The number of parents grouping just under the £100,000 ‘tax trap’ salary in order to maintain access to free childcare will “grow dramatically”, tax researchers have warned, while some households continue to claim the benefit despite earning above the income threshold.
The Centre for the Analysis of Taxation (Centax) has estimated that there could be nearly 12,000 parents deliberately holding their income below the £100,000 threshold in order to get free childcare.
This would be a rise of nearly 11,000 from 2022 when government data showed about 1,100 parents of three and four-year-olds holding their income below income of £100,000.
Former Chancellor Jeremy Hunt introduced a state-funded childcare scheme in March 2023. It determined that parents earning less than £100,000 per year altogether would be able to access 30 hours per week of childcare for under five-year-olds.
The government is reviewing the success of Hunt’s flagship policy. The policy, which was adopted by Labour as part of an effort to get more parents into work, costs the government nearly £5bn a year.
Centax analysts highlighted that one third of parents earning between £100,000 and £120,000 claimed and received free childcare through a loophole in the system.
This has come as parents can tell officials that their expected adjusted net income is below £100,000.
Tax trap has cost-free ‘solutions’
Centax said the system should be based on actual rather than projected income, which could also be raised to £111,000 at “no additional fiscal cost”.
Researchers also suggested that a removal of the threshold for free childcare entitlement would cost about £640m in 2030, thereby removing the tax trap faced by some high earners.
“Our analysis shows the childcare cliff-edge stands to grow dramatically by the end of this parliament, but there are solutions available to the government – including the opportunity to prevent parents whose incomes exceed the threshold from claiming free childcare,” Arun Advani, Centax director and University of Warwick economics professor, said.
His colleague at Centax, Jack Pepin-Hall, said that the system should be changed to be “fairer” for all higher earners.
The £100,000 tax trap has long beleaguered workers who face a higher effective tax rate than earners on over £125,000.
The tapering of the £12,570 tax-free personal allowance for those earning between £100,000 and £125,000 means that these earners already face a 60 per cent effective tax rate. For every £2 earned above the £100,000 threshold, the government reduces the allowance by £1.
This is on top of the free childcare trap and the extra payments paid on student loans. Economists have widely said this has partly stunted wage growth as workers have fewer incentives to push for higher salaries.