Written evidence submitted by the Low
Incomes Tax Reform Group (LITRG)
INTRODUCTION
1. The Low Incomes Tax Reform Group (LITRG)
is an initiative of the Chartered Institute of Taxation (CIOT)
to give a voice to the unrepresented. Since 1998 LITRG has been
working to improve the policy and processes of the tax, tax credits
and associated welfare systems for the benefit of those on low
incomes.
2. The CIOT is a charity and the leading
professional body in the United Kingdom concerned solely with
taxation. The CIOT's primary purpose is to promote education and
study of the administration and practice of taxation. One of the
key aims is to achieve a better, more efficient, tax system for
all affected by it—taxpayers, advisers and the authorities.
3. In this submission we consider tax and
tax credits aspects of the Spending Review that will most affect
low-income taxpayers and (in the main) claimants—the joint
HMRC and DWP proposals on fraud and error, and the tax credits
changes.
FRAUD AND
ERROR
4. HMRC has been set a target to reduce
its administration costs by 33% over the spending review period.
The Department's resources are to be "more effectively focused
on collecting revenue and providing better services for taxpayers".
At the same time, HMRC are charged, along with DWP, with reducing
fraud and error by £2 billion a year by 2014-15.
5. To conflate "fraud and error"
is misleading. Fraud involves intention to deceive, and is a criminal
offence. Error can stem from failure to take reasonable care,
or simple mistake despite having taken reasonable care. HMRC recognise
this distinction in their own legislation on penalties, and they
also recognise the difference between deliberate and non-deliberate
default.
6. Clearly therefore, to get an accurate
picture of the loss to the Exchequer generated by "fraud
and error", fraud has to be analysed separately from error
and tackled differently.
Types of error
7. Error falls to be sub-divided into customer
error and what one might call "official error".
Customer error
8. First, there is undisputed customer error.
About that, the National Audit Office has this to say in the context
of tax credits:
9. "Claimants have not always understood
their obligations to tell the Department when their circumstances
change and to report their actual income and circumstances at
the end of the year. Claimants also make genuine errors in their
applications which result in incorrect awards, for example because
they misunderstand what should be reported as income, or calculate
childcare costs incorrectly."[56]
10. Error can result not only in overpayments,
but also underpayments. "The Department's latest estimate,
based on finalised awards for 2008/09, indicates that error and
fraud resulted in between £1.95 billion and £2.27 billion
(8.3% to 9.6% of the finalised award)... In addition, the Department
estimates that error led to between £0.20 billion and £0.31
billion (0.8% to 1.3% of the final award) not being paid to claimants."[57]
11. We question whether the effect of underpayments
of tax credits or benefits, or overpayments of tax, has been fully
factored into the published figures on "fraud and error".
Overpayments of tax credits through official error
12. Official sources measure overpayments
due to official error in DWP-administered benefits at £1.1 billion,
in HMRC-run benefits at nil.[58]
Yet to our certain knowledge overpayments of several millions
of pounds have been written off by HMRC due to official error
overpayments within tax credits.
13. HMRC's code of practice on tax credit
overpayment recovery, COP 26, prescribes two reasons for HMRC
to write off an overpayment. One is in cases of hardship, the
other is where HMRC have "failed to meet their responsibilities"
to the claimant (known as "official error" in pre-January
2008 editions of COP26). Overpayment debt can also be written
off where it is irrecoverable, or collection would be uneconomic
having regard to the cost of recovery. Since April 2003, HMRC
has written off £1.7 billion of tax credits overpayments
and estimates that the collection of a further £2.5 billion
is doubtful.[59]
It is not known how much of this is due to official error write-offs
and how much to uneconomic costs of collection or the claimant's
inability to pay. But clearly, given the published data in HMRC's
own accounts, official error write-offs, while they may not be
as much as £1.7 billion, are not immaterial.
Official "misdiagnosis"
14. There is, apparently, a drive to "improve
professionalism by ensuring that staff working on tax credits
have the right skills to do the job".[60]
However, such professionalism has not been much in evidence in
some of the compliance interventions we have seen, and this represents
one category of "contributory error"—where HMRC
pursue a claimant when in fact HMRC are in the wrong and the claimant
is right.
15. For example, HMRC might wrongly decide
that a married couple who separate and claim tax credits separately
are actually still together, thereby generating a customer error
overpayment that turns out, when the true situation is established
(eg on appeal to the Tribunal), to be entirely illusory.
Official "contributory" error
16. A third category of official error,
"contributory error", occurs where officials give mistaken
advice which when acted upon by customers leads to customer error.
It also occurs where a customer is misled, or left in ignorance,
because of:
— unnecessarily complex systems and processes,
— computer-generated "help",
— inadequate or no explanation of difficult
parts of the law,
— incorrect programming of calculators.
Effect on the findings in the Spending Review
17. We conclude that an indiscriminate attack
on "fraud and error", without attempting to distinguish
the two concepts and without a proper analysis of the contribution
Government agencies make to error in the system, could result
in inflating the figures, penalising innocent error inappropriately,
and missing the opportunity for real reductions.
TAX CREDIT
ANNOUNCEMENTS
18. We are concerned that the proposed changes
to working tax credit will have a detrimental effect on work incentives,
while detracting from the welcome increases in the child element
of child tax credits. We are also concerned at the negative impact
on people with a disabled family member, an unintended side effect
of these measures.
Working tax credit—freezing basic and couple/lone
parent elements
19. Freezing the basic and couple/lone parent
elements of working tax credit (WTC) will increase the fall in
the child tax credit (CTC) first income threshold (ie the point
in the income scale at which CTC begins to be tapered away for
CTC only claimants) already brought about by the change in the
taper rate from 39% to 41%. To some extent this is offset by the
above-indexation increases in the child element of CTC in 2011-12
and again in 2012-13.
20. But the overall effect is to shift support
away from the work incentive instrument of WTC while trying to
maintain the support given to families with children through CTC.
However, eligibility to a number of passported benefits (ie benefits-in-kind
to which entitlement to mainstream benefits or tax credits gives
automatic entitlement, such as free school meals or healthy start)
is fixed by reference to the CTC income threshold, so if it drops
a number of people on the cusp of poverty will fall out of eligibility
to some passported benefits.
Removing WTC entitlement from couples with children
who work between 16 and 24 hours
21. This measure only affects couples where
one partner works at least 16 hours a week but less than 24, and
either the other partner does not work at all, or both partners
work less than 24 hours a week between them.
22. In our view this measure is regressive
and has a disproportionate impact on families with a disabled
member. It is regressive because it will primarily affect people
on incomes low enough to receive full WTC, whereas people on modest
incomes whose WTC is restricted by the 41% taper will not be affected
as much. Generally, those on higher incomes, whose WTC entitlement
has been completely tapered away and whose tax credits consist
entirely of CTC, will not be affected at all.
23. For instance, a couple earning £6,000
a year and who work 22.5 hours a week between them (one working
16 hours, the other 6.5 hours), with two children, will lose nearly
£4,000 WTC as a result of this measure. The same couple earning
£10,000 a year will lose about £2,500 WTC, while if
they earn (say) £17,000 they will lose no WTC at all. There
is a single exception in the case of a claimant family entitled
to the severe disability element of WTC (see para 26 below).
24. It is fair to say that those who lose
out may be partly compensated by increased access to means-tested
benefits and passported benefits. However, they suffer a net loss.
Effect on families with a disabled member
25. We believe that a typical profile of
claimant affected by this measure might be a family whose ability
to achieve the requisite hours is limited because they have caring
responsibilities. It is therefore quite likely that families with
a disabled member will lose out disproportionately.
26. This pattern is carried through to higher
income groups. For example, a claimant couple where one claimant
works and the other receives the severe disability element (SDE)
of WTC will lose out, even if they would not be receiving any
WTC now because their income was too high. The reason for this
is that SDE is not taken into account in setting the first income
threshold for CTC, so for them the loss of SDE will not be compensated
by any rise in the point at which their CTC begins to be progressively
withdrawn. Hence their CTC will drop.
27. Also, if one partner works (say) 20
hours a week and the other is incapacitated, the claimant couple
under current rules is entitled to receive the childcare element
of WTC which can be substantial. Unless the regulations make an
exception in such instances, the 24 hour restriction will mean
that this couple will lose their WTC including their childcare
element. In most cases this is likely to result in the working
partner having to give up work altogether.
Reduction in childcare element of WTC
28. The childcare element of WTC has been
given at 80% of eligible childcare costs since 2006, but next
year the level of support will come down to 70% of costs. A change
that could go unremarked unless attention is drawn to it is the
effect this will have on people eligible to claim tax-free and
NIC-free childcare vouchers from their employer. At present, it
is generally disadvantageous for a family on a modest income and
in receipt of tax credits to accept childcare vouchers from their
employer and lose tax credits on the childcare costs covered by
the vouchers. However, the fall in childcare support through WTC
could shift the balance the other way for some claimants.
29. HMRC will need to revise their calculator
to take account of this change, and educate their staff and the
public accordingly.
USE OF
PAYE REAL-TIME
INFORMATION FOR
TAX CREDITS
AND BENEFITS
30. The HM Treasury publication Spending
Review 2010 Policy Costings bases its estimates of savings in
2014-15 through the use of real time information (RTI) for tax
credits on the presumption that 25% of tax credit claimants will
migrate to Universal Credit in that year (mainly out of work claimants)
and that the real time PAYE data has an accuracy rate of 90%.
31. If RTI can be made to work, it will
undoubtedly have a positive impact on accuracy in the tax system.
In addition, if it were possible for tax credits to be linked
to RTI, the onus on claimants to notify changes in income would
be reduced, as would income-related overpayments (although there
would in our view be little impact on the main cause of overpayments,
namely late-reported or late-processed changes in claimants"
circumstances as opposed to income).
32. While applauding these objectives, we
have reservations about whether they are fully achievable. PAYE
income is determined on a cumulative basis throughout the year,
whereas tax credits income depends upon comparing the income of
the current year with the preceding year, taking into account
the "disregard" or extent to which income can increase
in a tax year without affecting the award. In short, the two measurements
of income in PAYE and tax credits are so radically different that
it would in our view be virtually impossible to link tax credits
with PAYE real time data without a complete realignment of the
income definitions.
33. Even if such a realignment were achieved,
it would still be necessary to overcome the mismatch between the
unit of assessment for taxation (the individual) and for tax credits
(the joint claimant, or couple). One can imagine the complexity
if a taxpayer/claimant forms a relationship or finishes one, or
is in more than one relationship, during a year. The system will
somehow need to analyse individual income data into couples, sometimes
more than one in the course of a year. The challenge will be all
the greater if one member of the couple is an employee in PAYE,
and the other is self-employed.
34. Nevertheless, if the benefits and tax
credits system were reformed along the lines set out in the DWP
consultation document 21st Century Welfare, RTI could ultimately
lay the foundations for a single unified set of income definitions
and units of assessment for both tax and welfare payments, whether
credits or benefits. Such an alignment must make administrative
sense and eventually produce cost savings. But whether it can
be achieved by 2014-15 as suggested in the HM Treasury paper cited
above is quite another matter.
November 2010
56 HM Revenue & Customs 2009-10 Accounts: Report
by the Comptroller and Auditor General, para 4.3. Back
57
Ibid, para 4.5. Back
58
Joint DWP/HMRC publication Tackling fraud and error in the benefit
and tax credits systems (October 2010), p 12. Back
59
HM Revenue & Customs 2009-10 Accounts: Report by the Comptroller
and Auditor General, para 4.28. Back
60
Ibid, para 4.10. Back
| 
