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Tax Credits

My Lords, I think that I would like to thank the noble Lord, Lord Northbrook, for his introduction to this short debate tonight. He is certainly right to bring to the House’s attention some of the ongoing concerns surrounding tax credits, which we all recognise are a powerful government tool to address child poverty—it is a tool of which I, for one, am very proud. Tax credits probably would not have been necessary in Beveridge’s time, but now that wages are individual wages and not family wages—rightly so, given changing demography, lifestyles and family patterns, as well as the fluidity of family forms and of labour—the state, rightly in my view, takes responsibility for additional payments where necessary to reflect family need and family dependency. That started with Eleanor Rathbone’s family allowances in 1948, going through to the family income supplement, which was introduced by the party opposite, to family credit, and now to tax credit. If I have any criticism of the speech of the noble Lord, Lord Northbrook, it is that he did not contextualise it by suggesting in any way the extent to which tax credits have begun to bridge some of the gaps in after-pay earnings between rich and poor and between the childless and families with children. Tax credits also, rather interestingly, bridge the gap between entry wages and median wages; the 40 per cent difference between the two is one of the biggest gaps in Europe, so tax credits help to sustain people who are in low-paid jobs. Tax credits also bridge the gap between women’s full-time and men’s full-time work, and between women’s part-time and men’s full-time work—we know that pay rates for women’s part-time work are roughly 50 per cent lower than pay rates for men. In all these problems in the distribution patterns in our society, tax credits have made a major contribution. But, as is inevitable in any such redistribution, there will be trade-offs that conflict with each other. I shall describe two of the most complex. First, if you make out-of-work benefits sufficiently generous—especially for larger families, in tackling child poverty—you can make it more problematic for people to find it worth while to go into work. That is why in the 1970s we had the wage stop. We call that situation the poverty trap, in which it is not worth working. The second problem is that, as tax credits are rightly related to income, and therefore withdrawn as income rises, there can be a very high deduction rate, along with tax and NI, for every extra pound earned. That is what we call the employment trap. Of course, one could reduce the taper and make it less severe, but then the problem moves higher up the income scale. In any case, the problem is not the taper but the interaction with other means-tested benefits—above all, housing benefit and council tax benefit. There are no right answers to this, just judgments to be made about how we trade the one problem off against the other. It is worth stating that some of those concerns may be more theoretical than real. On the poverty trap, for example, it is clear from research that people work for more than money: they work for adult status, autonomy, pride and family responsibility. As a result, the reserve wage that a number of people will take is amazingly low—often barely at benefit level—and that will be sufficient to bring them into the labour market. However, if a job is difficult to sustain around fluctuating childcare problems and if the pay is not good enough, a lone parent in particular is more vulnerable to dropping out of the labour market. The Institute for Fiscal Studies has shown that over the past 10 years or so, the levels of both the poverty trap and the employment trap have been reduced, largely due to tax credits. As for the problem of tapers and the complaint that, once in work, too much of each pound that a person earns goes in deductions, you obviously cannot simply universalise the benefit and then take it away from the better off. The income tax bands are not sufficiently progressive and it would be too expensive to do that. In 1997, I estimated that putting £10 on each and every benefit would wipe out almost the entire expenditure on the NHS, as it stood at that time, and still leave families poor. It cannot be done in that way. The result is that we have constructed a tax credit system which, rightly I think, has a sharp taper for adults—the working tax credit—and a shallower taper for children. In its recent report, the Institute for Fiscal Studies has shown that both incentives to work and progress within work, though varying by family type, have largely improved satisfactorily over the past few years. Therefore, the first problem is the generalised one of targeting, means-testing, the poverty trap and the employment trap. I was sorry that the noble Lord, Lord Northbrook, did not refer to that in his otherwise very detailed and analytical speech. 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. 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? 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.