The purpose of this chapter

5.  As is implied in the title of our inquiry and of this Report, we believe that it is necessary to consider the abolition of the 10 pence rate of income tax in the context of other Budget measures concerned with low-income households. In this chapter we outline relevant measures announced in Budgets since the introduction of the starting rate of income tax in 1999, including the creation of the new tax credits system. We also refer to the impact of some of the measures prior to those announced in the 2007 Budget on marginal deduction rates. We consider the broader context, including the fiscal context and the Government's broader social policy objectives, in chapter 5.

Introduction of the 10 pence rate of income tax

6.  The Labour Party's 1997 General Election manifesto stated:

Our long-term objective is a lower starting rate of income tax of 10 pence in the pound. Reducing the high marginal rates at the bottom end of the earning scale—often 70 or 80%—is not only fair but desirable to encourage employment.[6]

In his 1998 Budget, the then Chancellor of the Exchequer confirmed his intention to bring in such a starting rate "when it is right for the economy".[7] The introduction of the measure was announced in the following year's Budget as follows:

We said in our manifesto that we would introduce a 10p starting rate of income tax for individuals when it was prudent to do so. I repeated in the last Budget that we would introduce the 10p starting rate when it was prudent to do so. However, I have to tell the House that the 10p rate will not start in April 2000, like other income tax changes we are making today. It is prudent instead for people to get the benefit of the 10p starting rate now. So it will take effect in April 1999, a 10p starting rate on the first £1,500 of income, the lowest starting rate of tax since 1962, and it will be delivered a few weeks from today. People will see it in their pay packets in May. Nearly 2 million people will see their income tax bills cut in half, and take home 90p of every pound they earn.[8]

The accompanying Budget document expanded on the reasons for the new measure:

To put work first in the tax and benefit system, the Government will introduce a 10p rate of income tax. From 6 April this year, taxpayers will pay only 10 pence in the pound on their first £1,500 of taxable income …When the 10p rate is introduced, there will be three main rates of income tax—10, 23 and 40%. Basic and top rate taxpayers will gain £1·15 a week from the change. But those on the lowest incomes (below £8,835) will gain more, because the three rate structure helps to target the gains from the 10p rate on the lowest paid: 1.8 million people, of whom 1.5 million are low paid, will see their tax bill halved, and a further 300,000 people will be taken out of income tax altogether. The new 10p band will help to ease the poverty trap whereby people on low pay are discouraged from climbing the earnings ladder.[9]

7.  The 10 pence tax rate was not without its critics. In January 1998, the IFS concluded:

In terms of the key goal of improving work incentives, it is clear that the introduction of a 10% tax rate is an expensive way of achieving little. It is also clear that an income tax system with a 10% band is likely to increase the complexity of the tax system.[10]

Mr Edward Troup, then Head of Tax Strategy at Simmons & Simmons Solicitors, suggested to the then Treasury Committee following the 1999 Budget that "a perfectly simple tax system delivering whatever tax you want to almost anybody can be delivered with personal allowances and two rates of tax".[11]

The new tax credits system

THE TAYLOR REPORT

8.  The introduction of the 10 pence rate of income tax formed part of a wider Government commitment to reform of the tax and benefits system as a whole, a process initiated in the 1998 Budget.[12] At the time of that Budget, the Government published a report on work incentives by Martin Taylor, then Chief Executive of Barclays Bank. That report referred to the two consequences of the tax and benefits systems as they then operated:

• "the unemployment trap", whereby "in-work support is not sufficient to make work worthwhile"; and
• "the poverty trap", whereby "the high rate of withdrawal of benefits as incomes rise deters the low paid from seeking to increase their earnings".[13]

The Taylor report rejected the case for "full-blown integration" of the tax and benefits systems because of the different objectives of the two systems (the funding of Government expenditure and the relief of need), because of differences in the mechanisms of distribution and collection and because, "while taxation is paid by individuals, benefit is paid to household groups; both these arrangements are fiercely defended".[14] The Taylor report recommended that the existing Family Credit be replaced by a tax credit which would "associate the payment in the recipient's mind with the fact of working" and would be likely "to prove more acceptable to society at large".[15]

WORKING FAMILIES TAX CREDIT AND CHILDREN'S TAX CREDIT

9.  The Taylor report was followed by the introduction in October 1999 of Working Families' Tax Credit (WFTC) and the Disabled Person's Tax Credit which replaced the Family Credit and the Disability Working Allowance. The WFTC was based on a 'snapshot' of income and circumstances at the time of the claim and was unaffected by changes of circumstances in the following six months, but was more generous than the Family Credit, included a childcare element and was paid through the pay packet rather than to the main carer. In April 2000, the Government also introduced a Children's Tax Credit which replaced the married couple's allowance and related allowances.[16]

CHILD TAX CREDIT AND WORKING TAX CREDIT

10.  In the 2000 Budget the Government announced its intention to "go further in improving the transparency and administration of income-related payments through the tax and benefit system".[17] The main principles underpinning the new approach were to separate support for children from that for adults, to extend support to low-income households with at least one working adult but no dependent children and to align assessments of eligibility more closely with the rules for income tax. These principles were reflected in the introduction in April 2003 of the Child Tax Credit and the Working Tax Credit. The former was to be paid to the main carer, usually the mother, and was to provide a common framework for both low- and middle-income families.[18] The Child Tax Credit was to be for families who were responsible for at least one child or qualifying person. The Credit was to consist of a number of elements designed to acknowledge the circumstances of different families:

• A family element, a basic element payable to families responsible for one or more children. A higher rate of family element, often known as the baby element, was to be paid to families with one or more children under one year old;
• A child element, payable for each child within the family; and
• A disabled child element, for families caring for a child with a disability or severe disability.[19]

The Working Tax Credit was to support low-income families with at least one working adult, including families without dependent children where one adult was working over 30 hours a week and aged 25 or over. For those with dependent children, Working Tax Credit was to include a childcare element to provide help with childcare costs for people spending money on registered or approved childcare. Eligibility for both of the new tax credits was to be assessed using a "modern income test", building on the definition used in the tax system which was to be much more responsive to changing circumstances.[20]

11.  The new tax credits system is significantly more generous than Family Credit. It benefits vastly more people, around 20 million adults compared with 2.8 million for Family Credit.[21] Take-up levels for the new tax credits among families with children have been high since their introduction and generally on an upward path. According to the Treasury, in 2005-06 take-up of the Child Tax Credit was 82% with over 90% of the money available being claimed. Take-up amongst those on low incomes in that year was 90% and reached 96% for those on incomes below £10,000.[22] Prior to its implementation, it was estimated that the new tax credits system would cost £2.7 billion more in 2003-04 than the previous system.[23] The IFS has estimated that the cost of administering tax credits in 2003-04 and 2004-05 stood at just over 3 pence per pound paid out, which was higher than the cost of administering the previous Working Families Tax Credit and nearly three times the cost of administering child benefit.[24]

12.  When it reviewed the impact of its own reforms on incentives to work in March 2005, the Government emphasised the importance both of changes to the tax system and of tax credits. The Government identified the introduction of the 10 pence rate of income tax as one of the reforms of income tax and national insurance that had reduced the burden of tax on low-paid workers.[25] The Government also stressed the novelty of the Working Tax Credit, in that it was the first net tax payment from Government that benefited low-income working people without dependent children or a disability.[26] In part because of this novelty, the take-up of Working Tax Credit has been low amongst families without dependent children. In 2004-05, take-up among such families was around 19% by caseload and 25% by value. The Government estimated that around 980,000 families without dependent children had not claimed Working Tax Credit to which they were entitled, and the value of such unclaimed Working Tax Credits was £1.29 billion.[27] During our inquiry into the 2007 Budget, the then Chancellor of the Exchequer pointed to evidence of an upward trend in take-up among such families and reaffirmed the Government's commitment to increasing take-up.[28] In its written evidence for the current inquiry, the Treasury drew attention to evidence of increased take-up of Working Tax Credit among families without dependent children in 2005-06.[29] Analysis by HMRC indicated that take-up among such families had risen in that year to around 22% by caseload and 28% by value. However, the number of such families not claiming Working Tax Credit to which they were entitled had also risen—to 1,010,000—and the value of such unclaimed Working Tax Credits was £1.44 billion.[30] We consider the possible causes of these low take-up rates and measures that might increase such take-up later in this Report.[31]

ADMINISTRATIVE PROBLEMS AND THE 2005 REFORMS

13.  The new tax credits have also been subject to considerable administrative problems in their early years. In 2003-04, the first year of implementation, about one-third of all tax credit awards paid were overpaid, and this trend of overpayment continued in subsequent years. The value of overpayments was £2.2 billion in 2003-04, £1.8 billion in 2004-05 and £1.7 billion in 2005-06.[32] The value of underpayments was £464 million in 2003-04, £556 million in 2004-05 and £549 million in 2005-06.[33] The recovery of overpayments by HM Revenue & Customs (HMRC) has been the source of distress and dismay to individual claimants, particularly because many of those facing recovery did not believe that an error by them was the cause of the original overpayment. We considered the problems in the administration of tax credits in detail in a Report in June 2006, in which we called for a more claimant-centred approach by HMRC.[34]

14.  In December 2005, at the time of that year's Pre-Budget Report, the Government announced a series of reforms designed to improve the operation of tax credits, including:

• increasing the disregard for increases in income between one tax year and the next ten-fold, from £2,500 to £25,000;
• applying automatic limits on the amount of overpaid tax credits ("excess payments") HMRC recovers from claimants where awards are adjusted in-year following a reported change; and
• in the case of claimants who report a fall in income during the year, continuing to adjust their tax credits payments for the rest of the year to reflect their new income level but assessing whether they are entitled to a one-off payment for the earlier part of the year at the end of the year, rather than at the point at which they report the fall in income.[35]

The second of these changes was due to come into effect from November 2006, but the Government subsequently delayed implementation due to administrative problems, thus prolonging the period when claimants were at risk of facing demands for full re-payments for in-year adjustments.[36] The Government has been cautious in assessing the impact of these reforms, but the increased disregard has the clear potential to benefit families whose income increases.[37]

15.  In December 2005, the Government also announced new reporting obligations on claimants, the most notable of which was a shortening of the deadline for the return of end-of-year information from the end of September to the end of August.[38] A year later, following successful implementation of this change, the Government announced that in 2007 the deadline would be moved again, to the end of July, thus further shortening the period for the return of end-of-year information to four months. The Government stated that this change "will further reduce the time over which claimants are paid on potentially out-of-date information".[39]

The starting rate of income tax, tax credits and marginal deduction rates

16.  The introduction of a 10 pence rate of income tax was linked by the Government to its aim of reducing the number of households facing high marginal deduction rates. Marginal deduction rates measure how much of each additional pound of gross earnings is lost through increases in tax payments and withdrawn benefits or tax credits. High marginal deduction rates are closely associated with the poverty trap, because those in work have limited incentives to move up the earnings ladder when doing so may leave them little better off.[40] Between 1997-98 and 2006-07, the number of households facing marginal deduction rates in excess of 70% fell by half a million, and the Government argued that the introduction of the starting rate of income tax played a role in that marked reduction.[41] Most of the reduction in these very high deduction rates was achieved immediately following the 1999 Budget.[42]

17.  However, the introduction of the new tax credits in April 2003 has been associated with a sharp rise in the number of households facing marginal deduction rates between 60% and 70%, a number which reached around 1.5 million households following the 2006 Budget.[43] At that time, the then Chancellor of the Exchequer told us that the increase in the number of people facing marginal deduction rates of over 60% was a consequence of "more people going into work and more people claiming the Child Tax Credit or the Working Tax Credit". He noted that he "would like to do more, and we will do more over time", but emphasised that he had succeeded in "eliminating the highest marginal tax rates". We recommended then that the Treasury analyse the characteristics and income distributions of households facing marginal tax rates in the region of 60% to 70% and the extent to which these high marginal tax rates were discouraging people from entering the workforce, from working longer hours or from acquiring additional skills.[44]

Announcements in the 2007 Budget

OVERVIEW

18.  The then Chancellor of the Exchequer characterised his 2007 Budget as "a Budget to expand prosperity and fairness for Britain's families".[45] It contained many far-reaching measures, including a number which were designed for future tax years rather than the tax year about to commence. It is important to consider the abolition of the 10 pence income tax rate on non-savings income alongside the wider set of reforms to personal taxes and tax credits announced in that Budget to take effect during the period up to April 2010.[46] The IFS has argued that the measures as a whole were "carefully calibrated to ensure that various groups were protected from the abolition of the 10% band".[47]

THE ABOLITION OF THE STARTING RATE OF INCOME TAX FOR NON-SAVINGS INCOME

19.  The abolition of the starting rate of income tax announced in the 2007 Budget was to come into force in April 2008. At the time of the 2007 Budget, the personal allowances for those under the age of 65 for the tax year 2008-09 were not announced. They were confirmed in the 2007 Pre-Budget Report, when the Government stated that income tax allowances for 2008-09 would be indexed in line with the increase in the Retail Prices Index for the year to September 2007.[48] The effect of abolishing the starting rate of income tax was thus to provide that individuals aged under 65 would pay the basic rate on all income after the first £5,435 up to £36,000.[49] At the time of the 2007 Budget, the Government estimated that the removal of the starting rate of income tax on non-savings income would yield the Exchequer an additional £7.3 billion in 2008-09.[50]

REDUCTION OF BASIC RATE OF INCOME TAX

20.  At the conclusion of his 2007 Budget statement, the then Chancellor of the Exchequer also announced a reduction of the basic rate of income tax with effect from April 2008 from 22% to 20%, the lowest rate for 75 years.[51] As we will see in the next chapter, for most taxpayers, this reduction in the basic rate offset or more than offset their losses from the abolition of the starting rate.[52] The cost to the Exchequer from this measure in 2008-09 was estimated by the Treasury to be around £8.1 billion.[53]

HIGHER ALLOWANCES FOR THOSE AGED 65 AND OVER

21.  The 2007 Budget contained measures to insulate most pensioners from the effects of the abolition of the starting rate of income tax.[54] The Chancellor of the Exchequer announced increases well above indexation in the higher personal allowances for those aged 65 and over in 2008-09 and beyond. For those aged between 65 and 74, the tax-free allowance would rise in three stages from £7,550 in 2007-08 to £8,990 in 2008-09, to £9,500 in 2009-10 and then to £9,770 in 2010-11. For those over 75, the tax-free allowance would rise annually from £7,690 in 2007-08 to £10,000 by 2010-11.[55] The cost of the increases in personal allowances for those aged 65 and over in 2008-09 was estimated by the Government at £810 million.[56] Age Concern welcomed the fact that, as a result of these changes, "580,000 people aged 65 and over have been taken out of the income tax system altogether. This not only increases their income but simplifies their financial affairs by limiting their need to come into contact with HMRC."[57]

THE 10% SAVINGS RATE

22.  Although the 10 pence rate of income tax was to be abolished on non-savings income, the Government also announced in the 2007 Budget that, "to continue to reward saving, the Government will maintain the existing 10 pence rate of tax for savings income, which is identified separately in the income tax system".[58] During our inquiry into the 2007 Budget, Mr John Whiting of LITRG argued that this change was "to make sure that the pensioner community in particular are protected from the withdrawal of the 10% main band". He acknowledged that there would be others on low income, apart from pensioners, who would benefit from the retention of the 10% savings band, but suggested that there might have been simpler ways to protect the income of pensioners than retention of a separate savings rate.[59] During the current inquiry, LITRG, Age Concern and the Tax Faculty of the Institute of Chartered Accountants in England & Wales (ICAEW) all drew attention to the complexity which the retention of the 10% savings rate added to the tax system and the practical problems for taxpayers in ensuring that they benefited from this rate.[60] The ICAEW concluded that:

In the interests of simplicity, we do not think that the 10% rate should be retained in this limited way just for savings income. However, abolishing it will create further losers, and careful consideration and consultation is needed before anything is done.[61]

The 10% tax rate on savings income adds to the complexity of the tax system. Should the Government choose to remove the 10% savings rate in the future with a view to simplifying the tax system further, it should proceed with caution, ensuring that those who would lose from its abolition are clearly identified and that the precise effects of abolition are fully considered.

CHANGES TO THE HIGHER RATE THRESHOLD AND UPPER EARNINGS LIMIT

23.  As part of his intention to create a tax system for non-savings income "that has just two rates and two thresholds", the then Chancellor of the Exchequer included within the 2007 Budget measures to align income tax thresholds with those for employee National Insurance Contributions.[62] In 2007-08, employees were paying National Insurance at 11% on their weekly earnings between the primary threshold of £100 and the Upper Earnings Limit of £670. National Insurance was then paid at a rate of 1% above the Upper Earnings Limit.[63] This created a situation in which the marginal rate of deduction faced by employees through the combination of income tax and National Insurance Contributions was 33% for weekly earnings up to £670, but only 23% for earnings between £670 and £766. In the 2007 Budget, the Government set out to address this kink in deduction rates in two stages:

• In 2008-09, the Upper Earnings Limit was to be raised by £75 a week above indexation;[64]
• In 2009-10, the higher rate threshold was to be raised by £800 a year above indexation, while the Upper Earnings Limit was to be increased further to align it with the higher rate threshold at an equivalent of yearly earnings of £43,000.[65]

The effect of these changes if implemented as originally intended would have been to create in 2009-10 a consistent marginal rate of deduction of income tax and National Insurance for all weekly earnings between £100 and around £830 of 31%. The net increase in Exchequer yield from these combined measures was estimated by the Treasury to be £1.1 billion in 2008-09 with a further increase of £1.2 billion in 2009-10, with the increases achieved through higher National Insurance Contributions from those with weekly earnings above £695.[66]

CHANGES RELATING TO TAX CREDITS AND CHILD BENEFIT

24.  Reforms to the tax and National Insurance system in the 2007 Budget were accompanied by changes to tax credits. First, the Government announced that, from April 2008, the income threshold at which Working Tax Credit was received in full would increase by £1,200, to £6,420 a year. The Government stated that "this will support work as the best route out of poverty by increasing the gain to work for many low-income households, and reducing the net tax burden for working families".[67] The cost to the Exchequer of this measure in 2008-09 was estimated by the Treasury to be £1.3 billion.[68] This change meant that eligibility for Working Tax Credit extended in 2008-09 to those single adults without children with incomes up to around £12,900 and to those couples without children with a combined income up to around £17,500.[69] The then Chancellor of the Exchequer argued in his Budget statement that targeting expenditure on Working Tax Credit was effective in enhancing work incentives:

More than 1½ million low-income workers in Britain receive the Working Tax Credit, worth to them on average £48 a week. In making work pay, we ensure that people on low incomes get more benefit from the Working Tax Credit than either the minimum wage or any other tax measure, whether it be the 10p rate or personal allowances. If I invested a billion pounds in helping low-income workers by raising personal allowances, they would be only 68p a week better off. If I used the same money to lower the 10p rate, they would be just 67p a week better off. But the use of the same money to extend the Working Tax Credit means that they are £7.10 a week—£370 a year—better off. That is a clear incentive to take jobs, to gain skills, and to work your way up from a lower-paid to a better-paid job.[70]

25.  The benefits of the increase in the Working Tax Credit threshold were partially offset by an increase in the tax credit withdrawal rate by 2% to 39%. When the new tax credits were introduced, an award was gradually reduced at the rate of 37 pence for every pound of gross income over the threshold. The effect of the increase in the withdrawal rate is thus to make the rate of descent in payments as income increases slightly more marked, albeit from a much higher threshold.[71] The Treasury estimated that the savings to the Exchequer from the increased withdrawal rate would be £600 million in 2008-09.[72]

26.  The then Chancellor of the Exchequer also announced two further measures targeted specifically on children. The Government had previously committed to increase the child element of the Child Tax Credit in line with earnings indexation, but the 2007 Budget contained an additional commitment to increase this element in 2008-09 by £150 above earnings indexation, raising it to £2,080 a year.[73] The costs of this measure in 2008-09 was estimated by the Government to be £880 million.[74] Second, the then Chancellor of the Exchequer announced that the rate of child benefit paid to the first child would rise above standard uprating so that it reached £20 a week by 2010-11.[75] The Government estimated that the combined effect of measures announced in the 2007 Budget would be to take 200,000 children out of poverty, an estimate that was subsequently supported by the IFS.[76]

THE DEBATE ON THE 2007 BUDGET

27.  The fullest account of the overall rationale for the personal taxation, National Insurance and tax credits measures in the 2007 Budget was given by the then Chancellor of the Exchequer in oral evidence to us on 29 March 2007 when he said:

On the personal tax system, it seems to me to have two rates and two thresholds is something that has eluded every Government for the last 40 years, even when they have tried to do this … We have now not only got 20p as the basic rate of income tax, and I think the public will understand the importance of that as a signal about the importance of work and the rewards that are available for work, but we have also managed to get two thresholds because the resources that we have got have made it possible for us to harmonise the threshold for top rate income tax and the ceiling for National Insurance. That is a major change that any Chancellor of the Exchequer would like to have done were the resources available to do so. That is what has lain behind what we have been able to do. Because we can provide money through the child benefit and Child Tax Credits, through pensioner tax allowances and through the Pension Credit, and through the Working Tax Credit, because these three instruments are now available to us, it is possible to move from 22 pence to 20 pence without having a 10 pence rate which in a sense was a transitional rate while we got the new system into being. I believe that over time very few people will want to change this two rate and two threshold system of income tax.[77]

The reference in this answer to the 10 pence starting rate as "a transitional rate" appears to be the first occasion on which the Government indicated that it had viewed that measure as transitional. When we asked the Treasury when the Government first stated that the 10 pence tax rate was a "transitional " measure, it made no reference to any policy statement prior to 29 March 2007.[78] The characterisation of the 10 pence starting rate as "transitional" was echoed in the current Chancellor of the Exchequer's letter to the Chairman of this Committee on 23 April.[79]

28.  Given the centrality that the abolition of the starting rate has subsequently assumed in public debate, it is notable that the abolition of the 10 pence income tax rate did not dominate the parliamentary and public debate that followed the 2007 Budget. Some concerns were expressed: the TUC pointed out that "there may be a group of younger, childless, non-disabled, low-paid workers who do not qualify for tax credits who could lose out".[80] Geoffrey Robinson MP, a former Treasury Minister, said the following during the debate on the Budget resolutions:

I have a bone to pick with the Chancellor of the Exchequer and the Treasury Front Bench about the removal of the 10% … rate. I cannot believe that that is the last word from my right hon. and hon. Friends on the subject. It is hurting many people whom the Government never set out in any of their policies to hurt—I accept that that is a consequence and not an intention of the Budget. Indeed, when the 10p rate was introduced it was precisely to alleviate those problems that, in part, we are now creating. I know that there are tax benefits and that there are many other things that we have done for that category of taxpayer, but the matter should be revisited, and I hope that we will do so before the next Budget.[81]

When it was put to the Rt. Hon. Stephen Timms MP, the then Chief Secretary to the Treasury, at the conclusion of the debate on the Budget resolutions that a single person without children who earned less than £18,000 a year would be worse off as a result of the Budget, he replied "No, that is certainly not necessarily the case".[82]

29.  The most authoritative quantitative analysis of the 2007 Budget package available at the time was provided to us by the IFS on 26 March 2007, when Mr Robert Chote, Director of the IFS, gave an estimate that 5.3 million families lost as a result of the package, although he also stated that "most of them don't lose very much".[83] On 28 March, Mark Neale, Managing Director, Budget, Tax and Welfare, HM Treasury, said in evidence to us that "the figure that Robert Chote gave you is in the right ball-park".[84] The following day, in Treasury questions and in evidence to us, the then Chancellor of the Exchequer did not directly answer questions about the numbers who were worse off as a result of the Budget, but argued that the IFS figures did not take account of the rise in the minimum wage or the behavioural impact of changes to Working Tax Credits.[85] In evidence to us he also provided new information about take-up of Working Tax Credit.[86] In our Report, we welcomed evidence of a recent increase in take-up of Working Tax Credit and argued that increasing the low take-up rate of Working Tax Credit among those entitled to claim it without dependent children should be a priority.[87]

30.  Because the main tax changes announced in the 2007 Budget were not due to come into force until 2008-09, they were not included within the 2007 Finance Bill, but, during the report stage of that Bill in the House of Commons, Mr Frank Field MP moved a new Clause which, if enacted, would have required the Government to identify the effects of tax measures on different earnings groups and prepare transitional relief measures for those within the lowest quintile of earnings who were adversely affected.[88] In the course of the debate on that new Clause, Mr Field referred to a written parliamentary answer from HM Treasury which he considered implied that there were 3 million individual taxpayers who would lose from the abolition of the 10 pence rate of income tax coupled with the reduction in the basic rate.[89] In reply to the debate, the then Chief Secretary to the Treasury said:

The package reduces and simplifies personal taxation within a fiscally neutral Budget, protecting and boosting the incomes of vulnerable groups, with the number of losers minimised. I am not saying that there are none, but the number has effectively been minimised … If we all agree—I think that on the whole we do—that it is right to prioritise the reduction and ultimately the eradication of child poverty, we need to prioritise households with children in Budget measures. That is what the package in the Budget does … As far as I can see, where losses accrue to some as a result of the changes, they are small.[90]

The new Clause was rejected by the House after a division.[91] Subsequently, on 18 October 2007, the Treasury published a parliamentary written answer to a question from Mr Field which stated that "5.3 million households … will pay marginally more in net tax" as a result of the changes coming into effect in 2008-09.[92]

The 2007 Pre-Budget Report

31.  The Chancellor of the Exchequer's 2007 Pre-Budget Report, published alongside the Comprehensive Spending Review on 9 October, did not contain measures with a direct bearing on income tax, beyond the announcement of the indexation of allowances to which we referred earlier.[93] It did, however, contain a number of measures relating to tackling child poverty, measures which are relevant to the overall impact of the tax changes in the 2007 Budget.

32.  First, the Government announced that it would raise the child element of the Child Tax Credit by £25 a year above earnings indexation to £2,085 in 2008-09, in addition to the commitment in the 2007 Budget to increase the child element by £150 and that it intended to raise the child element again by a further £25 above indexation in April 2010.[94] The cost of this measure in 2008-09 was £150 million, rising to £310 million in 2010-11.[95] Second, the Chancellor of the Exchequer announced that he was doubling the amount of child maintenance that a family could receive without affecting their family benefits to £20 a week in 2008-09 and then to £40 a week in 2010-11.[96] Third, the Government confirmed that it would introduce nationally the previously piloted In-work Credit, a £40 a week (£60 in London) payment for lone parents who had been on Income Support during their first twelve months in employment.[97] The Government estimated that the combined effect of these measures would be to lift 100,000 children out of poverty.[98]

The 2008 Budget

33.  Like the 2007 Pre-Budget Report, the 2008 Budget held on 12 March contained no substantive new measures with a direct bearing on levels of personal taxation planned to come into effect in 2008-09. However, it did contain measures affecting overall household income targeted on pensioner households and certain households with dependent children.

34.  In addition to the Government's prior commitment to continue the level of the Winter Fuel Payment at £200 for households with someone over 60 and £300 for households with someone over 80 for the duration of the current Parliament, the Government announced extra one-off payments in 2008-09 which made the totals to be paid £250 and £400 respectively.[99] The cost to the Exchequer of these one-off payments in 2008-09 will be £575 million.[100]

35.  The 2008 Budget also contained three measures relating to child poverty. First, the rate of Child Benefit for the first child was to be raised to £20 a week in 2009-10, a year earlier than had been announced in the 2007 Budget, at a cost of £210 million in 2009-10.[101] Second, the child element of Child Tax Credit was to be increased by £50 a year above indexation from 2009-10, at a cost of £340 million in that year.[102] Third, receipt of Child Benefit was to be disregarded in calculating income for the purposes of Housing Benefit and Council Tax Benefit, at a cost of £350 million in the first full financial year in which it has effect.[103] The Chancellor of the Exchequer said that the combined effect of these measures would be to lift 250,000 children out of poverty, an estimate which the IFS broadly endorsed.[104] Of this eventual reduction, the Chancellor of the Exchequer attributed a reduction of around 150,000 children to the Child Benefit disregard alone.[105] Mr Mike Brewer, Director of Direct Tax and Welfare at the IFS, told us that he viewed the measure as well-targeted on child poverty.[106]

Developments since the 2008 Budget

36.  When we took evidence from Treasury officials on 18 March during our inquiry into the 2008 Budget, we sought and failed to obtain a direct answer to the question of how many people with an income of less than £18,500 would face a fall in their living standards in 2008-09 as a result of the abolition of the 10 pence rate of income tax and other measures.[107] In written evidence received the following day, the Treasury stated that 800,000 single earners with income under £18,500 would see their income decrease by around £1.45 a week on average, with the maximum loss to any individual being £232 a year (£4.46 a week)—about 3% of net income.[108] When we raised these figures with the Chancellor of the Exchequer on 19 March, he acknowledged that there were people who would be adversely affected by the measures in the previous year's Budget. With respect to those aged 60 to 64, he drew attention to the benefits of the additional winter fuel payment. He also said that "we have tried to help wherever we can through the tax credit".[109] In our subsequent Report we concluded:

Those most affected by the abolition of the 10 pence rate of income tax appear to be those below the age of 65 with an income under £18,500 who are in childless households. The effect is greatest on those households where no individual is above the age of 60 because the household does not then benefit from the higher winter fuel allowance. We accept that there are benefits in tax simplification and that there are merits to focus on both the needs of children and motivation to work. However, the group of main losers from the abolition of the 10 pence rate of income tax seem an unreasonable target for raising additional tax revenues to fund these and other initiatives.[110]

37.  Our views were part of a growing chorus of concerns about the effects of the tax measures as they came into force in the new tax year. The postbags and inboxes of Members of the House of Commons began to bulge with letters and e-mails expressing concern about the effects of the removal of the starting rate of income tax. That decision dominated the debate on the Second Reading of the Finance Bill on 21 April, during which the Rt. Hon. Yvette Cooper MP, the Chief Secretary to the Treasury, announced that the programme of work already underway on the next phase of tackling child poverty would be extended "to include consideration of households on low incomes without children".[111]

38.  Two days later, on 23 April, the Chancellor of the Exchequer wrote to the Chairman of this Committee indicating an intention to "do more to help" certain groups "now and in the future":

The main two groups we want to do more to help are, first, other low paid workers without children, and, second, pensioners under 65. We have been actively looking at two ways to help these groups—direct payments or changes to the tax credit system … As a sign of the Government's intent, we do not wish to wait unnecessarily until [the Pre-Budget Report in] November. Whatever conclusions we come to, all the changes [through direct payments] will be backdated to the start of this financial year.[112]

These remarks were echoed on the same day by the Prime Minister, who also said that measures relating to Working Tax Credit considered for the Pre-Budget Report would relate "to young people and part-time workers".[113] In the light of the announcements made on 23 April and the outcome of a preceding meeting between Mr Frank Field and the Prime Minister, Mr Field did not proceed with an amendment at the Committee stage of the 2008 Finance Bill similar in effect to that which he had tabled to the 2007 Finance Bill.[114]

39.  On 13 May 2008, the Chancellor of the Exchequer announced that he proposed to table an amendment at the report stage of the Finance Bill to increase the individual personal tax allowance by £600 to £6,035 for the current financial year, benefiting all basic rate taxpayers under 65.[115] We examine this announcement in more detail in chapter 4. However, before looking at options and decisions for the current tax year, it is important to look in detail at the initial effect of the abolition of the starting rate of income tax and related Budget measures.

7   HC Deb, 17 March 1998, col 1104 Back

8   HC Deb, 9 March 1999, col 188 Back

9   HM Treasury, Budget 99: Building a Stronger Economic Future for Britain, HC (1998-99) 298, March 1999, p 60, paras 4.49-4.51 Back

10   IFS, Green Budget, January 1998, pp 21-23, cited in Treasury Committee, Fourth Report of Session 1998-99, The 1999 Budget, HC 325, para 47, note 87. Back

11   HC (1998-99) 325, para 45 Back

12   HC Deb, 17 March 1998, col 1097 Back

13   HM Treasury, The Modernisation of Britain's Tax and Benefit System: Number Two: Work Incentives: A Report by Martin Taylor, March 1998, p 19, para 3.04 Back

14   Ibid., p 6, paras 1.10-1.11 Back

15   HM Treasury, The Modernisation of Britain's Tax and Benefit System: Number Two: Work Incentives: A Report by Martin Taylor, March 1998., p 8, para 1.22 Back

16   Treasury Committee, Sixth Report of Session 2005-06, The administration of tax credits, HC 811-I, Annex, paras 6-7 Back

17   HM Treasury, Budget 2000, p 87, para 5.16 Back

18   HC( 2005-06) 811-I, Annex, paras 8-9 Back

19   HM Treasury and HMRC, Tax Credits: improving delivery and choice - a discussion paper, May 2008, p 11 Back

20   HC (2005-06) 811-I, Annex, paras 9-11 Back

21   Ibid., Annex, para 18; Ev 122 Back

22   Ev 122 Back

23   HM Treasury, Budget 2002, p 134, Table A.1 Back

24   IFS, Green Budget, January 2006, p 146 Back

25   HM Treasury, Tax credits: reforming financial support for families: The modernisation of Britain's Tax and Benefit System: Number Eleven, March 2005, p 25, para 4.5 Back

26   Ibid., p 26, para 4.9. See also Ev 121. Back

27   HMRC, Child Tax Credit and Working Tax Credit: Take-up rates 2004-05, 2007, p 12, Table 10. All references are to the central estimate. Back

28   Treasury Committee, Fifth Report of Session 2006-07, The 2007 Budget, HC 389-I, para 43 Back

29   Ev 122 Back

30   HMRC, Child Tax Credit and Working Tax Credit: Take-up rates 2005-06, 2008, p 12, Table 10. All references are to the central estimate. Back

31   See paragraphs 184-191. Back

32   HM Treasury and HMRC, Tax credits: improving delivery and choice - a discussion paper, May 2008, p 30; HC Deb, 20 May 2008, col 12WS; NAO, HM Revenue & Customs 2005-06 accounts: The Comptroller General and Auditor General's Standard Report, July 2006, p 2; NAO, HM Revenue & Customs 2006-07 accounts: The Comptroller General and Auditor General's Standard Report, July 2007, p 3 Back

33   HM Revenue & Customs, Child and Working Tax Credits statistics, Finalised awards, 2006-07, April 2008, p 3 Back

34   HC (2005-06) 811-I; HC (2006-07) 382-i, Q 7 Back

35   HC (2005-06) 811-I, para 105 Back

36   Treasury Committee, Second Report of Session 2006-07, The 2006 Pre-Budget Report, HC 115, paras 76-77, 79; HC (2006-07) 382-i, Q 20 Back

37   HC (2006-07) 382-i, Qq 6, 18-19; HC (2005-06) 811-I, paras 121-127 Back

38   HC (2005-06) 811-I, para 106 Back

39   HC (2006-07) 115, para 76; HC (2006-07) 382-i, Qq 18-19 Back

40   Treasury Committee, Fourth Report of Session 2005-06, The 2006 Budget, HC 994-I, para 83 Back

41   Ibid., para 85; Tax credits: reforming financial support for families, p 29, para 4.20 Back

42   See HC (2005-06) 994-I, para 83 and Figure 2. Back

43   HM Treasury, Budget 2006, p 94, Table 4.2 Back

44   HM Treasury, Budget 2006, paras 83-85 Back

45   HC Deb, 21 March 2007, col 815 Back

46   Ev 39 Back

47   Ev 42 Back

48   HM Treasury, Budget 2008, p 131, para A.2.5 Back

49   Ev 42 Back

50   HM Treasury, Budget 2007, p 208, Table A1 Back

51   HC Deb, 21 March 2007, col 828 Back

52   See paragraph 48. Back

53   Budget 2007, p 208, Table A1 Back

54   Ev 42 Back

55   HC Deb, 21 March 2007, col 826. For 2007-08 allowances, see Budget 2007, p 211, Table A4. Back

56   Budget 2007, p 208, Table A1 Back

57   Ev 96 Back

58   Budget 2007, p 106, para 5.5 Back

59   HC (2006-07) 389-I, para 38 Back

60   Ev 81, 97, 152; Q 86 Back

61   Ev 152 Back

62   HC Deb, 21 March 2007, cols 826-827 Back

63   Budget 2007, p 212, Table A5. The Lower Earnings Limit (LEL) is £87 per week. No National Insurance is paid by employees in respect of earnings between the LEL and the primary threshold, but National Insurance is treated as having been paid to protect benefit entitlement. Back

64   Budget 2007, p 106, para 5.6 Back

65   HC Deb, 21 March 2007, cols 826-827; Budget 2007, p 106, paras 5.6-5.7 Back

66   Budget 2007, p 208, Table A1 Back

67   Budget 2007, p 108, para 5.15 Back

68   Ibid., p 208, Table A1 Back

69   Ev 43 Back

70   HC Deb, 21 March 2007, cols 823-824 Back

71   Ibid., p 108, para 5.15; HM Treasury and Inland Revenue, The Child and Working Tax Credits: The Modernisation of Britain's Tax and Benefit System: Number Ten, April 2002, p 6, para 2.24 Back

72   Budget 2007, p 208, Table A1 Back

73   Ibid., p 107, paras 5.12-5.13 Back

74   Budget 2007, p 208, Table A1 Back

75   HC Deb, 21 March 2007, col 825; Budget 2007, pp 111, 214, paras 5.20, A.31 Back

76   HC Deb, 21 March 2007, col 825; HC (2006-07) 389-I, para 47 Back

77   HC (2006-07) 389-II, Q 296 Back

78   Ev 129 Back

79   Ev 120 Back

80   Ev 108 Back

81   HC Deb, 27 March 2007, col 1365 Back

82   Ibid., col 1430 Back

83   HC (2006-07) 389-II, Q 61 Back

84   Ibid., Q 189 Back

85   HC Deb, 29 March 2007, cols 1619, 1622; HC (2006-07) 389-II, Qq 303-308 Back

86   HC (2006-07) 389-II, Q 312 Back

87   HC (2006-07) 389-I, para 45 Back

88   HC Deb, 25 June 2007, cols 108-110 Back

89   Ibid., col 121: "In 2008-09, all 31 million taxpayers would have benefited from the 10p rate of income tax. Some 28 million of these taxpayers stand to gain from the cut in the basic rate of income tax to 20p": HC Deb, 25 June 2007, col 384W. Back

90   HC Deb, 25 June 2007, cols 119-120 Back

91   Ibid., col 122 Back

92   HC Deb, 18 October 2007, col 1267W Back

93   See paragraph 19. Back

94   HM Treasury, Pre-Budget Report and Comprehensive Spending Review 2007, p 78, para 5.25 Back

95   Budget 2008, p 112, Table A.2 Back

96   HC Deb, 9 October 2007, col 172 Back

97   Pre-Budget Report and Comprehensive Spending Review 2007, p 75, para 5.12 Back

98   HC Deb, 9 October 2007, col 173 Back

99   Budget 2008, p 65, para 4.29 Back

100   Ibid,, p 110, Table A.1 Back

101   Budget 2008, p 63, para 4.17, p 110, Table A.1 Back

102   Ibid. Back

103   Ibid. Back

104   HC Deb, 12 March 2008, col 291; Treasury Committee, Ninth Report of Session 2007-08, The 2008 Budget, HC 439, para 50 Back

105   HC Deb, 12 March 2008, col 290 Back

106   Q 50 Back

107   HC (2007-08) 430, Qq 234-241 Back

108   Ibid., Ev 63 Back

109   Ibid., Qq 385-386 Back

110   Ibid., para 61 Back

111   HC Deb, 21 April 2008, col 1067 Back

112   Ev 120 Back

113   HC Deb, 23 April 2008, col 1302 Back

114   See paragraph 30 and HC Deb, 28 April 2008, cols 111-116. Back

115   HC Deb, 13 May 2008, col 1201 Back