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Session 2001- 02
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Standing Committee Debates
Tax Credits Bill

Tax Credits Bill

Column Number: 73

Standing Committee A

Thursday 17 January 2002


[MR. JIMMY HOOD in the Chair]

Tax Credits Bill

Clause 7

Income test

Amendment proposed [15 January]: No. 65, in page 5, line 10, to leave out from the word 'means' to the end of line 23 and to insert the words

    'current year income or previous year income as prescribed in regulations.'—[Mr. Webb.]

Question again proposed, That the amendment be made.

9.30 am

The Financial Secretary to the Treasury (Mr. Paul Boateng): I welcome you back to the Chair, Mr. Hood.

We were debating the amendment when the Committee rose on Tuesday. Its effect would be to reduce the flexibility that clause 7 provides for handling fluctuations in claimants' income. I understand the concerns of the hon. Member for Northavon (Mr. Webb) about simplicity, which we discussed during Tuesday's sitting and I hope that my explanation of how we intend the system to work under clause 7 will provide some reassurance.

The aim of the new tax credit is to combine continuity of support, where appropriate, with the flexibility to respond to changes in claimants' lives. In particular, it is important that tax credits should be able to intervene to provide extra support when claimants experience a significant fall in their income, thereby helping them to stay in work. The thrust of tax credits is to reaward work and to encourage and sustain it.

Although that flexibility is important, we are aware that people need as much certainty as possible about their tax credits. Clause 7(3) enables thresholds to be set for a change in income between one year and the next, so that only changes greater than the threshold will make any difference to entitlement.

Depending on what is set out in regulations, clause 7(3) will enable tax credits to be based on: current year income in all cases; current year income only if that is higher or lower, by a set amount, than last year's; current year income ignoring the first slice of a change by comparison with last year; or, in effect, previous year income.

Mr. James Clappison (Hertsmere): That sounds very straightforward.

Mr. Boateng: I am glad that the hon. Gentleman thinks so.

The clause must create a context for the regulations that come later, which must have the capacity to meet all eventualities if they are to be fit for the purpose.

A tax credit system that responds to falls in income and provides extra support at the point of need must

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be counterbalanced by the scope to adjust the amount of tax credits payable when people have had a significant rise in their income. That would entail setting thresholds under clause 7(3)(a) or 7(3)(a) and (b) together. If thresholds are set under both paragraphs, it is possible to allow people room for their income to rise by a certain amount without it affecting their tax credits for that year, so that their incentives to work and to increase their earnings are maintained.

The same sort of flexibility is available where people have falls in income. Thresholds can be set under clause 7(3)(c) and (d), so that people stay on previous year income unless they experience a significant fall in their income.

Because of the way in which clause 7(3) is structured, it would be possible to take a different approach to the treatment of falls and rises in income, and to respond to smaller falls in income than to rises. I see from the silent indication of assent from the hon. Member for Arundel and South Downs (Mr. Flight) that he understands and approves of that point.

Mr. Howard Flight (Arundel and South Downs): I thank the Minister for his clear explanation. He says that last year's income may be used as the basis, provided that this year's income is only modestly different, but last year's income is income as defined under subsection (3), so it includes that distortion. No comparison is made with actual cash income; rather, last year's income is income as defined for the purposes of the clause. Might there not be a compounding of the variance from this year's income?

Mr. Boateng: No. It will be reconciled at the end of the year, but I shall deal with that point, if I may, in due course.

As I said, because of the way in which clause 7(3) is structured, it is possible to take different approaches to the treatment of falls and rises, and it is designed to respond to smaller falls in income than to rises. Last year's consultation exercise revealed a consensus that tax credits should be able to be adjusted in this way. It also became clear, however, that interest groups and other respondents were concerned about how the provision would work in practice—a point that the hon. Member for Northavon is trying to tease out through his amendment.

One reason for providing flexibility through clause 7(3) is to allow further discussions before regulations are made. As I said, such discussions provide a context for the formulation of regulations that fit the purpose. My hon. Friend the Paymaster General has asked officials to take forward those discussions, and she is keeping in close contact with them.

I turn to the points that the hon. Gentlemen made when speaking to the amendment. It was asked why it is not possible to have a system based entirely on the income of the previous year. In one sense, that has a superficial attractiveness, in that it would offer certainty about the level of tax credits that people would get, subject to changes in circumstances that might affect their award. Our concern, however, is that there will be some who experience a drop in income in the current year, and if we use the previous year's

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income such changes could not be picked up for 12 months. The attractive point about the system proposed in the clause is that will help us to get over that problem.

Mr. Steve Webb (Northavon): I do not think that a decision on whether one uses the previous year's income or an estimate of the current year's income second guesses the separate issue of whether there can be within-year reassessment in the light of dramatic changes. The amendment, which presupposes using the previous year's income unless there is a major change in circumstances, would also allow for within-year reassessment where such change occurs. Indeed, I listed some of the changes that might apply. I doubt whether there is a tie-in, therefore, with an inability to detect major changes for 12 months.

Mr. Boateng: The jury is out on that one. The hon. Gentleman will recall that his earlier amendments would have established a period of six months. The issue was discussed in relation to clause 5, and there is no need to rerun that debate. I understand the approach, but we rejected it. Our view is that people who become entitled to income support or jobseeker's allowance would at that point move on to their full entitlement to child tax credit. We believe that we should go further than providing a basic safety net and have the scope to respond to falls in income while people continue in work. For example, someone might experience loss of regular overtime, which could have a significant impact on a family with a modest income. The framework provides us with the capacity to respond to that through regulations. Our fear is that without flexibility people will be forced to give up work to obtain extra support.

I assure the hon. Gentleman that clause 7 will enable thresholds to be set, which will result in virtually all claims being based on the previous year's income. I do not think that there will be a problem, but it is necessary for the clause to be framed as it is and the context to be set for the regulations to maintain that flexibility. One reason for taking such a flexible approach is to enable the system to be refined in the light of experience and we shall monitor it closely. I have no doubt that my hon. Friend the Paymaster General will address the issue in more detail when we consider the amendment tabled by my hon. Friend the Member for Regent's Park and Kensington, North (Ms Buck).

It may be helpful if I address the problem raised by the hon. Member for Arundel and South Downs and explain how the process will work. We intend claimants to start their awards on the basis of their previous year's income. That will generally be known. When thresholds have been set under clause 7(3), the Inland Revenue will advise people about the size of the change that should trigger a request for their award to be adjusted during the year. There will be a degree of certainty and people will be advised accordingly. At the end of the year, the amount of the tax benefit will be finalised when the actual income for the year just gone is known. There will be a reconciliation at the end of the year when the actual income becomes clear.

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The aim of setting thresholds under clause 7(3) is to enable claimants to remain on the previous-year basis unless they experience a significant change in the current year. As some hon. Members have said, and as many of those who responded to the consultation exercise said, the level of the threshold is crucial. The hon. Member for Northavon tried to tease that out on Tuesday and he will not have much more success today because we need to do further work on that before a firm decision can be made.

The hon. Gentleman also referred on Tuesday to the effect of a threshold under clause 7(3) that disregards the first slice of a change in income. He wondered whether such a threshold should be carried forward to the next year so that the reduced amount of income taken into account in the current year should be also be taken as the previous year's income for the year just starting. A threshold that ignores the first slice of income change in a year only affects tax credit entitlement for that year. In the following year entitlement would again be governed by the difference between actual previous year income and actual current year income. Otherwise the effect would be to increase the chance of a move to current year income in the following year by magnifying the gap, a point that the hon. Member for Arundel and South Downs made on a number of occasions. The situation would become increasingly distorted over time. Our approach would enable a catching up with actual income at the start of each year, similar to the way in which working families tax credit picks up changes after six months.

9.45 am

I want to reassure the hon. Member for Northavon that the Inland Revenue is conscious of the need to provide guidance to claimants. We discussed this matter at some length on Tuesday. The content of that guidance and its clarity will be important, particularly in this part of the system, and there will be opportunities to contact claimants and offer them advice and support. As we have discussed, claimants will not be subject to requirements to notify changes in income during the year, although they will have to provide that information at year end. The Revenue will be able to check the information provided during the year or at the end of the year.


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