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The Earl of Northesk moved Amendment No. 24:

The noble Earl said: My Lords, again this is a probing amendment. We merely seek clarification of what kind of social security benefits the Government intend to prescribe in the context of the subsection. As drafted, it appears to be very open-ended.

With apologies for perhaps being a little obtuse, I should like to press the Minister on one other point. My first reading of the subsection suggested to me that its purpose was to disqualify certain individuals from entitlement to tax credits if they were in receipt of other prescribed social security benefits. On re-reading it, it occurred to me that that was not necessarily its intent; rather, it could be delivering a mechanism whereby the income test is waived in circumstances where individuals are in receipt of other prescribed social security benefits.

There is a world of difference between my two interpretations. I should be grateful if the Minister can clarify the matter for me. I beg to move.

Baroness Hollis of Heigham: My Lords, I hope that the noble Earl will not pursue the amendment. We discussed this issue in Grand Committee. The amendment would remove the provision for regulations to suspend the tax credits income test for those families receiving income support or income-based jobseeker's allowance, a provision which is necessary in order that such recipients may have automatic access to maximum child tax credit.

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As I tried, obviously unhelpfully, to explain in Grand Committee, for most families the income test in Clause 7, which is based on the income of a tax year, provides a fair and simple way of assessing entitlement to tax credits and targeting support. However, for the poorest families there needs to be a safety net. Currently that is provided by IS or JSA, and both of those benefits include elements for the children in the household. But, from 2004, existing IS and JSA claimants with children will be transferred to the child tax credit and the child-related elements of these benefits will cease.

We want to ensure that those families continue to receive at least the same levels of overall support as they do now. If these families were subjected to a test of their annual income while claiming income support or income-based JSA, it is possible that they would not receive maximum child tax credit due to their income across the whole year— including periods when they may not have been receiving IS or income-based JSA—being more than the 5,060 income threshold. It is a way of protecting people who drop down into unemployment that they are able to receive this support which they would not otherwise do if we were, in some senses, anticipating or averaging the income that they had so far earned.

The regulations will make clear that for any period of entitlement to IS or income-based JSA, entitlement to child tax credit will be at the maximum rate and shall not be subject to a test of annual income. The income of the previous or current year when perhaps a period of employment or self-employment had come to an end will not be taken into account. This will ensure—this is why it is entirely benign—that the poorest families with children continue to receive the appropriate safety net support on a weekly basis. We believe that to be vital.

As to the noble Earl's final question, the income test is waived for those who are in receipt of IS or income-based JSA because they will receive the maximum CTC to which their circumstances entitle them. In that sense it is an automatic conveyor belt. I hope that that helps the noble Earl. It is a way of making sure that when people become unemployed and drop down onto the basic benefits they do not find their previous earnings disqualifying them from help during their most needy period.

The Earl of Northesk: My Lords, I am grateful to the Minister for that reply. I should perhaps apologise that it takes me a long time to wrap my head round the complexity of these issues. I do not have the experience of the noble Baroness. It is a delight always to hear her explanations as and when, slowly, they begin to enter my consciousness. I beg leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Lord Higgins moved Amendment No. 25:

    Page 5, line 19, leave out subsection (3).

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The noble Lord said: My Lords, the amendment seeks to leave out subsection (3), an important subsection which effectively defines "relevant income".

In her typically helpful way, the noble Baroness was kind enough to send me a letter on this issue following the exchanges which took place in Grand Committee. There are a number of matters I should like to pursue, but perhaps I may first clarify one point. Among the other helpful information provided by her department—in particular in relation to what we called category three government amendments—was an explanation that Amendments Nos. 47, 48 and so on, which we will debate later, replaced the references to "relevant income" in Clause 17. We are dealing here with Clause 7, not Clause 17, and, as far as I know, the expression "relevant income" appears in Clause 7, is defined there and remains a concept which is helpful in the Bill. I am not clear why the amendments to Clause 17 apparently replace references to "relevant income". I am sorry to throw this one to the noble Baroness at rather short notice—Clause 17 refers to the "final notice" and so on—but if she can clarify that point, if not now, then when we come to Clause 17, it would be helpful.

The noble Baroness argues in the letter she was kind enough to send me that the definition of "income" for the purposes of tax credits is effectively the same as the definition of "income" for normal tax purposes. That would be so particularly, apparently, so far as concerns income from capital. But, having said that, it appears to be the case—this is a point that I raised on an earlier amendment but the Minister suggested that we should come back to it later—that the rules which apply in the case of income tax do not apply to tax credits because of the need, on the one hand, to help people whose incomes fall within the year and, on the other hand, to reduce administrative charges where incomes rise during the year.

I am still not clear how the Revenue has been "persuaded"—I think that is the best way of putting it—to adopt such lenient attitudes with regard to the tax credit, and how it remains intransigent in regard to allowing people to have up to 2,500 extra income from one year to another without taxing them. Given, for the reasons the noble Baroness mentioned—that is, reducing the level of marginal rates as you go up the income scale—the fact that the tax credit goes up to 50,000, and beyond that where an individual also receives child credit, this seems to be a very asymmetrical way of doing it.

If it were related only to people on low incomes, one could understand it. But it seems very strange to do it for people who are not on low incomes. Or am I totally missing the point? Would everyone with an income of up to 45,000 be entitled to tax credits? It may be that I have misunderstood that particular point. Will anyone on an income of 45,000 who is not entitled to tax credit be taxed on an income increase during the year of less than 2,500? A person on tax credit will not be so taxed. I beg to move.

Baroness Hollis of Heigham: My Lords, taxation rules are not changing. If someone's income increases

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from 20,000 to 22,000, or from 45,000 to 47,500, he will continue to be taxed on that increase as now. There will be no change in that.

With regard to people on higher incomes, it was the interconnection between that and the taper off of the tax credit. As the noble Lord will know, you enjoy the full tax credit up to incomes of about 90 a week. You then taper off the working tax credit. You then taper off the child tax credit which includes the childcare element, the children's element and the family element. The last element to remain is the family element. The other elements have been tapered out at about 15,000 to 20,000 according to family size. You continue to enjoy the family element which was the old tax allowance up to about 50,000 whereupon it tapers out again and you finally end up just on child benefit.

On responsiveness, at the point at which all the elements of child tax credit have tapered out except for the family element—that is, between 20,000 and 50,000—it does not matter what happens to your income; you retain your entitlement to that sum. Therefore the head space issue does not come into play.

Earl Russell: My Lords, will the noble Baroness enlighten us? Does the Rooker/Wise amendment and the uprating procedure for indexing cover the limits at which the tax credit kicks in or will that have to be dealt with when we come to Amendment No. 37?

6.15 p.m.

Baroness Hollis of Heigham: My Lords, it will have to come under Amendment No. 37. Tax allowances are uprated automatically unless they are overruled by the Finance Act. Therefore that will come into that category. If I have any further information, perhaps I may come back to the noble Earl on Amendment No. 37.

With child tax credit being increased in line with earnings, and the working tax credit at present being increased in line with prices, I am not willing to make a commitment that that situation will continue in perpetuity. We may wish to rebalance that. The commitment for child tax credit for earnings is only until the end of this Parliament.

I do not know whether I have met the noble Lord's point about MDRs and deduction rates. First, he asked me a technical point about relevant income. The second more general point was about the asymmetry—it was the word I used in Committee—between drops and increases in income. I deal, first, with the technical point about the use of term "relevant income" in Clause 7. "Relevant income" is defined in Clause 7 but it was also used in Clause 17. It is no longer used in Clause 17. The terms "current year income" and "previous year income" are used instead. Noble Lords will understand that we tried deliberately to separate the two. But "relevant income" is still relevant to establishing the level of a claimant's entitlement and is still used, therefore, in Clause 7 and in Clause 13 which deals with that.

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On asymmetry, I accept that there is here a difference in treatment between the instance when people on very modest incomes become eligible for taxation and their eligibility for tax credit. There is an asymmetry. In Committee I sought to express my strong support for what we have done. The expectation is that anyone on tax credits will have his tax credits for the current year based on the preceding year's income. However, if his income in the current year falls he goes immediately on to the current year assessment. That is to help him. The last thing we want is for him to drop out of work because we are unable to top up his income in the course of that year. If anyone's income increases in the course of the current year the first 2,500 of that income increase will be ignored for that current year. However, in the following year he will go on to the new adjustment.

Is it right to have that discrepancy between immediately topping up a drop in income in the current year while ignoring the first 2,500 of increases in income in a current year, taking it into account only the following year? The noble Lord, Lord Higgins, pursued me on that question. At the end of the day, it is a matter of judgment and information. The information is that there are probably twice as many changes in income due to income increases rather than decreases. There is a practical reason. Something like 1.3 million families who are likely to be affected by tax credit see an increase in their income of up to 2,000 in the year but only about 0.7 million see their income fall by a similar sum.

People's incomes do go up. Second earners move into the household calculation. If they were to have their tax credits adjusted immediately, what would that mean in terms of administrative load and, more importantly, with regard to the message we are trying to get across that work pays? Often the increase is through increased hours. A partner, a second earner, may be tempted for the first time into work. Income will be assessed on gross income rather than net. Therefore, there is a relatively lower marginal deduction than would otherwise have been the case. We welcome that. We shall catch up with that the following year when people have established patterns of work and payment.

We think that it is right and decent—and generous—to have an asymmetry so that if people's incomes increase through their efforts in the current year they will go on to that adjustment only in the following year.

At the end of the day it is a philosophical debate. Above all, we seek to encourage people into work, to stay in work and to make them accept, with us, that work pays. We think that the best way to do that is to have an asymmetry so that any efforts they make to help themselves, certainly in the first year before possibly new patterns of work are bedded in, are not met with deduction rates. That will come into effect the following year because we also have a duty to the taxpayer as trustee of public moneys. But we think that this asymmetry is right and decent. It affects only those on modest income; in other words, those for whom

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high MDRs in the year in which they move into increased earnings or increased work might serve as a disincentive.

The noble Lord may not agree with me. I am confident that I shall have the support of the noble Earl, Lord Russell, and the noble Lord, Lord Newby, that it is right to have asymmetry here. It is decent; it is generous. I ask the noble Lord to accept that this is where we are coming from.

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