlapping subsidies could be merged into a single simplified and harmonised system.
First let us look at the bigger picture.
How many children are affected?
According to the population pyramid, there are nearly 800,000 children in each year cohort 0 up to 5.
|Age 3 and 4, registered nursery or child minder||859,000|
|Age 2, registered nursery or child minder||592,000|
|Sub-total ‘paid for’ childcare||1,451,000|
|Age 4, in a reception class at a state primary school||549,000|
The cost of children in a reception class forms part of the education budget and is largely outside the scope of this article, which focuses on the 1,451,000 receiving ‘paid for’ childcare.
Table 2: Average childcare costs before subsidies
|Nursery or primary school||Child minder|
|Child aged 0 or 1||£/week||£/week|
|Child aged 2, 3 or 4|
|After school club 15 hours||48|
|After school pick up||64|
The costs in London are 50% higher
Table 3: Total government spending on the various schemes 
|£m/per year||£m/per year|
|Free Early Education aged 3 and 4||2,400||2,400|
|Free Early Education aged 2||800||800|
|Working Tax Credits/Childcare Element||1,200||1,800|
|Employer Supported Childcare||800||400|
|Tax free Childcare||0||1,000|
Table 4: The number of children eligible to claim in each category
|Free Early Education aged 3 and 4||859,000||859,000|
|Free Early Education aged 2||250,000||250,000|
|Working Tax Credits/Childcare Element||745,000||745,000|
|Employer Supported Childcare vouchers||860,000||430,000|
|Tax free Childcare||0||500.000|
This compares with 2,000,000 children from Table 1. The bulk of the overlapping claims relate to Free Early Education.
The simple average planned cost/value per child is the total annual cost of £6.4 billion from Table 3 divided by 1,451,000 children in ‘paid for’ childcare from Table 1, which is £85 per child per week.
As mentioned, there are many children for whom parents claim Free Early Education as well as one of the other subsidies. The three main other subsidies are largely mutually exclusive. This can be represented as a flowchart:
Please note: the figure of £15,000 for household earnings is very approximate. The exact cut-off point for any individual household will depend on that household’s composition and parents’ working hours.
The various schemes in more detail and their average costs per child per week
Free Early Education –average cost/value
Each child is nominally entitled to 15 hours per week free care for 38 weeks a year @ £5.49 per hour, an average of £60 per child per week.
Free Early Education – children aged 3 and 4
This is a non-means tested, non-contributory, non-taxable and largely non-conditional benefit. It has the largest caseload and the highest cost. It has been criticised for simply pushing up childcare costs because of barriers to entry, meaning that childcare providers simply charge higher fees, but this can be said of all such schemes apart from a free place in a reception class at a state primary school.
In practice what happens is that local council pays registered providers a total of £3,129 per child per year, which the provider deducts from their charges. Where the hourly rate is less than £5.49, the provider simply credits the surplus against the charge for hours in excess of 15 per week. Where the hourly rate is more than £5.49, the parent has to pay the difference.
Free Early Education – children aged 2
This is a conditional benefit.
A two-year-old will be eligible for the same funding (15 hours @ £5.49 per week for 39 weeks a year) if their parent(s) claims any one of the following:
- Income Support/Income-based Jobseekers Allowance
- Income-related Employment and Support Allowance
- Child Tax Credits or Working Tax Credits and have an annual gross household income of no more than £16,190
Working Tax Credits/Childcare Element
The average cost/value per child per week is £28 as explained below.
This can be claimed by single parents who work at least 16 hours a week or couples who both work at least 16 hours a week and who spend money on registered or approved childcare.
The official upper limits of £175 for a household with one child or £300 for two or more children are nigh meaningless. The eligible amount for which a parent can claim is actual nursery costs minus Free Early Education payments minus Employer Supported Childcare vouchers multiplied by 70%. The actual claim is then abated by 41p for every £1 of gross wages over the threshold of £6,420.
Official statistics show that 93% of household claims are for total weekly costs of £160 or less and the official average amount paid out is £29 per child.
Table 5: Typical eligible amount: single parent with both children in full time childcare @ £180 per week for 48 weeks a year
|Actual costs (2 x £180 x 48 weeks)||17,280|
|Less Early Years Education payments (2 x 15 x £5.49 x 38 weeks)||-6,258.60|
|Net actual costs||11,021.40|
|Multiplied by 70% = eligible amount||7,715|
Table 6: Typical actual benefit after Working Tax Credits withdrawal
|Gross wages||Income over threshold||Amount withdrawn||Net payment per child per week||Per child per week|
|A = gross wages||B = A – £6,420||C = B x 41%||D = £7,264 minus C||E = D¸52¸2|
Please note: this article assumes that Child Tax Credits and Child Benefit are replaced with a much higher Child Benefit of around £56 per child per week and thus that Working Tax Credits withdrawal applies only to the Working Tax Credits/Childcare Element
Employer Supported Childcare vouchers
The average cost/value per child per week is £19.
Under a scheme introduced circa 2003, any employee could receive vouchers with a face value of £55 per week (regardless of the number of children) tax free by waiving £55 taxable salary (a salary sacrifice). The employee’s gross pay goes down by £55 per week, saving £18 per week in PAYE (income tax and Employee’s NIC at 32%).
This benefit is conditional on being in work and since 2011 is quasi-means tested. Parents/employees paying higher or top-rate tax had their allowance adjusted so all taxpayers have roughly the same maximum tax saving. The limits are:
- Basic-rate (20%) taxpayer: £55/week voucher, max annual tax/NI saving £930.
- Higher-rate (40%) taxpayer: £28/week voucher, max annual tax/NI saving £630.
- Top-rate (45%) taxpayer: £25/week voucher, max annual tax/NI saving £590.
In theory, a parent claiming Working Tax Credits/Childcare Element can also receive these vouchers, but it is a very marginal calculation. The PAYE saving is £18 per week but the eligible amount is reduced by £55 x 70% = £38. In turn, the amount of the abatement goes down by 41% x 55 = £23, so the net gain is £18 – £38 + £23 = £3. In some cases, parents claiming both can suffer a small net loss.
The scheme has been modified several times since inception and was closed to new entrants since the introduction of Tax Free Childcare in Autumn 2015.
Tax free childcare
This supersedes Employer Supported Childcare vouchers, although existing Employer Supported Childcare voucher recipients will be able to continue to receive them in the run off period.
To qualify, a single parent or both parents in a couple have to be in work, earning just over an average of £100 each a week and not more than £100,000 each per year. Tax Free Childcare cannot be claimed if the household is also claiming Working Tax Credits. Vouchers with a face value of up to £10,000 per child can be acquired for 80% of the face value and used to pay for childcare costs.
The maximum saving per child per week is £38. In most cases this will be a larger saving than the superseded scheme Employer Supported Childcare vouchers, unless only one parent in a couple is in work (saving £930 a year as against nothing) or a couple are both in work, pay basic rate tax and pay less than £194 per week (net of Early Years Funding) for childcare for one child.
Around two-thirds of 4 year olds are in reception class at a state primary for free. I assume that the other one-third do not attend because there is no reception place available for them or because their working parents require care until later in the afternoon/evening and send them to a nursery or child minder for which they claim the Free Early Education payments.
The value of Free Early Education vouchers is £60 per child per week.
The cost/value of the three mutually exclusive schemes in the bottom row of the flowchart per child per week is as follows:
Working Tax Credits/Childcare Element – maximum £51, average £28.
Tax Free Childcare – maximum £38, average unknown but less than £38.
Employer Supported Childcare – maximum £36, average £19.
So the average total claim per child per week is between £79 and £98.
Would it not make sense to harmonise the rates and increase the Free Early Education vouchers to £85 per week x 48 weeks a year for all 2, 3 and 4 years olds?
The total number of children in ‘paid for’ childcare is 1,451,000 (from Table 1). If each receives £85 per week in vouchers for 48 weeks a year, the total cost/value would be £5.9 billion. This represents a saving of £0.5 billion over the £6.4 billion expenditure forecast the House of Lords Select Committee from Table 3.
Winners will not just be those who would receive more per child per week, but all parents whose lives have been made much simpler and can now plan ahead and budget more sensibly.
Clearly, some would receive less in benefits than under the current schemes:
- Single parents on the minimum wage who would lose up to £26 per child per week in Working Tax Credits/Childcare Element,
- Parents with children in a reception class who receive claim for after school care,
- Parents in London, where childcare costs are 50% higher than the rest of the country, and
- Parents of children aged under 2 who currently claim for childcare costs.
I estimate that half a million children would be affected and the average shortfall is £20 per child per week, so the saving of £0.5 billion could be paid out as a transitional benefit of £20 per child per week for existing claimants until their children reach normal school age.
A slightly more radical proposal would be to spend the £6.4 billion on providing nursery classes at state primary schools for children aged 2 to 4. This will take time to implement but simplifies things for parents and does not have the unintended consequence of pushing up childcare costs.
 Total from House of Lords Select Committee, individual items adjusted for other sources to reconcile with their sub-totals.