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Tax Credits

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 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 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 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””.