House of Commons - Treasury - Thirteenth Report

Select Committee on Treasury Thirteenth Report

5 The broader context

100. Since early April, the debate on personal taxation has been concentrated almost exclusively on the question of how the Government can make amends for the abolition of the 10 pence rate of income tax. In the circumstances, this has perhaps been understandable. However, it is undesirable for individual tax policies to be considered in isolation from the broader fiscal context, not least because it encourages the notion that tax changes can be separated from their fiscal consequences. There is also a related risk that tax changes are seen solely in terms of their immediate impact on personal, family or household finances, and not in the context of the wider social objectives that the Government should be pursuing. In this chapter, we seek to redress the balance, and set the next stage of the debate in a broader context.

The fiscal context

OVERVIEW

101. We set out in our Report on this year's Budget the fiscal framework under which the Government operates. In its Code for Fiscal Stability, published in November 1998, the Government set out the principles by which it would conduct fiscal policy. The Government has two fiscal policy objectives, which are:

over the medium term, to ensure sound public finances and that spending and taxation impact fairly within and between generations; and

over the short term, to support monetary policy and, in particular, to allow the automatic stabilisers to help smooth the path of the economy.[270]

To achieve these two objectives, the Government has established two fiscal rules. These are:

the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and

the sustainable investment rule: public sector net debt as a proportion of Gross Domestic Product (GDP) will be held over the economic cycle at a stable and prudent level. Other things being equal, net debt will be maintained below 40% of GDP over the economic cycle.[271]

102. In that Report we noted that the credit crunch had begun to impact on the Government's forecasts for the overall state of the fiscal position going forward. During our inquiry into the 2008 Budget, Mr Chote told us that:

The Treasury has effectively admitted to about a £7.5 billion permanent deterioration in the outlook for the public finances which clearly reflects in large part the movements in equity prices since the Pre-Budget Report, expectations that were described to be a sluggish or flat house price growth, associated conditions in the property market, the mix of consumer spend, consumer spending being weak relative to GDP overall, and more consumer spending going on things on which less VAT is paid. Confronted with that £7.5 billion gap they have essentially said, 'We are going to raise £2.5 billion of taxes looking five years out' and they have also tightened the assumed spending squeeze in Spending Review 2009 and are borrowing a bit more. So they have dealt with some of it by measures, some of it by assumption and some of it just by borrowing more. History suggests … there are very big variations either side of the likely path but so far it has been seven budgets running in which the errors have been in the same direction.[272]

103. This deterioration in the fiscal position had also meant that the margin by which the Government was meeting its own fiscal rules was deteriorating. Under the sustainable investment rule, under which, other things being equal, the Government attempts to ensure that net debt will be maintained below 40% of GDP over the economic cycle,[273] the Government forecast a particularly slim margin in 2010-11. For 2010-11, the Treasury forecast at the time of this year's Budget suggested that there would be headroom of only 0.2 percentage points of GDP via which the sustainable investment rule would be met, which Mr Chote suggested equated to £2.8 billion.[274] This led us to conclude in our Report on the Budget that, while "the Government has forecast that it will meet the sustainable investment rule over the period up to 2012-13 … the margin by which it is now forecasting that it will meet the rule is extremely tight, especially considering the uncertainty surrounding the overall economic situation".[275] In its response to our Report, the Government pointed out that it had so far more than met its forecast for the current deficit in 2007-08:

Since Budget 2008, the provisional outturn from the Office for National Statistics (ONS) for 2007-08 show the current deficit, net borrowing and net debt lower in 2007-08 than expected in Budget 2008. The current deficit is provisionally £5.7 billion compared to the Budget 2008 estimate of £7.9 billion. Net borrowing in 2007-08 is provisionally £34.3 billion compared to the Budget 2008 estimate of £36.4 billion and net debt is 36.7% of GDP, compared to the Budget 2008 estimate of 37.1% of GDP.[276]

104. However, the significant downside risks to economic growth over the medium-term remain. At the time of this year's Budget, the average of independent economists' new forecasts for GDP growth was 1.6% in 2008 and 1.8% in 2009.[277] However, by May the average of these forecasts for GDP growth had changed to 1.7% in 2008—a slight improvement—but for 2009 had fallen by 0.3 percentage points to 1.5%.[278]

SPENDING PROSPECTS AND THE AME MARGIN

105. Documents released at the time of this year's Budget contained forecasts of the Annually Managed Expenditure (AME) margin. The AME margin exists to absorb changes to spending that is not subject to multi-year control through Departmental Expenditure Limits which may arise above and beyond those forecast by the Government. The AME margin is set at £0.9 billion for 2008-09, doubling to £1.8 billion in 2009-10 and reaching £2.7 billion in 2010-11.[279] The recent rise in the claimant count points to the impact on the Government's finances from potential rises such as the need to make additional payments for unemployment benefits.[280] Another risk would be a rise in the take-up of tax credits above that expected by the Government. The crystallisation of such risks would limit the potential for the Government to use the AME margin for other purposes in future periods. The concept of the AME margin as an additional resource awaiting allocation was rejected by Mr Chote. He told us that:

it is not free money; unclaimed tax credits are not sitting in a pot somewhere waiting to be spent. That would be new money that would need to be found if you had a doubling in the take-up of these various tax credits or benefits.[281]

THE FISCAL IMPLICATIONS OF THE DECISION OF 13 MAY

106. The decision by the Chancellor of the Exchequer to raise the personal allowance by £600 was estimated to cost £2.7 billion this financial year.[282] In his statement on 13 May, the Chancellor of the Exchequer announced that this measure would be funded by additional borrowing:

As I made clear at the time of the Budget, it is right and sensible to allow borrowing to rise and investment to be maintained as the economy slows. Debt is lower than it was in the past and low by international standards. Our fiscal policy, like our monetary policy, is designed to support stability in these uncertain economic times generated by the turbulence in world financial markets and global commodity-price inflation. I am able to finance the proposal through borrowing this year, ensuring that we do not take money out of the economy at this time.[283]

Given the slim margin available to the Government under the sustainable investment rule, the IFS pointed out what this extra borrowing meant:

if the tax cut had been announced at the time of the Budget, the Treasury would presumably have forecast that public sector net debt would hit the 40% ceiling in 2010-11 (measuring the net debt ratio to the nearest tenth of a percentage point as usual). If it wished to be more precise, it could claim to expect to remain £600 million below the ceiling in 2008-09 terms. If we assume that the Government is unable to claw back the cost of this 'one-off' giveaway in future years, net debt would be forecast to break through the ceiling in 2010-11, peaking a year later at 40.4% of national income - a breach of a little over £5 billion in 2008-09 terms. The Treasury would thus expect to break the sustainable investment rule as currently defined.[284]

A key issue for the fiscal sustainability of the 13 May announcement is whether the change would be permanent or not. In his 13 May statement, the only indication that the Chancellor of the Exchequer gave as to the intended duration of this measure beyond the current financial year was when he said that "For future years, our aim is to continue the same level of support for those on lower incomes and I shall bring forward proposals to do that in the Pre-Budget Report".[285] When questioned on the exact definition of those on "lower incomes" who would receive continued support, the Chancellor of the Exchequer refused to be drawn. He told us:

I chose my words [in the 13 May statement] deliberately. I see absolutely no point in boxing myself in in May or early June in advance of the Pre-Budget Report this autumn. Our starting position was how do we help the people who have lost out, particularly people on lower incomes? Because of reasons that we will no doubt go into, the particular way I decided to do this helps a wider range of people this year. I will be looking in future years to see what we can do especially to help people on lower incomes. I am not going to box myself in to saying here is an arbitrary ceiling here or there or whatever. I will do whatever I can to help people on lower incomes.[286]

107. There is a possibility of statistical changes that may aid the Government in meeting the fiscal rules. The IFS highlighted a potential increase in the margin available under the sustainable investment rule due to a change in how the national accounts are calculated. A study by the Office of National Statistics outlined the problem faced by statisticians:

The activity of financial services in general and of banks in particular has long been a challenging area for those who develop international standards. Market economic activity can be measured as cash values of sales and purchases of identifiable units such as cars or haircuts; these cash values can then be deflated by stripping out inflation effects to enable real growth to be derived. However the activity of banks is not so easily captured.

For some services explicit charges are made, such as commission on foreign exchange, account charges and flat rate fees for overdrafts. But the amount of these charges is significantly below the costs paid by the banking industry on wages and bonuses, and intermediate costs such as rental, electricity and stationery purchases. So under the conventional treatment there was the threat of what the OECD described as 'the paradox of a prosperous industry showing a negligibly positive, or even negative, contribution to the national product'.[287]

The IFS provided an estimate of the potential effect this change could have on the national accounts:

Experimental estimates by the Office for National Statistics suggest that incorporating "financial intermediation services indirectly measured" (FISIM) in the national accounts will increase the headline measure of national income by between 1.3% and 2.0% between 1993 and 2007. [288]

The IFS then calculated what such a change would mean for the margin available to the Government in meeting the sustainable investment rule. The IFS concluded that with:

the measured level of national income increased by 2% from 2007-08 onwards, in line with the ONS's latest experimental estimates of FISIM … This lifts the debt ceiling by the equivalent of £12 billion in 2008-09 terms and means that the Treasury would not expect net debt to exceed 40% under any of the three scenarios: it peaks at 39.2% if the addition to borrowing to pay for the tax cut is for one year only and at 39.6% if it is permanent. This implies that it would remain below the ceiling by £12.4 billion if the tax cut is 'one off' and £6.5 billion if it is permanent in 2008-09 terms.[289]

However, when we asked the Chancellor of the Exchequer whether the possibility of this additional increase in the margin allowed under the sustainable investment rule had been part of the planning for the 13 May announcement, he replied "It was not part of our considerations".[290]

CONCLUSIONS

108. Mr Chote argued that an independent Bank of England would eventually neutralise any fiscal stimulus which the Government might be tempted to implement. He noted that:

If through fiscal policy you pump a little bit of money in at the margins, you would expect that the Bank of England is likely to set interest rates slightly higher than they otherwise would be to still get the same outlook for growth and inflation that they would be happy with in the first place.[291]

As such, the Government is constrained in how much it can additionally borrow and inject into the economy, although the Chancellor of the Exchequer drew attention to the statement by the Governor of the Bank of England following the 13 May announcement which the Chancellor of the Exchequer summarised as being that the Governor did not think that that decision would have a significant effect on the inflationary outlook.[292]

109. We note the evidence from the Institute for Fiscal Studies that the sustainable investment rule would be broken in 2010-11 under the Government's forecasts at the time of the 2008 Budget if the measures announced on 13 May were carried forward in future years. We also note the possibility of which we have been made aware that there may be upward revisions to Gross Domestic Product from the incorporation by the Office for National Statistics of the statistics on "financial intermediation services indirectly measured"—currently experimental estimates of how the economic activity of financial services should be measured—into the national accounts. The remaining margin was already tight following the 2008 Budget. The fiscal rules are only effective if participants and observers, including the markets, believe that the rules will be adhered to. If the Government wishes to continue to meet its fiscal rules, it will have to take them fully into account when proposing further personal tax and benefit changes.

The Government's overall approach to tackling poverty

110. A welcome side effect of the abolition of the starting rate of income tax has been to raise the profile of the debate on poverty in the United Kingdom. Several submissions welcomed the renewed focus of policy makers on poverty, although the IPPR was concerned that now that the Government had presented its compensation package, the issue of low pay and the 'working poor' would "slip again out of the public, media and political spotlight".[293]

111. A large number of submissions to this inquiry acknowledged that the Government already had significant achievements in combating poverty. CPAG stressed that "one of the greatest successes of the current Government has been to put poverty firmly on the map" as well as helping to shape a "political consensus around the importance of tackling poverty".[294]

112. The IFS provided evidence of how different groups had fared under the impact of the Government's cumulative changes to the tax and benefit system since 1997:

The cumulative impact of Labour's tax and benefit changes since 1997 up to and including PBR07 has been to increase the average incomes of the poorest tenth of the population by 12% and cut those of the richest tenth by 6%. But, within the poorest tenth, pensioners have gained 24% and families with children 18%, while childless working-age adults have gained only 1%.[295]

The IFS went on to demonstrate that the profile of beneficiaries as a result of changes to the tax and benefit system since 1997 has been uneven with working-age families without children, in particular, gaining least or even, in some cases, losing out as a result of the Government's changes:

working-age families without children have lost on average from Labour's tax and benefit changes across nine-tenths of the income distribution. Measured as the number of individuals living in households with incomes (adjusted for household size and composition) below 60% of that enjoyed by the average (median) household, poverty has fallen by 600,000 among children, 200,000 among working-age parents and 200,000 among pensioners since 1996-97. But poverty has increased by 500,000 among working age adults without children. All these poverty counts measure incomes before housing costs and are up to 2005-06.[296]

113. The uneven distribution of the beneficiaries from the Government's changes to the tax and benefit system was also highlighted by witnesses. Mr Peter Kenway, Director of the NPI, illustrated the trade-offs in the Government's anti-poverty strategy, telling us that "the overt targeting of child poverty and the covert targeting of pensioner poverty means that the working age in general lose out, but particularly [those of] working age without dependent children".[297] Ms Perchard told us that "there have been quite a lot of winners from the tax credit and tax packages in the last two years, particularly families with children, and some of those have won a bit more from the increase in personal allowances as well".[298] She added that:

What seems to stand out now, however, is the people without children, particularly younger children, where they have not previously been a target for Government anti-poverty activity except with reference to minimum wage policy, and we feel that that is a group that perhaps needs more exploration.[299]

114. Mr Chote explained possible reasons why the Government had chosen to focus resources on combating poverty amongst these groups rather than amongst people of working age without dependent children:

The Government could make an argument that says clearly you need to worry more about pensioners, who are less able to change their own circumstances, and about children, who are unable to change their own circumstances, and some of the people for example who are now left as losers (because you would expect them to climb the earnings ladder and have children) may only be in this category of still identified losers temporarily, but it fits with the overall pattern of the relative generosity of the Government's anti-poverty strategy as regards these three groups.[300]

Child poverty

BACKGROUND

115. In 1999, the then Prime Minister committed the Government to the goal of ending child poverty "within a generation". The pledge was underlined by setting a series of targets and milestones to reduce child poverty on the way to halving it by 2010 and eradicating it by 2020. These targets were encapsulated in the 2002 Spending Review objectives set for HM Treasury and the Department for Work and Pensions, within the framework of Public Service Agreements, to reduce the number of children in low-income households by at least a half by 2010-11 and eradicate it by 2020-21.[301]

116. The Government has said it will judge its success reducing child poverty primarily through reference to the number of children in relative low-income households, defined as households with incomes below 60% of median income. For the 2004-05 milestone of cutting child poverty by a quarter, was measured in terms of 60% of medium income both before and after housing costs. The target to reduce by one half the number of children living in poverty by 2010-11 will be measured solely in terms of income before housing costs. The Government has also said it will use two additional indicators to measure progress against tackling child poverty in the coming years:

· The number of children in absolute low-income households, defined as households with incomes of less than 60% of median income held constant in real terms from a 1998-99 baseline; and

· The number of children in relative low-income households and in material deprivation: the introduction of a material deprivation indicator for child poverty is designed to provide a wider measure of living standards and reflects the view that tackling child poverty is about more than simply raising income levels.[302]

PROGRESS AGAINST THE CHILD POVERTY TARGETS

117. The Government's initial child poverty target was to reduce child poverty by a quarter by 2004-05. The baseline for progress against this target was the Government's estimate that 4.1 million children were living in relative poverty after housing costs in 1998-99 and that 3.1 million children were living in relative poverty before housing costs in that year. By both measures, the interim target was not met. Between 1998-99 and 2004-05:

· Child poverty after housing costs fell by 700,000, from 4.1 million to 3.4 million. This was a drop of approximately 17%; in order to meet the target, the number would have needed to have fallen by a further 400,000 to 3.0 million.

· Child poverty before housing costs also fell by 700,000 from 3.1 million to 2.4 million. In order to meet the target, it would have needed to have fallen by a further 100,000 to 2.3 million.[303]

118. Since then, the number of children in poverty has risen. In 2005-06, there was a reported rise in child poverty of 100,000 according to the Government's preferred measure before housing costs.[304] We expressed concern at this rise in child poverty in our Report on the 2007 Budget and called on the Government to state how it intended to meet the 2010-11 target to halve the number of children in poverty and where the resources would come from to meet that target.[305] The latest Household Below Average Income report was published by the Department for Work and Pensions on 10 June 2008. This showed that the number of children living in poverty rose by a further 100,000 in 2006-07 to 3.9 million after housing costs and 2.9 million before housing costs. As a consequence of these two successive rises, the number of children in poverty before housing costs is now 200,000 higher than it was in 2004-05.[306]

MEETING THE 2010 TARGET

119. The Treasury told us that the measures announced in the 2007 Budget, that year's Pre-Budget Report and this year's Budget which we referred to earlier would help lift a further 500,000 children out of poverty.[307] Mr Chote told us during our inquiry into the 2008 Budget that the measures in the 2008 Budget would move 200,000 to 250,000 children out of poverty, which would leave the Government around "450,000 short of the target". Mr Chote estimated that bridging this gap would require additional expenditure of around £2.8 billion for the Government to meet its 2010 target.[308] Save the Children told us that "following announcements in recent budgets, it is now estimated £3 billion will give the Government a 50:50 chance of meeting the goal".[309] The Chancellor of the Exchequer reaffirmed the Government's commitment to meeting its child poverty targets, telling us that "it is a very important target and I attach considerable importance to it".[310] The Chancellor of the Exchequer went on to tell us that "the battle to eradicate child poverty is not yet won; we have some way to go".[311]

120. We welcomed the measures in the 2008 Budget on child poverty in our Report on the 2008 Budget. We recommended that the Government clarify the targets that had been set relating to child poverty and report on performance against each of those targets in each financial year. Furthermore, we expressed concern that the Government "has yet to provide a clear explanation of the linkage between its target to halve child poverty by 2010-11 and the proposed deployment of resources to meet that target". We pressed the Government to "make it clear that the necessary resources to meet the 2010-11 target are available and that the Government is committed to deploying those resources directly to support low-income families".[312]

METHODS OF TACKLING CHILD POVERTY

121. In Ending child poverty: everybody's business, which was published alongside the 2008 Budget, the Government reiterated its broad strategy for tackling child poverty:

Recognising the multiple factors that cause child poverty, the Government's strategy is also broad-ranging, aiming to eradicate all the causes of child poverty now and in the future. The Government strongly believes that work is the most sustainable route out of poverty and supporting parents into work is at the heart of the Government's strategy to tackle child poverty. The Government is also committed to supporting parents in their parenting role and delivering excellent public services that improve children's lives in the short term and break cycles of deprivation in the long term. Key to the Government's approach to tackling child poverty is the principle of progressive universalism: delivering help for all families and more help for those who need it most, when they need it most.[313]

122. The Government's focus on increasing employment through active labour market policies, such as the New Deal, have been pursued alongside the introduction of measures such as the National Minimum Wage and Working Tax Credit to reward work and thus improve incentives for individuals to participate in the labour market. We discuss many of these policies in greater detail later in this Report.

123. Alongside the focus on moving people into employment, the Government has also improved financial and material support for families through the introduction of Child Tax Credit as well as through other changes to the tax and benefit system. We described all of the relevant measures in the 2007 and 2008 Budgets and the 2007 Pre-Budget Report in chapter 2 of this Report.[314] Save the Children summarised the broad thrust of Government policy in this area over the last few years, telling us that:

recent Budgets and Pre-Budget Reports have seen significant investments in child poverty reduction. These have included rises in the Child Tax Credit and a multi-year commitment to raise the child element in line with average earnings, increases in Child Benefit particularly focussed at the eldest child, the nationwide roll-out of the In Work Credit, increases in the disregard with respect to child maintenance payments and Child Benefit and extension of the Working Tax Credit thresholds.[315]

124. At the time of the 2008 Budget we asked Mr Chote whether the Government was more likely to meet its 2010-11 child poverty target through increasing employment levels or through transfer payments, such as tax credits and Child Benefit. At that stage, he viewed the remaining progress required as most likely to be achieved through the benefits system, stating that "it is either transfer payments or nothing at this stage". Mr Chote was sceptical about the contribution that increasing employment could make at this stage towards meeting the 2010-11 target:

It does not make much difference on the timescale for 2010. If you were to achieve the Government's lone parent employment target it would probably cut the amount you needed to spend by about £200 million. That was the calculation we did a year or so ago. It shows basically that success on that front does not really get you very far in terms of the near-term target.[316]

On another occasion, Mr Chote outlined a possible trade-off in that the 2010-11 target could put pressure on the Government to go down the quickest cost-effective route of getting there, which would be to increase transfer payments, whereas focusing on the 2020 target might lead the Government to prioritise investment in longer term social investments but potentially at the cost of making it more likely that the 2010 target would be missed.[317]

Pensioner poverty

125. A number of submissions to our inquiry focussed on pensioner poverty and why tackling poverty amongst the pensioner population should be a Government priority. Barnardo's told us that the rationale for focussing Government support on pensioners was based on:

pensioners being on fixed incomes and relying heavily on state benefits or other income which has been built up during their working lives. It is not realistic to expect those beyond state pension age to increase significantly the income they have to live on in retirement. Government support is therefore the only lever available to help increase the incomes of low-income pensioners.[318]

126. The Treasury stated that "over £11 billion more is being spent on pensioners in 2008-09 compared with 1997, with half the extra spending going on the poorest third". The Treasury went on say that "this has helped contribute to the 1.1 million pensioners who have been lifted out of relative poverty since 1997, and the 2.2 million pensioner households lifted out of absolute poverty".[319] Citizens Advice acknowledged that the Government had done much in this area with there being "a consistent fall in relative poverty amongst pensioners since 1997".[320] The latest Household Below Average Income report was published on 10 June 2008. This showed that the number of pensioners in poverty rose by 200,000 to 2.1 million after housing costs and by 300,000 to 2.6 million before housing costs in 2006-07. The IFS argued that "the actual increase is both statistically significant and unexpectedly large, especially as the Pension Credit guarantee is increased in line with average earnings".[321]

127. One of the Government's key policies to support pensioners was through the introduction of Pension Credit in 2003. Pension Credit is a means-tested benefit which, through the 'Guarantee' Credit element, provides a minimum guaranteed income for pensioners who choose to claim the benefit. The Treasury told us that "whilst the income support available to pensioners in 1997 was just £68.80, Pension Credit ensures that no pensioner has to live on less than £124 per week".[322] The increase in the Pension Credit to £124 a week for single pensioners in 2008-09 had been announced in the 2007 Pre-Budget Report and confirmed in the 2008 Budget.[323] Citizens Advice welcomed that rise, which they said "gave a welcome boost to the incomes of the poorest pensioners".[324]

128. Pension Credit is a means-tested benefit which claimants must apply for. However, a number of submissions to our inquiry focussed on low levels of take-up amongst pensioner households who were entitled to Pension Credit (as well as other means-tested benefits such as Housing Benefit and Council Tax Benefit) but were not claiming these benefits. The Treasury estimated that "the take-up rate for Pension Credit is between 70 and 78% when measured as a percentage of money being claimed, and between 60 and 69% when measured by caseload".[325] Since we concluded taking evidence, the Department for Work and Pensions has published new statistics on levels of take-up for Pension Credit. Worryingly, those figures indicate that in 2006-07 take-up fell, measured both by caseload and as a percentage of money claimed. The latest figures show that take-up in 2006-07 was between 59% and 67% by caseload, compared with between 60% and 69% in 2005-06 and that take-up was between 69% and 76% by expenditure in the more recent year, compared with between 70% and 78% in 2005-06.[326]

129. Prior to this latest announcement, Citizens Advice told us they believed that take-up of Pension Credit was very low with "estimates of the benefit unclaimed by people aged 60 and over … at least £2.4 billion and potentially as much as £4.2 billion per year".[327] Citizens Advice said that low take-up by pensioners was associated with the complexity of means-tested benefits, which leave many struggling as they fail to claim their full entitlement.[328] Ms Sally West, Policy Manager, Age Concern, agreed that take-up of Pension Credit was "a huge problem". She went on to outline some of the reasons why many pensioners are not taking-up Pension Credit:

I think non take-up is a combination of a number of related factors. Firstly, there is awareness, although actually Pension Credit has got very high awareness. More important is the perceived eligibility, so people may have heard of Pension Credit but think that in their particular circumstances it will not apply. A lot of homeowners think they will not be entitled to benefits. The next barrier is the process. People do not want to give all their personal details, they do not want to go through the system of making claims, and among some people there is still this feeling that it is not quite right asking for help.[329]

130. As we noted earlier, the Government has sought to tackle the problem of poverty in pensioner households in part through the introduction of the payment of a non-means-tested Winter Fuel Allowance to pensioners, and through an additional one-off payment in 2008-09.[330] Age Concern told us that they welcomed the Government's Budget announcement of "an additional one-off payment … 'to help pensioners who are facing pressures such as higher energy bills' and the £225 million package of assistance from the energy companies announced recently".[331] Ms West explained that the Winter Fuel Allowance was very popular amongst pensioner households, largely because "it is simple to explain and it gets to people because in general you do not have to claim it. In that sense, I think people very much welcome it".[332] However, Ms West went on to tell us that whilst people welcomed this year's additional winter fuel payment, there was concern that "it is described as a one-off payment … so that leads to worries because people are thinking, 'Maybe I'll get an extra £50 this year, but then what?'."[333] She said that the use of the Winter Fuel Allowance should not be seen as a long-term solution to tackling pensioner poverty:

We would not see that in the long-term structure you should be having to rely on one-off payments and concessions. Our ideal world is that people have decent incomes through state and private pensions so they do not need to have a one-off bonus to help them meet their fuel bills, but we are quite a long way from that and it certainly does reduce the worry for a lot of people about fuel bills.[334]

131. The Government, as part of its longer-term pensions strategy, and as part of a wider package of reforms to the pensions system, has pledged to restore the earnings link for the Basic State Pension. A legal basis for regular up-rating of the Basic State Pension (by the better of prices or earnings) was introduced in 1974. However, the 'best of' legislation ended in 1979 and was replaced by a prices link.[335] In its 2006 Pensions White Paper: Security in retirement: towards a new pensions system, which followed the recommendation of the Pensions Commission chaired by Lord Turner of Ecchinswell, the Government stated that "during the next Parliament, we will re-link the uprating of the Basic State Pension to average earnings".[336] Citizens Advice told us that they welcomed the Government's intention to increase the state pension in line with earnings, although they urged the Government "to set a firm date for its implementation soon, to prevent the relative value of the pension falling further".[337]

Fuel poverty

BACKGROUND

132. As discussed in the previous section on pensioner poverty, the Government has made a number of winter fuel payments and additional 'one-off' payments for pensioners. These payments represent a key element in the Government's strategy to tackle the problem of fuel poverty, which is a problem affecting many pensioner households. Age Concern confirmed to us that "older people are more at risk of fuel poverty than any other group, accounting for around 50% of households affected".[338]

133. The Government's Fuel Poverty Strategy, which was published in November 2001, set out targets to end fuel poverty in vulnerable households by 2010, where a vulnerable household was deemed to be one containing children, or those who were elderly, sick or disabled. The 2010 target was intended as a milestone towards eradicating fuel poverty in England by 2016. The 2016 target states that by 22 November 2016, as far as reasonably practicable, no person in England should have to live in fuel poverty. A household is said to be in fuel poverty if it needs to spend more than 10% of its income on fuel to maintain a satisfactory heating regime (usually 21^oC for the main living area, and 18^oC for other occupied rooms).[339]

134. The Scottish Fuel Poverty Statement, published in August 2002, sets out the Scottish Executive's overall objective for fuel poverty. This is to ensure that, as far as reasonably practicable, people are not living in fuel poverty in Scotland by November 2016.[340] The Welsh Assembly Government's target is that as far as reasonably practicable, no vulnerable household in Wales should be living in fuel poverty by 2010 and no household should be living in fuel poverty by 2018.[341] Northern Ireland has the same objectives as England.[342] The Government has stated that progress on this will be monitored by an inter-ministerial group and through the Fuel Poverty Strategy Annual Progress Report, which is published by the Department for Business, Enterprise and Regulatory Reform in conjunction with DEFRA. The Government has said that its primary tool in tackling fuel poverty over the period 2008-09 to 2010-11 will be DEFRA's Warm Front Scheme, which provides a package of heating and insulation measures to private sector households in receipt of certain benefits, and benefit entitlement checks to help maximise income.[343]

135. In our Report on the 2008 Budget we concluded that "it is important that the Government continues to tackle fuel poverty through a combination of targeted and universal measures and also stated:

In view of the importance of measures announced in Budgets and Pre-Budget Reports to the progress of the targets to eradicate fuel poverty set by the Government itself and by the devolved administrations, we recommend that the Government report in Budgets and Pre-Budget Reports on the effect of any measures announced at that time on progress towards meeting fuel poverty targets.[344]

136. Ms West explained the wide variety of factors that influence levels of fuel poverty and why tackling fuel poverty was so difficult:

fuel poverty is a combination of a range of factors. One of the difficulties of addressing it in Government is that it involves a lot of different government departments. It is about income levels, the cost of fuel, and also about conditions of housing and energy efficiency, so already you have got about four government departments, not including Treasury, that have an interest in that. That is the first thing we are arguing for, a very co-ordinated approach.[345]

Ms West expanded on some of the issues relating to housing and energy efficiency, telling us that:

of course there are people in difficult to heat properties, so if you do not have access to gas mains in rural areas … or you have properties where it is difficult to insulate them, then even if you have got slightly higher income you may be having to pay a huge amount of your income in order to keep a good warmth within your property.[346]

PROSPECTS FOR MEETING THE 2010 TARGET

137. National Energy Action (NEA) told us that, "since 2004 progress in reducing fuel poverty has been halted and reversed … The 2007 Energy White Paper demonstrated how remote and unachievable [the] fuel poverty targets had become."[347] NEA estimated "that some 3 million households in England are currently in fuel poverty", with the total rising to 4.5 million across the United Kingdom.[348] Age Concern estimated that "the number of pensioner households living in fuel poverty in the United Kingdom has doubled in the last four years, and now stands at 2.25 million".[349] NEA speculated that "significant further increases [in fuel poverty] may be imminent" given that energy prices had continued to rise over the last few months.[350] Ms West concurred that rising energy prices were an issue, telling us that "fuel prices have been going up substantially and are likely to continue to rise".[351] The Chancellor of the Exchequer told us that "fuel poverty fell steadily until about four years ago", before going on to explain the rise in fuel poverty since that date as taking place "mainly because of the oil prices which drove up electricity and gas prices".[352]

138. NEA noted that the Department for Business, Enterprise and Regulatory Reform had devised a model to assess the extent to which fuel poverty increased as energy prices rose, "with the model working on the assumption that a 1% real change in the price of both gas and electricity results in a further 40,000 households becoming fuel poor".[353]

SOCIAL TARIFFS AND ENERGY PRICES

139. In the 2008 Budget, the Government acknowledged that further action was needed to help vulnerable groups deal with rising energy prices. To this end, the Budget outlined plans to work together with energy supply companies. The Government welcomed "the steps the energy companies have already taken to help vulnerable customers cope with higher prices", but argued that more could be done.[354] The Government observed that "energy companies currently spend around £50 million a year on social tariffs", but went on to say that the Government would like to see that figure rising to at least £150 million a year. The Government stated that, acting with the companies and the energy regulator Ofgem, it would "draw up a plan for voluntary and statutory action to achieve that".[355] Since the 2008 Budget, the Government has announced that it had secured a commitment from the energy companies to provide an extra £225 million in social assistance by increasing their investment to £150 million per year by 2011. The Government estimated that this initiative could lift around 100,000 households out of fuel poverty.[356]

140. On 30 May the Government announced further measures to help tackle fuel poverty including, crucially, seeking changes in legislation to allow data-sharing with energy companies so that assistance could be targeted effectively on low-income households suffering from fuel poverty.[357] The Chancellor of the Exchequer explained how Government was working together with the power companies to try and tackle fuel poverty:

In relation to the power companies, there are two things I would point to. One is general help and of necessity this is medium-term, the obligation on power companies to do more to help their customers reduce their bills by insulating their homes and reducing their energy requirement. Also, I think the steps we have agreed with the energy companies in relation to the premium that poor people on low incomes have to pay if they are paying through a prepayment meter, for example, but also the measures that were announced by the DWP last week. They are not the only things we have done, they are part of a wider programme of making it easier to identify to people in the power companies people who are at risk of falling into fuel poverty. At the moment we have that data, the DWP has that data, but it is not possible to make that available. I think that is something that is worth looking at.[358]

141. NEA thought that the sums of money that the energy companies were preparing to spend on social tariffs were "totally inadequate" in the context of the estimated 4.5 million households suffering from fuel poverty and was, "proportionately, less than some suppliers currently spend on discounted social tariffs for their disadvantaged customers".[359] The NEA saw it as

a failure on the part of Government that it invites commercial companies to adopt a major role in pursuit of social welfare objectives and to determine, at their own discretion, the form and extent of assistance to vulnerable households; whilst energy suppliers may be a vehicle to deliver social policy they clearly cannot be the driver. NEA believes that a mandatory social tariff, prescribed by Government, and available in a consistent form to eligible households based on consistent criteria is the most rational approach to unaffordable energy costs.[360]

Age Concern reiterated these concerns, arguing that "mandatory social tariffs offering the lowest market rate should be made compulsory through the Energy Bill currently before Parliament".[361]

In-work poverty and making work pay

OVERVIEW

142. The announcement of the abolition of the starting rate of income tax as well as subsequent submissions to our inquiry have highlighted concerns about the extent of low pay and in-work poverty and the link between the two.

143. The IPPR told us that, in April 2006, over five million employees—around 22% of the workforce—were paid less than £6.67 an hour, equivalent to around £12,500 for a year based on a full-time working week and 60% of full-time median earnings.[362] The IPPR went on to say that "half of all poor children live in a working household, up from two-fifths a decade ago" and that the "incidence of low pay is a key factor underpinning the high rates of poverty and inequality".[363] The IPPR acknowledged that the relationship between low pay and poverty was complex, "given that the former relates to individuals and the latter to households" (meaning, for example, that a low-paid worker could be part of a household where the income of other members of the household lifted the household above the poverty line).[364] The NPI said that "the link between low paid workers and low income households is weak, with only 16% of low paid workers in a recent study belonging to households with incomes below the official poverty line".[365] However, despite the fact that many low-paid workers are not living in households experiencing poverty, it appears that a person is at greater risk of poverty if that person is low-paid. The IPPR told us that their own research showed that "the risk of being poor was 18 times higher for low-paid compared to non-low paid workers (7.2% compared to 0.4%)".[366]

IN-WORK POVERTY AMONG THOSE WITH DEPENDENT CHILDREN

144. As discussed earlier in this chapter, despite the fact that the Government has moved 500,000 children out of poverty since 1998-99, there are still 2.9 million children living in poverty. Of these 2.9 million children, around half are in families where someone works.[367] The IPPR stated that its own "research highlighted that half of all poor children live in a working household, up from two fifths a decade ago".[368] The IPPR went on to say that:

While employment has risen and worklessness reduced, too many families have exchanged poverty out of work for poverty in work—better off than on benefits, but not enough to raise them above the poverty line. Nearly 80% of all working poor families with children are couples, the majority of whom have only one earner.[369]

145. The NPI pointed out that the number of children "in in-work poverty for the most recent three years also happens to be the average for both the three years immediately prior to the start of the Government's anti poverty programme and the whole of the period since the start of the 1990s", concluding that "there has been no sustained reduction whatsoever in in-work child poverty since the end of Lady Thatcher's premiership".[370]

146. The fact that 1.4 million children live in families where at least one parent works, but which has not provided a route out of poverty, appears to cast doubt upon the Government's message that work is the most sustainable route out of poverty and that supporting parents into work is at the heart of the Government's strategy to tackle child poverty. It also illustrates that the reduction in child poverty is concentrated amongst workless families with 1.4 million poor children living in workless households—a reduction of 2 million from the total 10 years earlier. Ms Carey Oppenheim, Co-Director of the IPPR, told us that, "to some extent, probably what people are doing is exchanging more severe poverty out-of-work for less severe poverty in-work and that is probably better, but we definitely think people should be able to get out of poverty once they are in paid work".[371] However, despite the large number of children in poverty where at least one parent is working, it is important to remember that the risk of poverty for children in working families is relatively low at 14% compared to a 58% risk of poverty for children living in families where no one works.[372]

IN-WORK POVERTY AMONG THOSE WITHOUT DEPENDENT CHILDREN

147. A number of submissions highlighted the growth of in-work poverty among those without dependent children, an issue which, until recently, had received relatively little attention from policy-makers and the media. The NPI told us that "the furore over the 10p should also alert us to the fact that in-work poverty is by no means confined to those with children … the number of adults without dependent children who are in in-work poverty has risen over a decade from 1 to more than 1.5 million."[373] The NPI went on to tell us that "these working people, without dependent children yet in poverty, are now almost as numerous as working parents with dependent children in poverty".[374]

MARGINAL DEDUCTION RATES

148. The Treasury defines the poverty trap as occurring "when those in work have limited incentives to move up the earnings ladder because it may leave them little better off".[375] Marginal deduction rates are used to measure how far people's incentives to increase their income are being reduced. For instance, a marginal deduction rate of 70% means that, for every one pound of additional gross income, 70 pence of that extra pound is taken away, either by taxes or a reduction in benefits.

149. The Government has stated that "as a result of the introduction of tax credits, in combination with other reforms, individuals have improved incentives to progress in work".[376] The Treasury told us that "to help make work pay, the Government has also reduced the number of families facing the highest marginal deduction rates (above 70%) by over half a million since 1997".[377] As can be seen from Table 4, the Government has sharply reduced the number of working families with the highest marginal deduction rates of over 90%, from 130,000 before the 1998 Budget to 25,000.

Table 4: Number of working heads of non-pensioner families with high marginal deduction rates: changes since 1997

Marginal deduction rate	Before Budget 1998	2008-09
Over 100%	5,000	0
Over 90%	130,000	25,000
Over 80%	300,000	150,000
Over 70%	740,000	185,000
Over 60%	760,000	1,860,000

Source: Ev 126. Numbers given relate to marginal deduction rates for working heads of non-pensioner families in receipt of income-related benefits or tax credits where at least one person works 16 hours or more a week, and the head of the family is not receiving pensioner or disability premia: see Budget 2008, p 62, Table 4.2.

However, Table 4 also shows that the number of people caught by a marginal deduction rate between 60% and 70% has risen sharply, from 20,000 before the 1998 Budget to 1,675,000. We asked the Treasury about the large increase in the number of families facing marginal deduction rates of between 60% and 70% during our inquiry into the 2008 Budget. At that stage, Treasury officials told us that "the main reason for that is … as a result of the 2007 Budget measure that introduced extra help through tax credits from 2008. That brought more people into tax credits, the result being that more people then faced higher marginal deduction rates."[378] The Government has argued that "looking at marginal deduction rates alone gives an incomplete picture of work incentives". In Tax credits: improving delivery and choice, it said that this was because:

They ignore some key features of the tax and benefit system, such as the effect of the tax credits income disregard, which allows people to increase their income during the year without having their tax credits withdrawn in the current year. In addition, they only look at marginal changes in income whereas, in reality, changes in income tend to be larger and can move people off the tax credits taper or entitle them to additional support (through, for example, the 30 hours element of the Working Tax Credit). This means that the choice for individuals tends to be not about earning at the marginal rate but about much larger movements in income.[379]

150. The NPI noted that "tax credits are the Government's tool of choice when it comes to poverty",[380] before expressing concern that tax credits were increasing the marginal deduction rates faced by many lower-income families.[381] Mr Kenway said that "the longer term objective should be directed at ending the situation we have at the minute where the marginal rates of deduction … are basically 70% for anybody receiving a tax credit above the minimum".[382] The NPI argued that:

It cannot be said loudly enough that such high 'tax' rates (for that in effect is what they are) are quite absurd: the very households who would most benefit from even small amounts of extra money face the highest tax rates which reduce their net gain from extra earnings to a pittance. Substantial reductions in the marginal rates of 'tax' faced by low income working households are an essential part of the anti-poverty strategy going forward … [and] that a programme of 'cutting taxes at the bottom' is now required to help reduce in-work poverty. Increasing the income tax personal allowance is an integral part of this; although other measures are needed too.[383]

The IPPR also focussed on weak work incentives and, in particular, on what they described as the 'pinch points' in the benefits and tax credits system, which create the weakest work incentives and the greatest financial insecurity. The IPPR noted that "Housing Benefit and Council Tax Benefit are central to the problem of high marginal tax rates".[384] We discuss Housing and Council Tax Benefit further in chapter 7.[385]

Conclusions

151. Further measures arising from the removal of the 10 pence rate of income tax must be considered in the context of the wider objectives that the Government is seeking to achieve through the tax and benefits system. The case for action to meet the Government's target to halve child poverty by 2010-11 is more pressing than ever given the further rise in child poverty by 100,000 children in 2006-07 to 2.9 million before housing costs. Pensioner poverty rose significantly in 2006-07, by 300,000 to 2.6 million before housing costs, reversing the welcome downward trend since 1997. Progress on fuel poverty is being reversed by rapidly rising energy prices. The recent announcements on a social tariff, data-sharing and pre-payment meter charges are welcome, but much more needs to be done. The Government should consider urgently the case for extending the social tariff for all domestic energy suppliers, such as suppliers of liquified petroleum gas, heating oil and bottled gas, including through further legislation. The advances made in tackling poverty among those out of work in the last decade has not been matched by comparable progress in tackling poverty among those in work. We note that the total cost of the 13 May measures was exactly the amount required to meet the Government's child poverty target. In responding to the concerns arising from the removal of the 10 pence rate of income tax, the Chancellor of the Exchequer has been forced to reconsider the balance between a complex system of tax credits and a simpler, more transparent approach. Looking ahead, the benefits of simplicity, transparency and of reducing disincentives to work should be considered alongside the Government's other objectives.

270 Budget 2008, p 23, para 2.32 Back

271 Ibid., p 23, para 2.33 Back

272 HC (2007-08) 430, Q 42 Back

273 Budget 2008, p 23, para 2.33 Back

274 HC (2007-08) 430, Q 44 Back

275 Ibid., para 36 Back

276 Treasury Committee, Tenth Special Report of Session 2007-08, The 2008 Budget: Government Response to the Committee's Ninth Report of Session 2007-08, HC 689, p 3 Back

277 HM Treasury, Forecasts for the UK economy: a comparison of independent forecasts, March 2008, p 1, Table 1 and p 4, Table 4 Back

278 HM Treasury, Forecasts for the UK economy: a comparison of independent forecasts, May 2008, p 4, Table 1 and p 7, Table 4 Back

279 HM Treasury, Budget 2008: the economy and public finances-supplementary material, March 2008, p 34, Table 21 Back