We are now one year away from the planned launch date of tax-free childcare, a scheme that will allow many of the wealthiest families to save up to £2,000 a year in childcare costs. But what will the new scheme mean for the average earner? And how can Labour ensure that the scheme works best for its constituents should they win the 2015 general election?
First, some context is needed. Tax-free childcare will be a new scheme of childcare support for parents. Currently, parents have access to childcare vouchers, which are a hugely popular employee benefit that was introduced under the last Labour government. These allow for basic rate taxpaying families to save up to £1,866 a year on childcare costs. Ostensibly, this new scheme, which will eventually replace childcare vouchers, will provide parents with 20 per cent of their childcare costs up to a cap of £10,000 per child. This means some families will get £2,000 of childcare costs covered by the government.
However, there is a catch. To put it bluntly, not many parents spend £10,000 a year per child on care costs. According to the Department for Education’s early years survey, which asks parents to breakdown how much they spend on childcare, the average amount spent on day nursery provision per year is £5,030. If a two parent family, paying the basic rate of tax was spending this much on childcare, then they would only be eligible for £1,006 a year through tax-free childcare. Under childcare vouchers, they would be receiving up to £1,866. Indeed, to get more out of tax-free childcare than vouchers, this family would have to be spending over £9,330 a year on childcare costs for their child.
Unlike childcare vouchers, tax-free childcare is regressive. Under vouchers, the value of deductions you can make from your pre-tax salary is dependent on the rate of income tax you pay. Basic rate taxpayers can sacrifice more from their salary, and therefore save more than their wealthier counterparts. As we have seen above, the amount parents will save under tax-free childcare is dependent on their childcare costs. It is therefore likely that wealthier parents who can afford to pay for more expensive childcare will gain most from this new scheme.
There are also some significant operational differences between childcare vouchers and tax-free childcare. Childcare vouchers benefit from being operated through parents’ employers. This reduces the risk of fraud and error to a negligible level, and ensures nurseries receive the funds on time on a regular basis. Conversely, tax-free childcare will be dependent on parents paying into a Government account, and on HMRC to top-up the account with 20 per cent of its value. This will increase the likelihood of delays in the system, as the scheme is dependent on parental finances and HMRC’s IT systems. Moreover, parents will have to re-confirm their eligibility quarterly with government, and should they fail to do this successfully, they could be subject to significant financial penalties.
Ultimately, many of the stated objectives for tax-free childcare can be achieved through a much simpler and cheaper modification of the existing voucher scheme. Making vouchers available through a right-to-request mechanism would improve access, as would extending the scheme to the self-employed. To date, over a million people have advantaged from childcare vouchers, and these changes would see the support available through this extremely popular employee benefit reaching more and more people. It would also counter some of the major risks associated with tax-free childcare – of increased fraud and error, and of building a new and complicated IT system.
There is a lot for parents to consider when choosing between tax-free childcare or whether they should stick with childcare vouchers. For Labour, it will be necessary to objectively review tax-free childcare, and put serious consideration into what changes can be made to the scheme so that it provides support to those families that need it most.
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Paul Bartlett is head of employee solutions, Grass Roots Group
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