A.  INTRODUCTION

  1.  The Government announced in March 2000 that it wanted to ". . . bring together the different strands of support for children in the WFTC, Income Support and the Children's Tax Credit to create an integrated and seamless system of financial support for children."

  2.  The Government set out some objectives for a new integrated child credit in HMT (2000). It said that: "an integrated child credit will create a seamless mechanism for channelling support to children as part of the Government's commitment to abolishing child poverty. [It will provide]:

—  a more transparent system of support for children, helping parents understand what they can expect to receive, and facilitating public debate about the appropriate level of support. . .;

—  a portable and secure income bridge spanning welfare and work to improve work incentives;

—  a common framework for assessment and payment, where all families will be part of the same system, rather than dealing with low-income families through the benefits system while giving tax allowances to the better-off. Awards would be assessed on the joint income of couples;

—  a system where support for children is paid to the main carer. . .;

—  efficiency gains for Government and reduced hassle for parents from moving away from a system where support for children is delivered through four different mechanisms."

  3.  But HMT (2000) contains few practical details on how the credit will operate. No doubt this is partly to allow the Government to seek views on the operational details, but the integrated child credit is also a long-term reform: it would not start until 2003 at the earliest. The few details that were given on the possible structure of a credit in HMT (2000) were only illustrations of how an integrated child credit would look if it were based on the current structure of financial support for families with children[3]. As the integrated child credit represents a radical reform of the tax and benefit system for families with children, and the Government has given itself a long time to get it right, it is important to realise that almost any of the major parameters of the integrated child credit could be changed, such as how the credit relates to family size and income, the period of assessment and length of award, the responsiveness to changes in needs or income, whether the system is cumulative or non-cumulative, as well how it treats different sorts of income and capital.

  4.  In this note, we look at:

—  what the current structure of financial support for families with children looks like, and how the Government might restructure the system to separate out the adult and child components of transfer payments;

—  the arguments for and against extending the principle of tax credits to people without children, as announced by the Government in HMT (2000);

—  how the integrated child credit could be structured to meet the costs of children in different sorts of households;

—  some of the most important design parameters for an integrated child credit: its responsiveness to changes in income and family circumstances;

—  some of the rules and definitions which currently vary across the present mechanisms for giving financial support to families with children, such as the treatment of capital and income from capital, maternity pay, childcare costs and child support.

B.  THE STRUCTURE OF THE INTEGRATED CHILD CREDIT

Splitting the current support for families in the tax and benefit system into "adult" and "child" portions

  5.  The Government has said that it will ". . .bring together the different strands of support for children in the Working Families' Tax Credit (WFTC), Income Support (IS) or Job Seekers Allowance (Income Related) and the Children's Tax Credit to create an integrated and seamless system of financial support for children paid direct to the main carer, building upon the foundation of universal Child Benefit"[4]. Chart 1 below shows the structure of transfer payments from these four transfer mechanisms from April 2001 when the Children's Tax Credit is introduced. The chart assumes that the family qualifies for the WFTC at a weekly wage of £59.20, corresponding to 16 hours' work at the national minimum wage. (The chart shows the total value of Income Support and WFTC awards, not just the amount payable in respect of having a child.)

  Notes: assumes minimum wage work, so that family is eligible for WFTC at around £60 per week.

  Source: authors' calculations from the IFS' tax and benefit model TAXBEN.

  6.  Families claiming IS receive a "family premium" if they have any children, and a premium for each child, but they do not receive any extra money from Child Benefit as the total IS award is reduced by the value of Child Benefit. Families on WFTC receive a "basic credit" plus a credit for each child. Taxpayers with children can claim the Children's Tax Credit, which is offset against tax payments of up to £442 a year, and tapered away where there is a higher-rate taxpayer in the family. It will therefore be worth less than £442 to families who pay less than £442 income tax a year, and to families where one partner pays higher-rate tax (corresponding to gross incomes of £32,785 or more in 2000-01). All families not claiming IS receive the full value of Child Benefit. Table 1 shows the rates of these instruments.

  7.  Table 1 shows how many families currently receive each strand of financial support, but not the overlaps. These are:

—  all families with children can receive Child Benefit as well as IS, WFTC and Children's Tax Credit[5];

—  very few families claim both Income Support and WFTC or receive Income Support and benefit from the Children's Tax Credit at the same time;

—  families receiving the WFTC will generally also benefit from the Children's Tax Credit from April 2001 (unless they are earning less than the personal allowance, currently £4,385 a year).

  Notes: CB, IS and JSA estimates are for GB; WFTC and Children's Tax Credit for UK.

  Sources: Child Benefit, IS, JSA and WFTC figures from appropriate quarterly enquiries. Children's Tax Credit estimate from HMT (2000). HMT estimates that around 2.5 million children will benefit from Income Support, around 2.5 million from WFTC, and a further 6 million from just the Children's Tax Credit in 2001.

  8.  As the first step in constructing a possible integrated child credit, we split the current transfer payments for families with children into "child-related payments"—the extra transfer payments made to families because they have a child—and "adult-related payments"—whatever is left.

  9.  Splitting the existing transfer payments into "adult" and "child" components is straightforward except for the WFTC, where it is unclear how to treat the basic credit. It could be viewed in a similar way to the family premium in Income Support: it is a payment made to families with children that does not vary with the number of children, and it is likely to seem that way to a family without children who become eligible for the WFTC when they have children: they were getting no tax credits when they had no children, but with one child they are getting the basic credit and a child credit. In HMT (2000), the Government is choosing to treat the basic credit as an "adult" component. Yet, there seems to be no obvious argument as to why the line between the ICC and ETC should be set at this particular level[8].

  10.  We discuss the employment tax credit more below. Chart 2 shows the current system broken up into its component parts having split the WFTC in the way suggested in HMT (2000), "child-related support" varies from £15 for the richest families to £45.20 for the poorest, but goes as high as £49.10 for some families on WFTC[9].

  11.  Chart 3 shows how an integrated child credit could be constructed from the current levels of transfer payments for families with children, assuming that the integrated child credit together with Child Benefit is equal to the maximum amount payable at present for children (£49.20)[10]. Above 16 hours a week, a family would no longer be entitled to JSA/IS and would claim the ETC instead. But the integrated child credit would still be paid at the same level ("a seamless payment across the welfare to work divide").

Why an employment tax credit for people without children?

  12.  The Government has said that the integrated child credit will be complemented by an employment tax credit paid through the wage packet, and that this will be extended to people without children, with the twin aims of:

—  increasing work incentives for low-paid workers;

—  relieving in-work poverty in working households without children.

  13.  The IFS' Green Budget discussed some of the implications of introducing an employment tax credit for people with and without children (see IFS, 2000). It showed that extending the adult component of the WFTC to all adults in work would be very expensive, and not well targeted on the low-paid, with the largest gains going to people in the 3rd quintile. 91 per cent of the expenditure would go to single people, nearly two thirds of whom are under 26. Because of this profile of potential beneficiaries, one possibility might be the introduction of an ETC with a substantially reduced rate for those under 25 without children.

C.  STRUCTURING THE INTEGRATED CHILD CREDIT TO MEET THE COSTS OF CHILDREN IN FAMILIES OF DIFFERENT INCOMES?

  14.  From 2001, financial support for children including Child Benefit will range from at least £50 to £15. If this is maintained under an integrated child credit, it means that an integrated child credit—like the children's tax credit—would give nothing to the very richest families. That means that the Government needs to design an integrated child credit that varies from £35 to £0 across the income distribution to build on Child Benefit.

  15.  Some studies have attempted to estimate the financial cost of children (in expenditure terms, rather than in terms of foregone earnings): these suggest that the maximum proposed value of the integrated child credit plus Child Benefit is close to the estimated cost of a child—and it is certainly a lot closer than the implied financial support for children in the tax and benefit system several years ago[11]. But there is no principle that indicates how transfer payments for children could be tapered away with income: this is a policy-design question about how to choose the best structure for an integrated child credit that balances, amongst other things, the need to save money and best target expenditure with the desire to keep marginal withdrawal rates low to preserve work incentives. The Green Budget looked at some alternatives.

  16.  It is not clear how the integrated child credit will be structured for families of different sizes. But Table 3 shows that the current system of support for children is weighted towards payments for the first child, even assuming that the basic credit of the WFTC is not counted as support for children.

  Notes: All values are correct as of October 2000, but the table anticipates the Children's Tax Credit, which is not introduced until April 2001.

  Source: authors' calculations.

  17.  The literature on the costs of children generally finds that there are small economies of scale in the costs of children, which could provide a justification for skewing support towards the first child (although this can sometimes be confused with the fact that children seem to cost more as they get older). But rates of worklessness and poverty are significantly higher for families with three or more children than families with 1 or two children (see table 4 for figures on worklessness, and see Gordon et al (2000) for some estimates of how poverty varies with family size). This might reflect that the extra demands on parents' time in families with three or more children can limit their availability for work even if the direct financial costs of having children do not increase in proportion to the number of children. This could suggest that the integrated child credit should direct more resources to families with three or more children than those with one or two children if one of its objectives is to reduce child poverty.

  Source: authors' calculations from first quarters from 3 waves of the LFS: spring, summer, autumn 1998.

  Notes: Families with head of family aged less than.

D.  DESIGN ISSUES: PERIOD OF ASSESSMENT AND RESPONSIVENESS TO CHANGES IN NEEDS AND INCOME

  18.  Designing the integrated child credit afresh gives the Government a great opportunity to rationalise the rules in the three existing mechanisms that have evolved individually over time to achieve their different objectives.

  19.  At present, Income Support awards are based on weekly income. It is a non-cumulative system, in that past income is ignored. Claimants have to inform the Benefits Agency of income changes each week, and are liable for overpayments. So IS responds immediately to changes in circumstances, but at the cost of frequent contact between parents and the Benefits Agency, and high administration costs.

  20.  WFTC awards are based on a snap-shot assessment of income, and then fixed for 6 months regardless of changes in household circumstances or income. This means that the WFTC can take up to 6 months to respond to a change in circumstances. The non-cumulative, snap-shot, assessment also means that income during some months is completely ignored when calculating awards.

  21.  The Children's Tax Credit is a tax allowance, paid monthly on a cumulative basis: it adjusts over the financial year to minimise under- or over-payment by year-end. This means that it can respond monthly to changes in circumstances, but it responds to annual income, so it is unlikely to change by much month-on-month.

  22.  The Government faces important trade-offs when designing a tax and benefit system between[12]:

—   ensuring the existence of a safety-net system, by getting integrated child credit payments to those in greatest need with minimal delay;

—  preserving work incentives, by both ensuring certainty of the integrated child credit award across the welfare-to-work divide, as well as trying to avoid having very high marginal deduction rates;

—  guaranteeing fairness and equity between families of similar resources and needs;

—  reducing unnecessary Government expenditure, by targeting money on those that need it most;

—  minimising administrative costs at Inland Revenue and the hassle for parents in claiming the integrated child credit, particularly if the Government would like to see take-up rates as high as possible[13];

—  not letting parents build up large liabilities to the Inland Revenue.

  23.  In very general terms, the importance of the mechanism for assessing and paying the integrated child credit will be higher the greater is the extent of changes in income and family status. For example, if families' incomes changed very little during the year, then an annual eligibility assessment could be sufficient for deciding the appropriate level of integrated child credit payments. But this is not the case. There is a substantial degree of income mobility within a given family structure—particularly amongst those on low incomes—and there are also frequent changes in family structures as partnerships separate and form and children are born and grow up. The new integrated child credit system must account for all these transitions.

  24.  There is no perfect data source that can tell us about the dynamics of incomes and family status, particularly about the short-term (within-year) dynamics. But there has been some recent work, including Iacovou and Berthoud (2000), Hills and Jenkins (2000).

  25.  One option for the structure of the system would be to design it so that eligibility for IS or the employment tax credit would entitle parents to a full integrated child credit award. People receiving less than a full integrated child credit award could have the award based on some estimate of annual income. At this level of income, temporary income fluctuations might be of less concern, and perhaps there would be a reassessment of the integrated child credit award once or twice a year. But this still leaves several major administrative issues to be resolved, such as:

—  who would be responsible for tracking income to decide on the appropriate reward level: the families or the Inland Revenue;

—  how frequently would the awards be paid. Comparing US and UK evidence suggests that families on low incomes may react very differently to in-work payments made annually to ones made fortnightly (see Brewer, 2000).

  26.  As was discussed in the Green Budget, the fact that the integrated child credit is based on a family's joint income perhaps represents a turning point in the structure of taxes and benefits since the 1990 reform to introduce individual taxation. This move perhaps reflects the Government's recognition of the limitations of an individual tax system when targeting support to the poorest families rather than to the poorest individuals[14].

  27.  In practice, the joint assessment rules will mean that mothers will have to tell the Inland Revenue about changes in their living arrangements and relationships, especially where these affect the family's joint income. But this does not represent a significant change in practice from the current situation: families claiming IS and WFTC already have to make joint claims, and guidance on the Inland Revenue's website suggests that people who go on to claim the Children's Tax Credit will have to inform the IR whenever there is a change in the family structure.

E.  WHAT ARE SOME OF THE OTHER KEY PARAMETERS OF AN INTEGRATED CHILD CREDIT?

  28.  The integrated child credit will be merging three systems of financial support, each with their own definition of income and their own treatment of capital. Table 5 summarises the current system.

  Notes: authors' interpretations of Child Poverty Action Group's "Welfare Rights 2000/01". There are many other smaller differences which may be very important in particular circumstances.

  29.  Three of the most significant inconsistencies between the systems are:

—  the treatment of capital and income from capital, where families on Income Support and WFTC face a less generous regime than taxpayers not claiming the WFTC;

—   the treatment of child support, where parents in receipt of Income Support face a less generous regime than other parents;

—  the treatment of maternity pay (maternity allowance and Statutory Maternity Pay), where mothers on WFTC face the most generous regime, and mothers on Income Support the least generous regime.

  30.  The Government has said that it wants the integrated child credit to provide a common framework for assessment and payment and a more transparent system of support for children, and to create a system that is simple for people to understand so that recipients are both aware of their entitlement and their responsibilities. HMT (2000) says that "the next phase of modernisation offers an opportunity for a thorough review of the treatment of income and capital in assessing a person's or family's entitlement to support. The current rules applied in Income Support and those inherited from FC by the WFTC have developed over a considerable period of time and reflect a process of incremental change. The modernisation of IT systems offers an opportunity to rethink the way the system works". This all strongly suggests—but cannot be interpreted as a commitment—that the Government would like a common definition of income and capital throughout the integrated child credit.

  31.  Of the major criteria for deciding in which direction to move—whether to extend the most or least generous regime to all parents—may be cost. Recent changes in benefit rules might suggest which way the Government might move:

—  the treatment of child support under WFTC is different from (and more generous than) its predecessor Family Credit[15]. It seems unlikely that the Government would want to reverse that so quickly;

—  in the 2000 Budget, the Government increased the capital thresholds for pensioners claiming Income Support to reduce their implied disincentive to save. These arguments apply equally well to non-pensioners;

—  the Government is currently reviewing maternity leave provisions. But Government documents have said often that the early years of childhood are all important[16]. Certainly poverty rates are higher for families that contain a pre-school child, and the effects of low-incomes on children's development can be observed at very young ages. Given this concern, it seems odd that the poorest mothers—those on Income Support—benefit less from maternity pay than better-off mothers.

References

  Brewer (2000), "Comparing In-work Benefits and Financial Work Incentives for Low-Income Families With Children", IFS Working Paper W00-16.
  Chennells, L, Dilnot, A and Emmerson, C (2000), The IFS Green Budget: January 2000, The Institute for Fiscal Studies.
  Department of Social Security (1999), Income-Related Benefits Estimates of Take-Up in 1996/97 (revised) and 1997-98.
  Dilnot, A, Kay, J and Morris, C (1984), The Reform of Social Security, Institute for Fiscal Studies.
  Gordon, D et al, Poverty and social exclusion in Britain, York: Joseph Rowntree Foundation.
  Gregg, P, Harkness, S and Machin, S (1999), "Poor Kids: Trends in Child Poverty in Britain, 1968-96", Fiscal Studies, 20(2).
  Hills, M and Jenkins, S (1999), Poverty Amongst British Children: Chronic or Transitory ?, ISER Working Paper 99-23, University of Essex.
  Iacovou, M and Berthoud, R (2000), Parents and Employment, DSS Research Report 107.
  HM Treasury (1999), Supporting Children Through the Tax and Benefit System, The Modernisation of Britain's Tax and Benefit System 5.
  HM Treasury (2000), Tackling Poverty and Making Work Pay: Tax Credits for the 21st Century, The Modernisation of Britain's Tax and Benefit System 6.
  Middleton, S, Ashworth, K and Braithwaite, I (1997) Small Fortunes: Spending on Children, Childhood Poverty and Parental Sacrifice, York: Joseph Rowntree Foundation.
  Paull, G, Walker, I and Zhu, Y (2000), "Child Support Reform: Some Analysis of the 1999 White Paper", Fiscal Studies 21(1).

Andrew Dilnot
Director, Institute for Fiscal Studies

Mike Brewer and Michal Myck
Research Economists

September 2000

4   HMT (2000). Back

5   Families on IS do not see any income gain from receiving Child Benefit, but they do receive it. Back

6   6 February 2000. Back

7   7 February 2000. Back

8   Note, however, that currently disabled adults without children can claim the Disabled Person's Tax Credit, worth the same as the basic credit in WFTC. Back

9   These figures do not quite correspond with the figures in HMT, which have allowed for the usual indexation of benefits in April 2001. Back

10   This is broadly the same as Chart 2.6 in HMT (2000). Back

11   See, for example, Middleton et al (1997). Back

12   Some of these criteria were discussed in Dilnot, Kay and Morris (1984). Back

13   Government estimates are that around a quarter of those entitled to Family Credit did not claim it in 1997-98 (see DSS, 1999). Back

14   The Green Budget also noted that this view seemed to be shared by the Conservative Party, who proposed transferable tax allowances in their 1997 general election manifesto. Back

15   See Paull et al (2000). Back

16   See, eg, HMT (1999). Back