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Tax Credits

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. I can certainly confirm that the official view is that it is an excellent report. That does not, of course, make it Conservative Party policy. 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 dependence on benefits by working more hours or otherwise seeking higher pay. Instead, they become trapped in benefit dependence at a higher level of income than before—a new form of poverty trap. This dynamic will, over time, tend to produce higher levels of benefit dependence than before because the incentive to escape benefit dependency is too weak. The cost to the public purse, currently over £15 billion a year for tax credits alone, will remain high. 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, "““poverty has become more entrenched””.—[Official Report, Commons, 28/3/06; col. 710.]" 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 the noble Lord responds. The way in which tax credits have been implemented has caused genuine hardship to very many families, at the extreme requiring some to rely on food parcels from the Salvation Army just to survive the chaos of implementation. The system has been poorly implemented in the way that it has opened itself up to major fraud via the online portal and the operation of wholly inadequate helplines for much of the period. Tax credits are so badly designed that nearly 2 million overpayments and 1 million underpayments occur each year. 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.