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Tax Credits

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work incentives are encountered by people on low incomes who face having their means-tested benefits or tax credits withdrawn if they increase their income.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 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.