Historical Background

  16. The foundations of the welfare benefit system that exists today were laid under the 1945-50 Labour Government. A system of contributory National Insurance Benefits plus means-tested National Assistance was introduced, modelled on the proposals of the Report by Sir William Beveridge.[20] Also in the late 1940s family allowances were introduced for all families with two or more children. Other support for families with children included children's additions on national assistance and national insurance benefits. Taxpayers received child tax allowances to reduce their tax burden. Family allowances were only uprated twice in the period from 1948 to 1967 although child dependency additions paid with insurance benefits and national assistance were uprated more frequently. Child tax allowances were also uprated.

  17. The benefit system established in the 1940s assumed that those in employment would have an income sufficient to support themselves and a small family. In the early 1970s there were major changes in provision for families with children, designed to address the increasing problem of the working poor. The introduction of Family Income Supplement (FIS) in 1971 represented an important step in social security provision. This benefit provided financial support for families with children where the head of the household was in full-time employment but earning a relatively low wage. FIS was a means-tested benefit (based on income, earnings and assets) which was paid for a fixed period (originally six months, later for twelve) regardless of changes in circumstance.

  18. Family Income Supplement was intended originally only to be a temporary scheme. In the year following its introduction the Government published a Green Paper on proposals for a tax credit system which indicated that for members of a tax credit scheme the need for Family Income Supplement would disappear.[21] The Green Paper recognised the difficulties that the overlap between the tax and benefit systems caused for effective family support:

    "The combination of the full tax allowances and family allowances alone results in nine different rates. Nor can it really be said that the differing amounts have a logical connection with one another. As a result, the system of family support is more costly to administer and more difficult to understand than is necessary."[22]

A Select Committee on Tax-Credit was established in December 1972 to consider the Green Paper. The Select Committee reported in June 1973, recommending that the proposed Child Credits should be a cash payment on a universal basis through the Post Office to the mother or whoever had day-to-day control of the child.[23]

  19. It was hoped that tax credits would be introduced in 1977.[24] Following the change of government in 1974, the tax credit plan was shelved and FIS continued. One aspect of the tax credit proposals which did survive was the merger in 1977 of family allowances and child tax allowances into a single benefit, Child Benefit. Child Benefit delivered non-means tested cash help to all families with children, helping those in particular whose income was too low to take advantage of tax allowances.

  20. In 1982-83 the House of Commons Treasury and Civil Service Committee inquired into the structure of personal income taxation and Income Support. Although unable to agree a full Report because of the early dissolution of Parliament for the 1983 General Election, the Committee produced a Special Report to which was attached the Report from the Sub-Committee which had not been fully considered by the full Committee.[25] The Sub-Committee Report covered much of the same ground as this Committee's present inquiry, indicating the long-standing and seemingly intractable nature of some of the problems identified.

  21. Between 1984 and 1986 the then Secretary of State for Social Services, Rt Hon Sir Norman Fowler MP, oversaw a series of reviews of social security provision. The Government's Green Paper following those reviews considered further alignment of the tax and benefit systems, whilst acknowledging the different natures of the systems.

  22. The Fowler Reviews led to the many changes contained in the Social Security Act 1986, which were mostly implemented in 1988 (for example the replacement of Supplementary Benefit by Income Support, the alignment of many rules across the means-tested benefits, the introduction of the Social Fund and reforms to Housing Benefit). Despite suggestions in the June 1985 Green Paper on the Reform of Social Security there would be closer links between tax and benefits, there was no major integration.[26] Instead Family Income Supplement was replaced by a new benefit, Family Credit. Family Credit was more generous than Family Income Supplement but had much the same aims, "to ensure that families on relatively low incomes are better off in work than when unemployed".[27] The key step was to base entitlement to benefits on income net of tax:

    "By basing entitlement on income after tax and national insurance contributions, and assessing Housing Benefit on the same basis, Family Credit will end the present position where a reduction in benefit as earnings rise can mean an actual fall in net income after housing costs are taken into account. Similarly, by creating closer alignment between the benefits available to those families in work and those out of work, it will help to ensure that families will generally be significantly better off in work than when unemployed."[28]

  23. The White Paper proposed that Family Credit should be paid through the wage packet, despite acknowledging that there had been opposition to this proposal,[29] as an important step towards closer co-operation of the social security and tax benefit systems.[30] The issue, sometimes termed as `wallet versus purse' is discussed in more depth in paragraphs 61 and 62. The Government suffered a defeat in the House of Lords on this point and Family Credit was implemented as a cash benefit paid usually to the mother by order book or bank payment. According to Mr David Willetts MP:

    "It was defeated in the House of Lords by an alliance of two groups. The small business lobby complained that employers were going to be asked to carry out much more complicated calculations to deliver PAYE than they had in the past. It was feared it would be an unfair burden on business. There was also a campaign ... about `wallet versus purse'. The critics wanted a family benefit to go to the purse of the mother who might well not be working rather than in the wallet of the working father."[31]

In 1989 the House of Commons Social Services Committee inquired into the possibility and feasibility of a Minimum Income but did not produce a final Report.[32]

Objectives of tax/benefit integration

  24. Tax and benefit integration might underpin a wide range of different policy objectives:

•   helping more people out of work to take jobs

•   helping people already in work, but on relatively low wages, to stay in work and to ensure that they are always better off in work than not working

•   smoothing the administrative barriers between benefit and work

•   improving take-up of benefits, removing stigma, reducing fraud

•   ensuring that families with children receive more support than single people or childless couples at similar income levels

•   supporting one parent families over two parent families, or seeking neutrality

•   supporting marriage over cohabitation, or seeking neutrality

•   supporting people outside the labour market caring for children or elderly or disabled relatives

•   using the tax and benefits system to redistribute from rich to poor, or vice versa

•   maintaining stable public finances and controlling the level of public expenditure.

    "The debate tends to be muddled because it is not clear whether the objective is to reward work or to improve the well-being of families. The two objectives, while not incompatible, produce different policy recommendations, depending on the relative importance of each."[33]

We believe it is vital that there are stated aims and objectives for any moves towards tax/benefit integration. We concur with the memorandum from Andersen Consulting which stated that:

    "clarity and common agreement on objectives are a pre-requisite to the successful implementation of major change."[34]

Tax and Benefits: suitable cases for integration?

  25. When looking at objectives it is important to recognise that the taxation and benefits systems have very different functions, roles and customers. The primary purpose of taxation is to raise revenue. Yet it may also be used to pursue certain `social policy' objectives, as with child tax allowances or help with pensions and housing costs. In the process of raising that revenue, tax systems will often have unintended consequences on individuals and families; on incentives to work, save and perhaps even to form stable family units. The Meade Committee (1978) investigated the effects of different tax (and benefit) systems on incentives and argued that as far as possible, people's choices should not be determined by the presence of a tax system.[35] The tax system in the UK has become more neutral in respect of savings while the means-tested benefits system, pursuing other objectives, has strict capital limits which reduce entitlement for those with substantial liquid assets. The rationale for this is blurred but arises because the tax and means-tested benefits systems affect different groups in society. Mr Chris Kelly, Head of Policy for the Department of Social Security, told us:

    "...it is quite important to realise that the fact there are two systems is not an accident. It is because it reflects the fact that they are pursuing different objectives to some extent and are dealing with an overlapping but distinct group of people. In terms of barriers that have to be overcome, I think they must flow from the different characteristics of the two systems which reflect their different purposes. "[36]

  26. Professor Minford described the different nature of the two systems:

    "I am a bit sceptical ... that there can be any great gains from that [integration] given that you are really dealing with two very different classes of problem: the administration of benefits, on the one hand, with a whole clientèle that is very distinct; and in the case of the Inland Revenue, taxes, and that clientèle on the other."[37]

The memorandum from Dr Sheila Lawlor, the Director of Politeia, questioned whether tax and benefits ought to be integrated:

    "We would be concerned at the prospect of merging tax and benefits because (to revert to the themes which made policy successful in this century for this country) it would be wrong to deny in practice the centrality of the specific contributory principle (as opposed to the redistributive one). The National Insurance system from 1942 evolved on the basis of the very idea that contribution and benefit are linked, and Beveridge (just as predecessors in Britain in preceding decades) had rejected redistributive taxation as the basis for funding social security because it did not allow for the all important direct relationship between contribution and benefit."[38]

Other evidence submitted to us revealed very different views on the possibility of tax/benefit integration. For example, EDS argued:

    "Tax and benefit integration is a reasonable, but not easy, direction for the government to follow. Integration, properly approached, would help government overcome the issues of complexity and fragmentation and produce a fair benefit system which would encourage the taking of work and be more accessible to the public. We have looked at what seem to be the major obstacles to integration and have concluded that none are insurmountable."[39]

  27. Nonetheless there is already considerable interaction between the tax and benefit systems. In her memorandum to the Committee, Ms Fran Bennett explained that the change introduced in 1988 to calculate means-tested benefits in work on net (post-tax) income had limited the scope for Chancellors to use the income tax system by itself to improve incentives for low-paid claiming means-tested benefits, since as their net incomes increased because of reduction in taxation their benefits will be reduced.[40] In her oral evidence, Ms Patricia Morgan explained the effects of "churning",[41] i.e. taxing people who were also receiving means-tested benefits:

    "A lot of people on Family Credit are paying taxes. Taxes do cut in at an extraordinarily low rate. I do not think we should tax away people's subsistence. There always should be a certain amount of income for the individual and for any dependants which is not taxed, because you are taxing people into poverty if you are not doing that."[42]

Memoranda from RADAR[43] and the Association of Disabled Professionals[44] discussed the non-taxable nature of many benefits for disabled people.