Lies, damn lies and Childcare Tax Credits

I was reading an article by the Low Incomes Tax Reform Group this morning, which reminded me how 'misleading' the following propaganda is:

From HMRC's Q&A
Q: "Can I get help with the costs of childcare if I’m working?"
A: "The childcare element is worth up to 80p in tax credit for every £1 a week you spend on approved childcare".

Woah! "Up to" sounds good, doesn't it? But you need to be earning the income first to generate the net income to pay for a nursery. Let's assume that one parent is in work and earns £20,160 per annum, the PAYE deducted is £4,562, leaving net employment income of £15,598. The other parent is at home with two young children and the household also qualifies for £3,628 in Tax Credits per annum.*

Now let's assume the non-working parent decides to go back to work and puts the two children into a nursery costing £300 a week in total** (the maximum eligible amount for Tax Credits). That parent also finds a job paying £20,160, so knows that the tax deducted will be £4,562 and the net income will be £15,598, just enough to pay for the nursery places. (Let's assume that the parent who returns to work finds a job locally, so travel costs aren't an issue, and is happy to break even on the deal because the kids are learning to socialise and the parent knows that long career breaks are bad for future earnings potential etc.)

The parents then resubmit their Tax Credit claim, and, ignoring the income disregard which shelters them for up to a year, they are now entitled to Tax Credits of £8,186.

That's £4,558 extra Tax Credits per annum*, or about 30% of their actual nursery costs. Mathematically it is impossible to get anywhere near 80%, because the Tax Credits are withdrawn at 39% of your gross income above a certain threshold, on top of 31% PAYE.

To put it another way, let's assume that:
1. The £300 weekly upper limit for childcare costs for two children and also the actual nursery fees for both children go up by £4 a week, and
2. Coincidentally, one parent gets a pay rise which is just enough, after deducting PAYE and adding additional Tax Credits, to cover the extra £208 nursery costs. That equates to a £140 per annum pay rise, minus 31% PAYE is additional net employment income of £99.

The potential extra tax credits of £166 (£4 x 52 weeks x 80%) are reduced by 39% of the extra £140 gross income, i.e. £166 is reduced by £55 to £111. That's 53% of the additional childcare costs.

Check - £140 minus £43 PAYE plus £111 tax credits = £208.

The story continues in my next post.

* And £1,634 in Chid Benefit, so PAYE paid less Tax Credits and Child Benefit is a net payment of £700 to the household. So a £10,000 tax-free personal allowance and a transferable non-working parent's allowance of £10,000 could replace the whole morass, for example.

** After deducting Early Education Funding where applicable, of course.

*** Ironically, those extra Tax Credits are pretty much equal to the PAYE deducted from the now working partner's salary.