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Lord Oakeshott of Seagrove Bay: My Lords, I thank the noble Lord for that. I do not think that I misheard him. I do not disagree with him on negative income tax, but I understood him to say that tax credits did not have disincentive effects. Obviously, I accept that he was talking particularly about America, which may have had longer to refine the operation of the system. My point in encouraging people to study this IFS report is that as tax credits
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Baroness Hollis of Heigham: My Lords, I apologise for intervening again on the noble Lord’s contribution, which is extremely interesting. The IFS report goes into detailed analysis of household types in chapters 5 and 6 in particular, tracks them longitudinally over time and sets against that an array of different possible interventions available to Government—large family premium, CTC, working family tax credit and so on. The Institute for Fiscal Studies recognises, first, that incentives to go into and to stay in work are stronger in 2005 than in 1979 and that, secondly, notwithstanding all the other possible remedies—though some may be more effective than others—there is very little scope. Does the noble Lord agree that because of the trade-offs built into any system linking social and economic policy, government interventions would make differences at the margins that might be worth having, but that that does not mean—the IFS never says this—that tax credits as a policy should be abandoned as a result?
Lord Oakeshott of Seagrove Bay: My Lords, no, we do not say that they should be abandoned. I know of course that the noble Baroness will have read the report carefully. I have chapter 6 with me. No one is suggesting that things have not improved since 1979: it would be a grim state of affairs if they had not. It says that identifying those very serious disincentive effects—there are various charts—for some groups shows that tax credits in their current form are not working for those groups. Given all the improvements that have been made under the noble Baroness among other people, that is still a serious criticism of our system nine years into a Labour Government.
7.45 pm
Baroness Noakes: My Lords, my noble friend Lord Northbrook has chosen for debate today a very important question which has had too little attention in your Lordships’ House. I agree with the noble Lord, Lord Oakeshott, that it has been a wide-ranging and thoughtful debate which has shown the strength of the House. It has also, incidentally, given my noble friend Lord Trenchard another opportunity to remind the House about the Chancellor’s raid on pension funds by way of dividend tax credits.
The noble Lord, Lord Oakeshott, taunted me with my noble friend Lord Trenchard’s reference to the report last week of my noble friend Lord Forsyth—the Tax Commission’s report—which he described as excellent.
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The importance of tax credits goes beyond the routine assessment of government policies, because they are the Chancellor of the Exchequer’s personal project, and they give us insight into the Chancellor and his aims. The outcomes of the scheme must reflect on him. That is important when we start to look at what might happen if the Chancellor moves into No. 10 as he clearly wishes to in the immediate future.
The Chancellor said some four years ago, when he was launching an advertising campaign for tax credits, that:
“The new tax credits ... are central to this Government’s goals of not only tackling child poverty and making work pay but ensuring family prosperity for all”.
Those were the goals he set four years ago. During Starred Questions, the Minister told the House that these goals had been achieved. He said that,
- “this has been an ambitious system that has delivered three key achievements. It has improved incentives to work; it has reduced the tax burden on low- to middle-income families; and it has helped dramatically to reduce child poverty”.—[Official Report, 7/6/06; col. 1259.]
I should like to examine these claims and set what has been achieved against the very real problems that exist in the tax credits system, which my noble friend Lord Northbrook laid out so well.
The first claim made by the Minister was that the tax credits system has improved incentives to work. The noble Lord, Lord Oakeshott, referred extensively to the IFS study on behalf of the Joseph Rowntree Foundation—neither organisation could be said to be a spokesman for Conservative Party thinking. The report found that incentives to work and earn more had strengthened since 1979 but they have weakened since 2000, the period during which tax credits were introduced. It said:
“Overall, reforms under the Conservatives acted to strengthen average work incentives whereas Labour’s reforms to date have weakened financial work incentives on average; since 1999 tax and benefit changes have increased the average effective marginal tax rate by almost 3 percentage points”.
We have discussed the effective marginal tax rates today. For the best paid workers in the land, such as the Minister, it is 41 per cent. As the noble Lord, Lord Oakeshott, and my noble friend Lord Trenchard have pointed out, more than 2 million workers stand to lose more than half of any increase and 160,000 would keep only 10p in the pound. As the noble Baroness, Lady Hollis, pointed out, this is the toxic effect of the combination of tax, national insurance, tax credits, council tax benefit, housing benefit and any other benefits that have a withdrawal rate. The plain fact is that means-tested benefits, which is what tax credits are, weaken work incentives. The UK has the worst poverty trap in the OECD for moving from part-time to full-time work.
I do not dispute—I could not—that many families have benefited from the introduction of tax credits alongside part-time and low-paid work. But if effective marginal tax rates are too high, this effect will not encourage those families to progress further into reduced
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The second claim is that tax credits have reduced the tax burden on low- to middle-income families. One of the features of the tax system in this country is that income is taxed at relatively low levels and that fiscal drag, especially engineered by the current Chancellor by holding allowances down below the rate of earnings growth, has ensured that many more people come within the fiscal net. That has been a feature of the past 10 years. So it might well be true to say that some low- to middle-income families now pay less tax, but that rather begs the question whether they should, in a rational system, have been paying tax in the first place. It certainly begs the question whether there should be two parallel systems—to collect tax and to pay tax credits—if the effect is only to churn income between the two.
The claim to reduce the tax burden on low- to middle-income families sits very uneasily with the fact that, in practice, child tax credits are given up to income levels of £56,000 and, if the £25,000 disregard is added, up to income levels of well beyond £80,000.
The third claim is of a dramatic reduction in child poverty. Let me be clear: we applaud reductions in child poverty, and I am not going to talk this evening about the Government missing their own targets. The tax credit system has certainly directed further resources to families with children, thereby helping to reduce poverty. But the Joseph Rowntree/IFS report highlights the fact that while increasing the child element of the child tax credit has had the direct effect of reducing child poverty, it can have the indirect effect of increasing poverty by weakening the incentives of parents to work, thereby taking themselves out of poverty eventually.
Since the children of families in which parents do not work are themselves more likely to be workless and benefit dependent, it may simply be that the reduction in child poverty through tax credits hardwires benefit dependency into the system. I am reminded of Mr Alan Milburn’s conclusion earlier this year in another place that, in the past decade,
It is not the aims of tax credits about which we have concerns; it is whether they are the best method of dealing with the problems that exist in our society. I have outlined some of those doubts, but they are reinforced by the way in which tax credits have been implemented, as my noble friend Lord Northbrook so excellently laid out this evening. I should like to read out a brief summary of the charge sheet. They are expensive to operate, costing, I believe, more than £500 million a year. My noble friend Lord Trenchard asked the Minister that question, and if I have that figure wrong, I look forward to being corrected when
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I said at the outset that I would want to see how the Chancellor’s own project of tax credits could shed light on what kind of Prime Minister he would be. If the experience of the tax credit scheme were anything to go by, it would indicate that ambitious aims are not matched by effective delivery. That is true whether effectiveness is measured at the level of practical implementation or at the level of achieving good, long-term outcomes. It does not bode well for the country.
7.55 pm
Lord McKenzie of Luton: My Lords, I thank the noble Lord, Lord Northbrook, for initiating this debate and all noble Lords who have spoken. I have had posed to me this evening far more questions than I could possibly answer if I had an hour in which to speak, but I will do my best.
Tax credits help support 20 million people—6 million families and just over 10 million children. They have made a significant difference to the well-being of families and individuals across Britain. The take-up of tax credits is substantially higher than in any previous system of income-related financial support for in-work families who most need it. In the first year of tax credits, 93 per cent of families on incomes below £10,000 claimed their entitlement. That should be compared with a take-up rate of 50 per cent for the early years of family income supplement, 57 per cent for family credit and, at best, 65 per cent for working families tax credit. Take-up is around 80 per cent across the board and 93 per cent for those most in need.
I reiterate that tax credits have delivered three major goals. They have improved incentives to work; they have reduced tax burdens for low-to-middle-income families; and they have dramatically reduced child poverty. Tax credits in the context of our wider economic stability have contributed since the spring of 1997 to an increase of more than 2 million in the number of people in work, with long-term unemployment reduced by some 450,000.
Tax credits have reduced the tax burden. The latest OECD study shows a large fall in the tax burden for low-to-middle-income families as a result of tax credits. The burden on a single-earner couple with two children earning £21,000 a year has fallen from more than 17 per cent of gross earnings in 1997 to 9.8 per cent in 2004. That is the lowest rate of any G7 country. In the UK, a single-earner family with two children can now earn just under two thirds of the average wage before it starts to pay any net tax. Tax credits have helped
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The introduction of tax credits has been a huge undertaking for HMRC. It is the biggest single change to the welfare state since the Beveridge reforms. Problems with the IT system in the early days created difficulties, but HMRC has made significant progress. There is, however, more to be done. Last May, the Paymaster General set out a series of administrative measures designed to reduce the risk of errors, to clarify communications with tax credit recipients and to improve procedures for recovering overpayments. Since then, significant progress has been made in each of these areas. Building on the progress so far, major software releases were successfully implemented last November and this April, delivering real improvements in operational performance, not to mention in the service to claimants.
Since the introduction of tax credits, HMRC has worked closely with the voluntary and community sector to improve its service to claimants. For example, responding to feedback from the voluntary and community sectors, it has revised award notices to include a clearer summary of what will be paid and, for the first time, an explanation of how this has been calculated. HMRC has been working with the voluntary and community sector also to make claimants aware of their entitlement to tax credits; for example, with the tax credits take-up resource pack, which was provided by citizens advice but funded by HMRC. Building on the progress made on administration in Pre-Budget Report 2005, the Government announced a package of further improvements to the tax credits system. This struck a balance between providing more certainty and stability for families, particularly those on lower incomes, and maintaining the flexibility to respond to changes in income and family circumstances.
A number of noble Lords touched on the issue of end-year adjustments, which are inevitably an integral part of a flexible financial support system. Payments are based on household incomes which can, of course, change during the course of the year. Payments are therefore subject to adjustment during the course of the year and, if necessary, at the end of the year once these changes in incomes are known.
National statistics show that year-end adjustments leading to an overpayment have fallen by one-fifth from 2003-04 to 2004-05. Improved performance of the tax credits system has meant that fewer overpayments are now caused by IT or administrative error. The statistic of 97.75 per cent accuracy in processing and calculating awards was quoted by my noble friend Lady Hollis. HMRC expects to recover the majority of the money overpaid, except where
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The national statistics relate to 2004-05, and so do not show the impact of measures announced at the time of the 2005 Pre-Budget Report to give greater certainty to families while maintaining flexibility to respond to changing circumstances. Once these come fully into effect the level of year-end adjustments are expected to fall by a further third in future years. Eliminating the need for adjustments altogether would require a move to a fixed system in which eligibility was based on the previous year's income and circumstances—a system where, as a result, flexibility would be diminished. This flexibility to respond to changing circumstances is a key part of the system, especially in today’s modern labour market where in any single year 3 million people change jobs and 200,000 men and women who move into new or better jobs see their family income rise by more than £10,000.
Noble Lords raised a number of questions. The noble Lord, Lord Northbrook, pressed me on a whole raft of questions relating to the Treasury Select Committee report, and I hope that he will forgive me if I do not deal with all of those in detail. The Government have not responded formally to that report but will do so shortly, and perhaps we might have another debate in due course when those responses have been made formally.
I was asked about overpayment awards for 2004-05. The amount currently calculated is £1.8 billion. The figures for 2005-06 are not yet available as the claims have not yet been finalised.
On our confidence about the costings relating to the £25,000 disregard, we have two years’ data from 2003-04 and the 2004-05 overpayments, which help us to a better estimate of the costs involved. I refer the noble Lord, Lord Northbrook, to the letter written to the Public Accounts Committee, which sets out some of the background to that.
The noble Lord asked, too, about the causes of overpayment. The main causes are income rises, families overestimating income falls, provisional payments being made on out-of-date information and delays in reporting changes of circumstances.
On the issue of error and fraud, figures published on 11 July gave HMRC’s estimate of error and fraud in the tax credits system for 2003-04, which was of course several years ago. The information on organised fraud shows that HMRC successfully stopped the majority of claims identified as being submitted by organised fraudsters. Some £409 million of fraudulent claims have been prevented, and there is no evidence of new major organised frauds comparable to those involving organisations such as DWP and Network Rail, which were reported to the House in January. It is planned to increase the number of compliance staff by 190.
My noble friend Lady Hollis raised the issue of the large family premium. The Government recognise that children in large families are at a disproportionate risk of being poor. The 2004 child poverty review set out a long-term aspiration to improve the financial support
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I am afraid I do not have any good news about the position on financial support for grandparents. I think my noble friend is aware of the situation. It is one thing where there are formal childcare arrangements in place, but it is difficult for a Government to involve themselves in commercialising arrangements within families. It is important to differentiate between situations where the Government are paying, such as the carer’s allowance, and those where you would be encouraging payments between family members. There would be difficulties if it were judged that grandparents were not felt able to fully undertake their responsibilities.
The issue of regional differences is an interesting one. I think it has been considered recently in relation to the minimum wage. The Government felt it was not the right way to go. Marginal tax rates, which a number of noble Lords raised, are high but effective marginal rates of over 70 per cent have fallen by half a million since 1997.
I admire the ingenuity of the noble Viscount, Lord Trenchard, on the dividend tax credit. Forgive me if I do not rehearse the debates we have had on that before, but I am sure we will have ample opportunities to do so in the future. The cost of administering the system was £467 million in 2005-06, which must be something like 0.25 pence in the pound.
The noble Viscount made reference, as did others, to the Tax Commission, chaired by the noble Lord, Lord Forsyth. We would say that transferable tax allowance is an untargeted measure that is of most benefit to those on higher incomes. Indeed, policies have increased the personal allowance by £7,185 by abolishing the 10p starting rate, which, it was suggested, would cost £4.6 billion. An increase in the personal allowance disproportionately benefits the better-off on higher marginal tax rates and is therefore regressive. Changes to tax allowances cannot reduce tax liability below zero and therefore fail to support the poorest. The combined effect of the new higher income tax allowance, the proposed abolition of the 10p starting rate, the new 20p basic rate and the abolition of tax credits for hard-working families higher up the income scale would mean that of the poorest quarter of households only one-third would see any benefit from the package and two-thirds would not get a penny, while every single household in the wealthiest quarter would benefit. We simply do not see that as the right way to go.
My noble friend Lord Giddens raised issues arising from the Joseph Rowntree report, which suggests a basic rate of income tax of 37 per cent to pay for changes to the system. If anything, we would say the tax system they have designed is very much like the
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