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Tax Credits

My Lords, I thank the noble Lord, Lord Northbrook, for initiating this debate and all noble Lords who have spoken. I have had posed to me this evening far more questions than I could possibly answer if I had an hour in which to speak, but I will do my best. Tax credits help support 20 million people—6 million families and just over 10 million children. They have made a significant difference to the well-being of families and individuals across Britain. The take-up of tax credits is substantially higher than in any previous system of income-related financial support for in-work families who most need it. In the first year of tax credits, 93 per cent of families on incomes below £10,000 claimed their entitlement. That should be compared with a take-up rate of 50 per cent for the early years of family income supplement, 57 per cent for family credit and, at best, 65 per cent for working families tax credit. Take-up is around 80 per cent across the board and 93 per cent for those most in need. I reiterate that tax credits have delivered three major goals. They have improved incentives to work; they have reduced tax burdens for low-to-middle-income families; and they have dramatically reduced child poverty. Tax credits in the context of our wider economic stability have contributed since the spring of 1997 to an increase of more than 2 million in the number of people in work, with long-term unemployment reduced by some 450,000. Tax credits have reduced the tax burden. The latest OECD study shows a large fall in the tax burden for low-to-middle-income families as a result of tax credits. The burden on a single-earner couple with two children earning £21,000 a year has fallen from more than 17 per cent of gross earnings in 1997 to 9.8 per cent in 2004. That is the lowest rate of any G7 country. In the UK, a single-earner family with two children can now earn just under two thirds of the average wage before it starts to pay any net tax. Tax credits have helped ensure that the number of families with children paying no net tax has risen from under 2.5 million in 1998 to more than 3 million this year. They have made a major contribution to reducing child poverty, with 700,000 children lifted out of relative poverty since 1997. More than 1.8 million fewer children are in absolute low-income families than in 1997 on a before-housing-costs basis. I believe that that is an achievement that we would all applaud. My noble friend Lord Giddens made another important point about tax credits. He said that they delivered support in a way which is non-stigmatising. The introduction of tax credits has been a huge undertaking for HMRC. It is the biggest single change to the welfare state since the Beveridge reforms. Problems with the IT system in the early days created difficulties, but HMRC has made significant progress. There is, however, more to be done. Last May, the Paymaster General set out a series of administrative measures designed to reduce the risk of errors, to clarify communications with tax credit recipients and to improve procedures for recovering overpayments. Since then, significant progress has been made in each of these areas. Building on the progress so far, major software releases were successfully implemented last November and this April, delivering real improvements in operational performance, not to mention in the service to claimants. Since the introduction of tax credits, HMRC has worked closely with the voluntary and community sector to improve its service to claimants. For example, responding to feedback from the voluntary and community sectors, it has revised award notices to include a clearer summary of what will be paid and, for the first time, an explanation of how this has been calculated. HMRC has been working with the voluntary and community sector also to make claimants aware of their entitlement to tax credits; for example, with the tax credits take-up resource pack, which was provided by citizens advice but funded by HMRC. Building on the progress made on administration in Pre-Budget Report 2005, the Government announced a package of further improvements to the tax credits system. This struck a balance between providing more certainty and stability for families, particularly those on lower incomes, and maintaining the flexibility to respond to changes in income and family circumstances. A number of noble Lords touched on the issue of end-year adjustments, which are inevitably an integral part of a flexible financial support system. Payments are based on household incomes which can, of course, change during the course of the year. Payments are therefore subject to adjustment during the course of the year and, if necessary, at the end of the year once these changes in incomes are known. National statistics show that year-end adjustments leading to an overpayment have fallen by one-fifth from 2003-04 to 2004-05. Improved performance of the tax credits system has meant that fewer overpayments are now caused by IT or administrative error. The statistic of 97.75 per cent accuracy in processing and calculating awards was quoted by my noble friend Lady Hollis. HMRC expects to recover the majority of the money overpaid, except where there has been a mistake by HMRC and it is not reasonable to expect the claimant to have noticed the error. The national statistics relate to 2004-05, and so do not show the impact of measures announced at the time of the 2005 Pre-Budget Report to give greater certainty to families while maintaining flexibility to respond to changing circumstances. Once these come fully into effect the level of year-end adjustments are expected to fall by a further third in future years. Eliminating the need for adjustments altogether would require a move to a fixed system in which eligibility was based on the previous year's income and circumstances—a system where, as a result, flexibility would be diminished. This flexibility to respond to changing circumstances is a key part of the system, especially in today’s modern labour market where in any single year 3 million people change jobs and 200,000 men and women who move into new or better jobs see their family income rise by more than £10,000. Noble Lords raised a number of questions. The noble Lord, Lord Northbrook, pressed me on a whole raft of questions relating to the Treasury Select Committee report, and I hope that he will forgive me if I do not deal with all of those in detail. The Government have not responded formally to that report but will do so shortly, and perhaps we might have another debate in due course when those responses have been made formally. I was asked about overpayment awards for 2004-05. The amount currently calculated is £1.8 billion. The figures for 2005-06 are not yet available as the claims have not yet been finalised. On our confidence about the costings relating to the £25,000 disregard, we have two years’ data on from 2003-04 and the 2004-05 overpayments, which help us to a better estimate of the costs involved. I refer the noble Lord, Lord Northbrook, to the letter written to the Public Accounts Committee, which sets out some of the background to that. The noble Lord asked, too, about the causes of overpayment. The main causes are income rises, families overestimating income falls, provisional payments being made on out-of-date information and delays in reporting changes of circumstances. On the issue of error and fraud, figures published on 11 July gave HMRC’s estimate of error and fraud in the tax credits system for 2003-04, which was of course several years ago. The information on organised fraud shows that HMRC successfully stopped the majority of claims identified as being submitted by organised fraudsters. Some £409 million of fraudulent claims have been prevented, and there is no evidence of new major organised frauds comparable to those involving organisations such as DWP and Network Rail, which were reported to the House in January. It is planned to increase the number of compliance staff by 190. My noble friend Lady Hollis raised the issue of the large family premium. The Government recognise that children in large families are at a disproportionate risk of being poor. The 2004 child poverty review set out a long-term aspiration to improve the financial support available to large families. The introduction and increase in the per child element of the child tax credit has disproportionately benefited larger families and, compared to 1998-99, the risk of poverty has fallen by 33 per cent for large families compared to 23 per cent overall. Nevertheless we will continue to consider options to go further, including the introduction of large family unlimited tax credits, along with equalising child benefits, as others have suggested, and increasing the child element. I am afraid I do not have any good news about the position on financial support for grandparents. I think my noble friend is aware of the situation. It is one thing where there are formal childcare arrangements in place, but it is difficult for a Government to involve themselves in commercialising arrangements within families. It is important to differentiate between situations where the Government are paying, such as the carer’s allowance, and those where you would be encouraging payments between family members. There would be difficulties if it were judged that grandparents were not felt able to fully undertake their responsibilities. The issue of regional differences is an interesting one. I think it has been considered recently in relation to the minimum wage. The Government felt it was not the right way to go. Marginal tax rates, which a number of noble Lords raised, are high but effective marginal rates of over 70 per cent have fallen by half a million since 1997. I admire the ingenuity of the noble Viscount, Lord Trenchard, on the dividend tax credit. Forgive me if I do not rehearse the debates we have had on that before, but I am sure we will have ample opportunities to do so in the future. The cost of administering the system was £467 million in 2005-06, which must be something like 0.25 pence in the pound. The noble Viscount made reference, as did others, to the Tax Commission, chaired by the noble Lord, Lord Forsyth. We would say that transferable tax allowance is an untargeted measure that is of most benefit to those on higher incomes. Indeed, policies have increased the personal allowance by £7,185 by abolishing the 10p starting rate, which, it was suggested, would cost £4.6 billion. An increase in the personal allowance disproportionately benefits the better-off on higher marginal tax rates and is therefore regressive. Changes to tax allowances cannot reduce tax liability below zero and therefore fail to support the poorest. The combined effect of the new higher income tax allowance, the proposed abolition of the 10p starting rate, the new 20p basic rate and the abolition of tax credits for hard-working families higher up the income scale would mean that of the poorest quarter of households only one-third would see any benefit from the package and two-thirds would not get a penny, while every single household in the wealthiest quarter would benefit. We simply do not see that as the right way to go. My noble friend Lord Giddens raised issues arising from the Joseph Rowntree report, which suggests a basic rate of income tax of 37 per cent to pay for changes to the system. If anything, we would say the tax system they have designed is very much like the current system except with higher rates, and we have a manifesto commitment not to raise basic or higher rates of income tax. We have touched upon issues of year-end adjustments. I quote again the figure that each year at least 200,000 men and women move into new and better jobs and see their family income rise by more than £10,000. The noble Lord, Lord Oakeshott, in particular, talked about the IFS report. In response I say: look at the evidence. Employment, which my noble friend Lord Giddens touched on, is at record levels, with 28 million people in work. The UK’s employment rate is the highest of the G7 economies bar the US and Canada. Since 1997, New Deal programmes, which are part of the strategy, have helped reduce long-term youth unemployment and long-term unemployment by over two-thirds. Working tax credit provides financial support on top of earnings and, together with the national minimum wage, helps to improve work incentives and relieve in-work poverty. Lone parent employment has risen by 11.3 percentage points to 56.6 per cent, the highest on record. There are now over 1 million lone parents in work, over 300,000 more than in 1997. The noble Baroness, Lady Noakes, made a number of points on marginal tax-rate issues and on the Chancellor’s approach to those matters. I have no doubt that a Chancellor who is about tackling poverty and improving incentives to work and who wishes to reduce tax burdens for low-to middle-income families would make an excellent Prime Minister, as I am sure that he will. I have run out of time. I hope that noble Lords will forgive me for not having dealt with all the points that have been raised. I conclude by saying that tax credits and economic stability have helped to increase the number of people in work by more than 2 million since spring 1997. Since 1997, long-term unemployment has reduced by 450,000. Tax credits have improved work incentives, reduced the tax burden on low-to middle-income families and helped to reduce child poverty dramatically. Of course, we should remain vigilant to the administrative challenges that these bold measures create, but we should celebrate the outcome of the policy and the substantial improvement it has made to the lives of many.