Letter to the Chairman of the Committee
from HM Treasury concerning the tax credit system
During the hearing the Committee asked a number
of questions relating to the measures announced in the PBR to
improve the operation of the tax credits system.
On the question of the cost of the tax credits
package, the Committee said it would like a detailed written explanation
of the cost of the package by the end of the day. The Pre-Budget
Report 2005 sets out the Exchequer effects of measures over the
next three years. These are -£100 million in 2006-07, +£200
million in 2007-08 and +£50 million in 2008-09.
As I said during the hearing, it is important
to bear in mind that this is a balanced package. Some elements
announced involve a cost to the Exchequer because they effectively
increase families' tax credit entitlement, or because they involve
extra payments to claimants in the short term. Other elements
generate a yield. This mainly comes from measures designed to
reduce the amount of money paid out to claimants that later turns
out to be an overpayment. These measures effectively prevent money
going out that we would then have to recover and consequently
generate a yield. There appeared to be particular interest in
the question of why the increase in the annual income disregard
to £25,000 does not have a great impact on the overall costs.
There are two main reasons.
Firstly, as the Paymaster General set out in
her statement to the House of 5 December, ongoing overpayments
under the current system are expected to come from a number of
sources of which income rises from one year to the next is only
one. The statement explains that:
"Analysis of overpayments suggests that
they result from a number of factors: income rises from one year
to the next; families overestimating the extent to which their
income has fallen when they seek extra support during the year;
provisional payments made at the start of the tax year, which
are based on out-of-date information that is subsequently updated
when the award is renewed; and delays in reporting changes in
families' personal circumstances to HMRC."
As a result it is not the case that the increased
disregard, combined with other measures, will cause overpayments
to disappear. The Paymaster General's statement explained that
we expected the package as a whole to reduce overpayments by around
a third.
The second important reason, and I think this
is a point I did not get round to covering, is the way in which
tax credit's payments score in the public finances, which is on
the National Accounts basis. The central point is that the cost
of the higher disregard is the foregone recovery of overpayments
caused by income rises above the current £2,500 disregard.
Let me explain this in more detail. There are
important timing effects underpinning this cost. The basic principle
is that when money is paid out to tax credit claimants, it scores
as a cost to the Exchequer. On the other hand, when any overpaid
tax credits are recovered, there is a yield. Our baseline forecast
included a prudent assumption for ongoing over payments, which
were accounted for in full as a cost to the Exchequer.
I hope the Committee finds this helpful.
7 December 2005
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