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Select Committee on Treasury Ninth Report

4 Child poverty, fuel poverty and the poverty trap

Child poverty

BACKGROUND

44. In 1999, the then Prime Minister committed the Government to the goal of ending child poverty "within a generation". The pledge was underlined by setting a series of targets and milestones to reduce child poverty on the way to eradicating it by 2020. These targets were encapsulated in the 2002 Spending Review objectives set for HM Treasury and the Department for Work and Pensions, within the framework of Public Service Agreements, to reduce the number of children in low-income households by at least a half by 2010-11 and eradicate it by 2020-21.[172]

CHILD POVERTY INDICATORS AND PROGRESS TO DATE

45. The Government reiterated its commitment to halving child poverty by 2010-11 at the time of the 2007 Comprehensive Spending Review. The Government announced in that Review that it would use three indicators to measure progress against tackling child poverty in the coming years:

Indicator 1: the number of children in absolute low-income households, defined as households with incomes of less than 60% of median income held constant in real terms from a 1998-99 baseline;

Indicator 2: the number of children in relative low-income households, defined as households with incomes below 60% of median income. This is the indicator used for the target to reduce by a half the number of children living in poverty by 2010-11; and

Indicator 3: the number of children in relative low-income households and in material deprivation: the introduction of a material deprivation indicator for child poverty is designed to provide a wider measure of living standards and reflects the view that tackling child poverty is about more than simply raising income levels.[173]

The baseline for progress against the target to halve the number of children in relative low-income households by 2010-11 was the Government's estimate that 3.4 million children were living in relative poverty in 1998-99. This meant that child poverty levels needed to be reduced to 1.7 million in order for the Government to meet its 2010-11 target. Between 1998-99 and 2005-06, child poverty by this measure fell by 600,000, from 3.4 million to 2.8 million, which meant that there would need to be a fall of 1.1 million children in relative poverty between 2005-06 and 2010-11 in order to meet the target.[174]

OUR PREVIOUS CONSIDERATION

46. In November 2007, following the 2007 Comprehensive Spending Review, we expressed concern that the Spending Review was not accompanied by a clear explanation of the linkage between the Government's target to halve child poverty by 2010-11 and the proposed deployment of resources to meet that target.[175] Our Report also expressed concern that the Government might have drawn back from a whole-hearted commitment to meeting the 2010-11 child poverty target. We concluded that "a failure to meet that target would represent a conscious decision to leave hundreds of thousands of children in poverty for longer than is necessary or desirable".[176] In its response to our Report on the 2007 Comprehensive Spending Review, the Government implicitly rejected our call for a clear statement about where the resources would come from to meet the 2010-11 child poverty target. Instead it stated that "decisions on the levels of financial support provided to families will continue to be set at future Budgets and Pre-Budget Reports in the normal way".[177]

MEASURES IN THE 2008 BUDGET

47. The 2008 Budget contained three measures intended to contribute towards meeting the Government's child poverty targets:

Increasing the first child rate of Child Benefit to £20 a week from April 2009;

Increasing the child element of the Child Tax Credit by £50 a year above indexation from April 2009; and

disregarding Child Benefit in calculating income for Housing and Council Tax Benefit from October 2009.[178]

The combined cost of these measures will be £870 million in 2010-11. The increase in the child element of Child Tax Credit and the Child Benefit disregard each cost £350 million whilst the increase in the first child rate of Child Benefit will cost a further £170 million.[179]

48. Regarding the announcement that from October 2009 Child Benefit income will be disregarded in calculating income for Housing Benefit and Council Tax Benefit purposes, the Treasury told us that, "compared to the current system, this reform amounts to an additional disregard in net incomes for Housing Benefit/Council Tax Benefit purposes up to the value of Child Benefit for any family receiving Child Benefit". The Treasury went on to state that, compared with the current system, this reform would lead to a genuine increase in income for any family receiving Child Benefit whose net earnings for Housing Benefit/Council Tax Benefit purposes currently exceeded their applicable amount (and who currently faced withdrawal of Housing Benefit/Council Tax Benefit). The Treasury concluded that "transferring additional resources via Housing Benefit and Council Tax Benefit ensures that gains are focussed on low income families with children, with greater gains for larger families where the risk of child poverty is greater".[180] Mr Chote noted the complexity of the disregard, telling us that "if it is understood by the people who are intended to receive this they are brighter people than I am".[181]

49. Asked about the balance in the Government's strategy between universal and in-work benefits, Mr Chote suggested that this year's Budget placed emphasis on incentives for work, telling us that "the changes in disregards as affecting Housing Benefit and Council Benefit … may provide a useful incentive for people to get into work in the first place". He went on to say that:

In terms of the balance, some mixture of the two can certainly look appropriate but the difficulty is that you do not get as much bang for your buck in terms of reducing the target measure of child poverty by going for something like Child Benefit because a lot of it is spent on people who are well above the poverty line anyway.[182]

Mr Chote told us that the Institute of Fiscal Studies had not yet made a projection of which groups the measures in the Budget would benefit most, but suggested that, based on past experience, it would be most likely to lift children in families already close to the 60% level above that level.[183]

PROSPECTS FOR MEETING THE 2010-11 CHILD POVERTY TARGET

50. The Treasury estimated that the measures in the 2008 Budget would lift up to a further 250,000 children out of poverty. The Treasury also estimated that the measures in the 2008 Budget, combined with the reforms announced in the 2007 Budget and the 2007 Pre-Budget Report and Comprehensive Spending Review, would lift a total of over 500,000 children out of poverty.[184] Mr Chote told us that he broadly agreed with the Government's assessment of the Budget measures, telling us that the Institute of Fiscal Studies had calculated that they would move 200,000 to 250,000 children out of poverty.[185]

51. Mr Chote explained to us that, prior to the measures announced in this year's Budget, the Government "would have ended up 700,000 short of where they wanted to be by 2010-11".[186] He also said that, if the measures in the 2008 Budget reduced child poverty by 250,000, then the Government "are probably still 450,000 short of the target". He estimated that bridging this gap would require additional expenditure of around £2.8 billion for the Government to meet its 2010-11 target.[187] He viewed the remaining progress required as most likely to be achieved through the benefits system, stating that "it is either transfer payments or nothing at this stage".[188] He was sceptical about the contribution that increasing employment could make at this stage towards meeting the 2010-11 target:

It does not make much difference on the timescale for 2010. If you were to achieve the Government's lone parent employment target it would probably cut the amount you needed to spend by about £200 million. That was the calculation we did a year or so ago. It shows basically that success on that front does not really get you very far in terms of the near-term target.[189]

52. The Chancellor of the Exchequer told us that the Government remained committed to meeting its child poverty targets, telling us that "we aim to halve the number [of children] in poverty by 2010" and that the future 2020 target was also very important.[190] He added that meeting the child poverty targets would be "difficult", but that the targets were "well worth pursuing".[191] We welcome the measures in the 2008 Budget on child poverty, which will make an important contribution towards reducing child poverty. We recommend that the Government, in its response to this Report, clarify the targets that have been set relating to child poverty since the pledge to eliminate child poverty in a generation was first made and report on performance against each of those targets in each financial year. We further recommend that that response set out the Government's estimate of the effect of each measure relating to child poverty in this year's Budget on progress towards the 2010-11 target in each financial year from 2008-09 to 2010-11. We remain concerned that the Government has yet to provide a clear explanation of the linkage between its target to halve child poverty by 2010-11 and the proposed deployment of resources to meet that target. It is of crucial importance that the Government makes it clear that the necessary resources to meet the 2010-11 target are available and that the Government is committed to deploying those resources directly to support low-income families. It is also important that the Government sets out the policy instruments under consideration to meet this target.

Fuel poverty

53. In recent years, the Government has made a number of winter fuel payments and additional "one-off" payments to pensioners.[192] The level of the winter fuel allowance, established in 1997, has changed nine times in 12 years.[193] In this year's Budget statement, the Chancellor of the Exchequer announced that "further action is also now needed to help vulnerable groups deal with rising energy prices".[194] He announced that he would help pensioners who were facing higher energy bills by raising the winter fuel payment for over-60s from £200 to £250 and for the over-80s from £300 to £400, which would ensure that "nine million pensioner households will be better off".[195] The cost of the payments for Winter 2008-09 is £575 million.[196]

54. The additional winter fuel payment for 2008-09 is a one year commitment. In coming years, the Government expects that further assistance will be available from energy supply companies. The Chancellor of the Exchequer said in his Budget statement that "energy companies currently spend around £50 million a year on social tariffs. I want to see this rising to at least £150 million a year in the period ahead."[197] The Treasury had targeted the energy suppliers rather than energy producers in part because the legislation that enabled the payment of social tariffs, the Energy Bill, only applied to electricity and gas suppliers.[198] The Chancellor of the Exchequer indicated that the Government would "work with the companies to take forward further action on a voluntary and on a statutory basis to underpin this as necessary".[199] Treasury officials told us that "it may be necessary to have some kind of statutory underpinning to ensure a fair distribution of the contributions from the energy companies".[200] However, they emphasised that they were entering "into discussions with the presumption that we can achieve agreement rather than waving the stick too much".[201] They also told us that they were "looking for further action on bringing down the price differential between pre-payment meters, which a lot of people who fall into the fuel poor category have, and those people on direct debits or standard tariffs, and that will also obviously contribute".[202] The Treasury hoped to make proposals arising from the discussions with the energy supply companies for Winter 2009-10.[203]

55. We explored with witnesses whether an increased social tariff and other measures taken with the energy industry would make good the shortfall if the increase in the winter fuel allowance were to be a one-off measure, as currently envisaged. That allowance is not means-tested and currently it is paid to all UK residents over the age of 60. As such, it is not targeted on those most in need, as Treasury officials indicated: "one of the problems there is around targeting additional spending … on people who are fuel poor, is identifying the groups … to be honest, some of the instruments you use are quite crude".[204] The Chancellor of the Exchequer emphasised that it was not easy to ensure that support through energy supply companies was effectively targeted:

On the face of it, you might think: why do we not just give the electricity companies or the gas companies the names of people receiving benefits. There is a real difficulty in that there are some people who just do not want that information passed on. They have every right to have their privacy respected just as you or I have … We are discussing it within government. There ought to be a way round it because we know who people are who are likely to be fuel poor.[205]

The Chancellor of the Exchequer said that the proposed social tariffs would work alongside other measures to target those suffering from fuel poverty.[206] He also explained that any decisions on the future payments of the winter fuel allowance would be taken in subsequent Budgets or Pre-Budget Reports.[207]

56. A household is said to be in fuel poverty if it needs to spend more than 10% of its income on fuel to maintain a satisfactory heating regime (usually 21 degrees for the main living area, and 18 degrees for other occupied rooms).[208] The UK Fuel Poverty Strategy, published in November 2001, set out targets to eradicate fuel poverty by 2016. The Government has a target to eradicate fuel poverty in England in vulnerable households by 2010, where a vulnerable household is deemed to be one containing children, or those who are elderly, sick or disabled.[209] There is a further target that by 22 November 2016, as far as reasonably practicable, no person in England should have to live in fuel poverty. The Scottish Fuel Poverty Statement, published in August 2002, sets out Scotland's overall objective for fuel poverty. This is to ensure that, as far as reasonably practicable, people are not living in fuel poverty in Scotland by November 2016.[210] The Welsh Assembly Government's target is that as far as reasonably practicable, no vulnerable household in Wales should be living in fuel poverty by 2010 and no household should be living in fuel poverty by 2018.[211] Northern Ireland has the same objectives as England.[212] The Government has stated that progress on this will be monitored by an inter-ministerial group and through the UK Fuel Poverty Strategy Annual Progress Report, which is published by the Department for Business, Enterprise and Regulatory Reform in conjunction with the Department for Environment, Food and Rural Affairs. The Government has said that its primary tool in tackling fuel poverty over the period 2008-09 to 2010-11 will be the Department for Environment, Food and Rural Affairs' Warm Front Scheme, which provides a package of heating and insulation measures to private sector households in receipt of certain benefits, and benefit entitlement checks to help maximise income.[213] It is important that the Government continues to tackle fuel poverty through a combination of targeted and universal measures. We look forward to a constructive outcome to continuing discussions between the Treasury and the energy supply companies, particularly with regard to lowering the differential in charges between those with pre-payment meters and those making other forms of payment. In view of the importance of measures announced in Budgets and Pre-Budget Reports to the progress of the targets to eradicate fuel poverty set by the Government itself and by the devolved administrations, we recommend that the Government report in Budgets and Pre-Budget Reports on the effect of any measures announced at that time on progress towards meeting fuel poverty targets. We further recommend that, in the 2008 Pre-Budget Report, the Government report specifically on:

the outcome of its discussions with the energy supply companies;
any legislative measures in this area under consideration; and
its assessment of the effectiveness of the one-off increase in the winter fuel allowance for Winter 2008-09 in terms of progress in meetings its obligations relating to fuel poverty.

We expect to examine during our inquiry into the 2008 Pre-Budget Report whether the increase in the winter fuel allowance for 2008-09 and the additional measures proposed for the Winter of 2009-10 will be effective in reducing fuel poverty in line with the Government's targets.

Marginal deduction rates and the poverty trap

HIGH MARGINAL DEDUCTION RATES

57. The Treasury defines the poverty trap as occurring "when those in work have limited incentives to move up the earnings ladder because it may leave them little better off".[214] Marginal deduction rates are used to measure how far people's incentives to increase their income are being reduced. For instance, a marginal deduction rate of 65% means that, for every one pound of additional income earned, 65 pence of that extra pound is taken away, either by taxes or a reduction in benefits. Chart 1 shows how the Government's policy mix has affected the distribution of marginal deduction rates over time.

Chart 1: Marginal deduction rates and the poverty trap

Sources: Budget 2002, p 79, Table 4.4; Budget 2003, p 91, Table 4.2; Budget 2004, p 97, Table 4.2; Budget 2005, p 98, Table 4.2; Budget 2006, p 94, Table 4.2; Budget 2007, p 102, Table 4.2; Budget 2008, p 62, Table 4.2

As can be seen from Chart 1, while the Government has been successful at moving people from the highest marginal deduction rates above 70%, the number of people caught by a marginal deduction rate of between 60% and 70% has increased—by around 200,000 between the tax years 2007-08 and 2008-09.

58. The Treasury stated in the Budget that that this increase was "primarily due to the introduction of tax credits, which has extended financial support so that far more families benefit, including low-income working people without children".[215] Mr John Whiting of PricewaterhouseCoopers explained that changes within the Government's policy mix had also increased the number of people caught by marginal deduction rates at this level:

as the tax credits have become more generous … that naturally takes this level at which the claw back starts to affect people up higher. If we go back two or three years when tax credits were first introduced we would be looking at people on incomes of £12,000 to £14,000 and as the credits have become more generous that has made them more available further up the income scale but it has meant more people being subject to claw back over a wider income band than used to be the case.[216]

However, Mr Whiting acknowledged that such high marginal deduction rates might be the consequence of the Government trying to achieve its social policy goals. He told us that "It is one of the imponderables … that as soon as you give benefits and then say, 'We want to withdraw them', you are facing people with a significant taper".[217]

59. When asked why around 200,000 extra people now faced marginal deduction rates between 60% and 70%, Treasury officials told us that:

The main reason for that is partly, indeed primarily, as a result of the 2007 Budget measure that introduced extra help through tax credits from 2008. That brought more people into tax credits, the result being that more people then faced higher marginal deduction rates.[218]

Treasury officials also acknowledged the choice faced by Government when deciding how to distribute benefits:

There is not a perfect answer. You could go for universal support, as, of course, he has done with child benefit, but in that situation you are not targeting the public resource on those who need it most and that leads inevitably to one of two consequences: either you have to spend more to provide that level of support for the poorest or on the other hand you support the poorest less, so that is universal support. You could equally go for a very steep cliff edge with very high marginal deduction rates which would leave a smaller group of people affected by high marginal deduction rates, but then you are leaving those people with a massive disincentive, or, which is what the Government has done, you can focus resource on the more needy and then gradually withdraw that through a taper.[219]

The Chancellor of the Exchequer defended the decisions made on tax credits, and the consequences that this had had on the marginal deduction rates faced by some people. He explained that:

When you decide you want to increase people's incomes through the tax credit system, the down side is that when they come off it there might be a disincentive there. You try and avoid that by a taper but of course the taper will then take you further up the income scale. There are ways in which you can mitigate that but I would not want to get myself into a situation where frankly I did not increase the incomes of people if I thought that was the right thing to do.[220]

60. The increase in the number of people facing marginal deduction rates of between 60% and 70% is a direct consequence of decisions made by Government as to how the tax and benefit system will work. We acknowledge that such decisions are finely balanced between the overall cost of a benefit, and the rate at which it is withdrawn. We recommend that the Government undertake further research into how the design of the tax credit system, in conjunction with the overall tax and benefit system, is enhancing or impeding progress on the Government's welfare to work objectives, and report on such work in the 2008 Pre-Budget Report. We recommend that, as a basic principle, the Government ensure that high marginal deduction rates are limited wherever possible, and we will continue to keep this matter under review.

TAX CREDIT TAKE-UP RATES

61. High marginal deduction rates are faced by those who are already part of the tax credit and benefit system, but not all those eligible take up the tax credits owed to them. The importance of the need for higher levels of tax credit take up were highlighted when we discussed the reforms announced in the 2007 Budget, which included the abolition of the 10 pence starting rate of income tax, and a reduction in the basic rate of income tax from 22 pence to 20 pence from April 2008.[221] As a result of these reforms, some low-income workers may have been potentially disadvantaged because the loss of the 10% starting rate of income tax was not outweighed by the gain from an overall lower basic rate of income tax. The Treasury provided the following evidence as to who might lose as a result of the changes in Budget 2007, and how those losses may be mitigated:

Estimates are that 0.8m single earners with income under £18,500 will see their income decrease by around £1.45 a week on average. The reforms overall, however, are of particular benefit to low income households. The reforms will lift around 200,000 children out of poverty, and analysis of the reforms by the Institute for Fiscal Studies showed the greatest gains are for households in the poorest two deciles. The maximum amount any single individual could be worse off by is £232 per year (£4.46 per week) about 3% of net income. This loss would be completely offset by increases in Working Tax Credits for those eligible to claim. For those not eligible for [Working Tax Credits] it is possible that households around or under the level of income achieving the maximum loss could be receiving Housing and/or Council Tax Benefits and could therefore have up to 85% of this loss offset by increases in HB/CTB. For households that are worse off, the average loss is about £2 per week.[222]

The Chancellor of the Exchequer acknowledged that there were some sections of society that would be affected by the loss of the 10 pence starting rate of income tax:

There is a particular group of people, mainly women between the age of 60 and 65, who would have been paying the 10p rate who, if you look at where their incomes have come from in the last ten years, [are] better off than they were. Yes, it would affect them.[223]

The Chancellor of the Exchequer was also keen to point out that "We have tried to help wherever we can through the tax credit. I have mentioned the winter fuel payment and for a lot of people their incomes will have gone up." He also to stated that overall "the reduction to 20 pence will benefit very substantial numbers of people".[224] 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.

62. Despite tax credits being identified as one of the ways of mitigating the loss of the 10 pence starting rate of income tax, as Treasury officials acknowledged, there has been a continuing problem of low take-up rates of working tax credits.[225] As we noted last year, the problem of low take-up rates is especially acute among families without children, where the central estimate of the take-up rate of working tax credits was 22% for the financial year 2005-06.[226] Treasury officials pointed out that

take-up of the working tax credit, which I agree has not been as good as we would have liked, is increasing. That is also an important reality to bear in mind, and steps are being taken to draw the attention of people who can claim that tax credit to the fact that it is available, and that is having some success. More people are claiming the working tax credit.[227]

The Chancellor of the Exchequer also acknowledged that "There are particular groups who would be eligible for the working tax credit who are not taking it up and that is something that we need to do something about".[228] He reiterated his desire to see further action, telling us that "where take-up is insufficient, particularly with people without children, I would like to see us do more".[229] We are concerned by the poor take-up rate of working tax credit among eligible families without children, especially given that working tax credits are intended to mitigate for low-income households the effect of the removal of the 10 pence starting rate of income tax. We expect the Treasury and HM Revenue & Customs to galvanise their efforts in this area in coming months and years. We recommend that the Government report regularly in Budgets and Pre-Budget Reports, starting with the 2008 Pre-Budget Report, on progress in increasing the take-up rates of working tax credits for those sections of society with particularly low take-up rates. We further recommend that the Treasury commission research into whether the withdrawal of the 10 pence income tax band and high marginal deduction rates are creating disincentives that could frustrate the Government's welfare to work objectives.