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The second problem, to which he devoted most of his time, is what the Opposition, and he today, have called “errors”. It is fair to say that when we introduced the Tax Credits Bill we did not predict that 50 per cent of lone parents would undergo more than a dozen changes in circumstance a year. Those include changes in childcare arrangements virtually every school holiday, changes in hours worked and sometimes a change of partner. The result is that if, as the noble Lord suggests, you seek to track every change and every three to four weeks change the credit for half the population claiming tax credits, even if the computer could handle it, I doubt very much whether the lone parent could. Such adjustments would be made six weeks in arrears and there would be no way in which that parent would be able to construct a family budget with such unreliable and non-robust flows of income, especially as some of the changes in circumstance cancel each other out.

That is why the Government, rightly in my view, went for a balance-sheet adjustment at the end of the year. The problems occurred disproportionately because, again, I think that the Government underestimated the occasions on which the female in a couple household went into work and produced a major increase in family income—often used to pay off the debts acquired by the couple over the previous years—but that was not reported early enough.

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Therefore, at the end of the year, the couple faced a very large overpayment bill, which the departments involved rightly sought to reclaim. It is a fact of human nature that people are much more likely to report a drop than a rise in income. The Government increased the head space from £2,500 to £25,000 so that in the one year in which the female goes back to work the couple is not bedevilled by these problems—it may be the one opportunity that they have to pay off their debts. Simultaneously, the Government also require monthly, as opposed to three-monthly, reviews of information. I hope that those measures together will address the problem.

As for errors in the conventional sense, mentioned by the noble Lord, I was amazed at how few there are. Something like 95 per cent of the poorest families—lone parents—claim their entitlement. There is something like a 98 per cent accuracy rate, which is amazingly good.

I have three questions for my noble friend. The first concerns the problems associated with larger families. Half of all poor children live in larger families—not necessarily one-parent families, but often couple families who are out of work, or black, minority ethnic families. Yet in Britain we concentrate benefit and support on the first child. In most of Europe, more money goes to later children in the family. Will my noble friend tell us the Government’s thinking on introducing either a later-child premium or some balancing factor, so that that problem can be addressed? The Institute for Fiscal Studies has shown that that would be the single most effective tool in simultaneously reducing out-of-work poverty for children and increasing in-work incentives for parents because they would continue to take that premium into work with them. I hope that my noble friend can give us some good news on that.

My second question for my noble friend is whether grandparents who provide childcare might be eligible for the childcare tax credit. At the moment it goes only to registered childminders, but the real test for a lone parent on whether she is willing to go into work and sustain work when it gets difficult—if the child is sickly or if there are difficulties in hours—is whether she has childcare that she can trust, that she is confident in and that will hang on in. That is usually childcare of the sort that she would give, provided by someone who loves the child, so that the mother is guilt-free. That often means childcare by her own mother. Those grandparents may themselves have been lone parents, often living in poor estates. Such a measure would allow us to help three generations of families: the women in their 50s who need to work, their daughters who seek work and their children whom we must lift out of poverty. What is my noble friend doing on that?

Finally, we have a national minimum wage and national levels of tax credits. Yet we all know that the cost of living, transport and housing varies widely within the UK between the south-east and other regions. Has the Government’s thinking moved at all on a regional premium on the minimum wage or on tax credits? If so, what will happen?

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Tax credits have been transforming for families—particularly for lone parents. A young mother with a child who would be earning barely £5 or just above on a minimum wage can take home a man’s wage—double that. Because she has a tax credit that makes working pay, and a child tax credit that is earnings related, which means it keeps pace with rises in real wages, we have been able to transform the opportunities for lone parents and their children. Tax credits are a government measure of which I am hugely proud, which along with the introduction of the minimum wage have been transforming for parents and children alike.

7.18 pm

Viscount Trenchard: My Lords, I am most grateful to my noble friend Lord Northbrook for introducing the debate on tax credits. My gratitude is without the reservation shown by the noble Baroness, Lady Hollis.

I am surprised that it has taken so long for the public at large to ascertain just how inefficient and wasteful is the absurdly complex system of taxes, tax credits and benefits that the Government have introduced. The Government spent £15.4 billion on tax credits in 2006-07 compared with £2.4 billion spent on family credit in 1997-98. The increase in expenditure is equal to more than 4p on the basic rate of income tax. Will the Minister tell us the total cost in the past year of administering the tax credit system, including reclaiming overpayments? Further, will he tell the House what that sum would translate to in terms of the basic rate of income tax?

As proposed by my noble friend Lord Forsyth of Drumlean, and his Tax Reform Commission in an excellent report published last week, the need for tax credits could be reduced by increasing the personal allowance and making it transferable between parents of young children. The tax credits system is so complicated as to be incomprehensible to most people, and a severe disincentive to those in work but on low incomes to work harder and earn higher salaries or win promotion, because the progressive withdrawal of tax credits has created an effective marginal rate of 70 per cent or more for many workers. As the Institute for Fiscal Studies has pointed out, the weakest work incentives are encountered by people on low incomes who face having their means-tested benefits or tax credits withdrawn if they increase their income. More than 2 million workers in Britain stand to lose more than half of any increase in earnings to taxes and reduced benefits. Some 160,000 would keep less than 10 pence of each extra pound they earned.

Tax credits have provided some incentive for people to move from unemployment into low-paid employment. However, as the report of my noble friend Lord Forsyth pointed out, they are not well focused on reducing poverty. The noble Baroness, Lady Hollis of Heigham, has claimed that tax credits have made a great contribution to reducing the gap between rich and poor, and between men and women. However, child tax credits can be claimed by families earning nearly three times the average national income. The poorest fifth of households are therefore paying a higher share of tax, and receiving a lower share of benefits, than they were when the

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Government came to power. As my noble friend Lord Blackwell pointed out in his excellent paper, Take Poor Families Out of Tax, published in October last year, a further disadvantage of the tax credits system is that, since credits are calculated on the previous year’s income, many families find that their income fluctuates widely. If their income rises, they may find themselves faced with an unexpected and unaffordable bill to pay back credit payments which they have already spent.

This inefficient system has created a serious and expensive problem of benefit fraud. For three consecutive years, the extent of overpayments due to error or fraud has led the National Audit Office to qualify its audits of taxes and tax credits. My noble friend Lord Northbrook has already well illustrated this point.

“Tax credits” is a misnomer. These benefit payments are not credits against taxes. The Government massively overtax low-income families and then, at enormous administrative cost, give money back to the same people. In the process, they create a demotivating dependency culture and remove—or substantially dilute—incentives for people to better themselves.

There is, or was, another kind of tax credit: dividend tax credits. Mr Liam Halligan, economics editor of the Sunday Telegraph, said in his excellent article of 15 October that Terry Arthur, a fellow of the Institute of Actuaries, supported by Watson Wyatt, calculates that the Chancellor’s first and worst stealth tax raid, the abolition of dividend tax credits—real credits against corporation tax—had actually cost pension schemes up to £150 billion. The Minister may, or may not, remember that, in the debate on the Loyal Address on 18 May last year, I estimated that the stealth tax raid had actually cost some £166 billion. I am no actuary, but I feel I am in good company now.

Against the background of changing demographics, the Chancellor’s raid on our pension funds was the largest single factor leading to the present crisis in retirement provision. It is therefore all the more necessary to cast away the cumbersome, wasteful and highly inefficient scheme of working tax credit and child tax credits without delay and use the savings to procure a substantial increase in the personal tax allowance to, say, at least £7,500, transferable between spouses, thus freeing millions of people from the burden of paying tax at all. It will be hard for the Minister to claim that the operation of the tax credit system is satisfactory, and I look forward to his reply.

7.25 pm

Lord Giddens: My Lords, tax credits do not seem to be bringing out noble Lords in droves, especially during their dinnertime, but I shall be less diffident than my noble friend Lady Hollis in thanking the noble Lord, Lord Northbrook, for initiating this debate. Tax credits may not be in the foxhunting league, but their impact on the country is much greater.

Tax credits have a long history. They were initiated in the United States in the 1970s by Senator Russell

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Long. They began as a relatively uncontroversial, small scheme of incentives to get to people into work. They were generalised during the Clinton Administration, and they effectively became a very large anti-poverty programme. As the noble Lord mentioned, tax credits have been used for many other purposes—for example, President Clinton introduced environmental tax credits—but I shall speak mainly on the relationship between tax credits and the alleviation of poverty because that is where they are most important.

If we look at the record of the Clinton Administration, the impact of tax credits was immense. They were the main reason why approximately 10 million people were lifted out of poverty during his period in power. At the end of that period, the number of people below the poverty line in the United States was the lowest it had been for 25 years. In the United States, it was a very successful policy, and it is not surprising that it was initiated here, albeit under a different name: the working families’ tax credit.

As my noble friend Lady Hollis said, tax credits are a powerful instrument. That is so for several reasons, and it is important to bear them in mind when discussing issues of complication, overpayment and so forth. First, they are non-stigmatising. They are not perceived, as orthodox, passive benefits often are, as stigmatising to the people who claim them and to the rest of the population who fund them. That is an important quality of tax credits compared with orthodox benefit payments. Secondly, they are a positive incentive for job search and job creation more generally. When Senator Long introduced tax credits, they were a reaction against Milton Friedman’s negative income tax, one of the problems of which was that it would effectively have acted as a disincentive to work, unlike tax credits. Thirdly, tax credits connect social policy and economic policy. That is why they have been such an important element of government policy. They get a lot of people into work and alleviate poverty at the same time because we know the best way of doing that is to get people into jobs. At the same time, they directly contribute to economic dynamism. There are very few social policies that do both those things.

The record of this country in job creation and employment is substantial. Some of the major EU economies, such as France or Germany, have about 64 or 63 per cent of the labour force in work. In the UK, about 74 per cent of the labour force is in work—one of the top figures not only in the EU but among OECD countries. That is crucial, because it generates the tax revenue that makes possible investment in public services.

A fourth reason why tax credits are so important is that, unlike many other benefits systems, they have a proven track record. They have been used in the United States for quite some time and a large number of studies show that they work: they benefit some of the poorest sectors of society and, crucially, they provide an important and direct incentive for job search and job creation.

One must concede, as my noble friend Lady Hollis conceded, that there are problems with tax credits. The question is whether those problems are, in the

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light of what the noble Lord, Lord Northbrook, said, structural or the result of how they are implemented. That is crucial. One should recognise that all benefits have problems. Again, as my noble friend said, if you have a straightforward universal benefits system, the problem is that a lot of money goes to people who do not really need it. There will always be problems and dilemmas in the relationship between targeted and universal benefits. No system is perfect.

The first problem, much discussed in the British press recently, is that of overpayment. It is best to look to the United States to see whether that is a structural problem or whether it is largely the result of the computer system—or, I think one must say, mistakes made. The evidence from the United States is pretty clear. There was overpayment in the beginning in the United States. That has been radically reduced. There was a lot of fraud initially in the United States, but that has been radically reduced. There is still some overpayment in the US, but it is much less than it was. That leads me to conclude that overpayment is not primarily a structural problem of tax credits and that we should be following the same procedures as have been instituted in the United States to reduce those problems.

The second issue, also mentioned by noble Lords, is the fact that the tax credits are complicated and difficult to understand. If I may say so, one must have a nuanced view of that. Simplicity is of course a virtue, but it is not the sole virtue of a tax system, especially when we recognise the crucial fact that fiscal systems have an impact on behaviour. That is a crucial aspect of what tax credits do. Much more important than sheer simplicity is whether they do the job of bringing the money to the right people in the right way at the right time. I take it that that was the point raised by the noble Lord. I think that we must have a flexible system. Therefore, I am not in favour of the proposal that seems to have been made by the Liberal Democrats of having a six-month stable payment. Because poverty is so complex and changes so much even during the course of a year, you must have a flexible system. One of the main things that we have discovered about poverty is that it is not a unitary state. Poverty has so many different faces and any system must be tailored to that.

Thirdly, we must be careful that the old poverty traps do not return. That can happen if tax credits are not properly adjusted as times and income levels change. We know that the old poverty traps put poorer people in a terrible situation of having a much higher marginal rate of taxation than more wealthy people. There is a danger that the tax credit system can drift towards that as well if we do not modify it as it goes along. I would like to hear the Minister's comments on what has been said by members of our party, such as Alan Milburn, who has expressed reservations from that point of view and, perhaps, on the recent Rowntree report, which also expressed reservations about that. That is an important part of the debate.

However, I very much diverge from the noble Lord over tax credits. I think he would have to look very hard to find another system that links together

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increasing social justice, economic dynamism and employment in a single-policy system. It would be a great mistake to disentangle them, which is why I was very pleased to hear the noble Lord, Lord Northbrook, say that he fully supported the idea of tax credits in principle. I think that is what he said.

Finally, anyone can make a mistake about tax systems and fail to understand them. I leave noble Lords with this little story. A tax inspector goes to see a businessman with a multi-million pound business. He knocks on the office door and says, “I’m the man from the VAT”. The businessman behind the desk says, “You’re a bit premature. I haven’t decided whether I will join yet”.

7.35 pm

Lord Oakeshott of Seagrove Bay: My Lords, this has been a short debate but one that shows some of the strengths of this House. We have had a good range of people talking about practical difficulties in the system, as well as with great expertise about its more theoretical aspects.

I congratulate the noble Lord, Lord Northbrook, on keeping this problem in front of us and on continuing to try to hold the Government to account. He painted a serious picture, which I believe is correct, of continuing inefficiency, overpayments, underpayments, error and fraud in the tax credits system.

The noble Baroness, Lady Hollis, spoke with her unique combination of commitment and expertise, and I will certainly develop her argument about the employment and poverty trap and about the effect of housing and other benefits. I do not, however, agree with the thrust of her summary of the very important Institute for Fiscal Studies report, supported by the Joseph Rowntree Foundation, about which I propose to say a little more.

The noble Lord, Lord Giddens, also gave us a useful historical sweep, but I cannot agree that tax credits are not a disincentive to work. A careful study of the IFS report would make him think very hard about that. Briefly, he spoke about the Liberal Democrat proposals to re-fix tax credits every six months. I agree that flexibility is fine, and obviously one would like the system to work better. The problem at the moment is that the system seems to be seizing up, and re-fixing tax credits every six months is a short-term practical proposal to help.

The noble Viscount, Lord Trenchard, concentrated on administrative costs and reclaiming overpayments, and followed the main thrust of the noble Lord, Lord Northbrook. I notice that he called the Forsyth commission’s report excellent. Is the noble Baroness, Lady Noakes, allowed to agree with that from the Conservative Front Bench, or would it break Mr Osborne’s vow of silence? He seems to have invented a whole new concept. Noble Lords may remember that the Chancellor of the Exchequer used to go into pre-Budget purdah for a few weeks. The new Osborne doctrine seems to be that shadow Chancellors go into pre-election purdah for about four or five years and cannot talk about tax at all.

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I mentioned the IFS report, The poverty trade-off: work incentives and income redistribution in Britain, which came out earlier this month. I pay tribute yet again to the great work that the Joseph Rowntree Foundation does in supporting valuable public-policy initiatives of this kind. The conclusions were that Labour’s reforms to date have acted to weaken both incentives to be in work at all and incentives for those in work to increase their earnings. It rightly draws particular attention to the fact that housing benefit recipients have some of the weakest work incentives of all. As the noble Baroness, Lady Hollis, pointed out, it is the interaction of that with other benefits that really makes marginal tax rates on poor people very high. The Government must face up to this very serious disincentive to work and let people on housing benefit, particularly, keep more of their earnings as they work more.

The IFS report refers to lone parents, whom Labour talk about a great deal, and points out that this group still has the weakest work incentives of the six demographic groups that it considered. It says that the number of lone parents has more than doubled since 1979 and that this should be a key focus for the attention of policy makers. The IFS goes into considerable detail and puts a very powerful case when it states that,

We have to face that increasing the child element of CTC in particular would reduce the incentive to work substantially for large numbers of people. The report points out how a classic increase in means-tested support is very successful in targeting money at the poor, but is very weak for work incentives. In the face of this evidence, I do not see how the noble Lord, Lord Giddens, can argue that work incentives are not weakened.

This short debate has focused on operational difficulties, but more on what I would call fundamental design faults in the tax credits system, which, because it is so complicated, makes it operationally very difficult and undoubtedly affects work incentives.

Lord Giddens: My Lords, will the noble Lord clarify what he just said? I am not sure whether he is arguing against me. I was arguing that negative income taxes tend not to work because basically they are disincentives to work, whereas tax credit systems work much better. If they are fine-tuned properly, they help to get a lot more people into work.

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