rose to ask Her Majesty’s Government whether the operation of the tax credits system is satisfactory.

The noble Lord said: My Lords, I am grateful to have the opportunity for this debate on whether the operation of the tax credit system is satisfactory. The new tax credits—the child tax credit and the working tax credit—were introduced in April 2003. The most recent parliamentary review of them by the House of Commons Treasury Select Committee was published in June this year. It is a cross-party document, and I have taken it as the best non-partisan source for my remarks tonight. I will cover three problem areas that are highlighted in particular: first, overpayment of the credit to claimants; secondly, fraud and organised crime; and, thirdly, the way forward to improve the system.

The Government state that the tax credit regime provides support for 6 million families and 10 million children. However, in 2003-04 about one-third of all tax credit awards paid—nearly 1.9 million awards—were overpaid at a cost of nearly £2 billion. In December 2005, the Paymaster General indicated that, but for reforms announced in the Pre-Budget Report 2005,

“initial estimates had suggested that subsequent years’ overpayments would have been of broadly the same level as in 2003-04”.

I am not certain if the overpayment figures for 2004-05 and 2005-06 have been published yet. Will the Minister give me those figures? For 2003-04, of the 1.879 million claimants who received overpayments, about 41,000 received overpayments of £5,000 or more. Half the total overpayments related to some 283,000 families, who had been overpaid by £2,000 or more.

The National Audit Office explained why the design of tax credits necessarily results in overpayments. It said,

“A tax credit award is provisionally based on a family’s income and circumstances from the preceding tax year. The award is finalised after the end of the tax year once income and circumstances are known for certain. The final award will be lower than the provisional award where incomes increase, although the first £2,500”—

now up to £25,000—

“of any income increase is disregarded”.

However, the NAO also stated:

“Further unforeseen overpayments have occurred”.

Full recovery of overpayments from 2003-04 is expected to take nearly five years. To date, the Government have written off some £95 million of overpayments and have made provision for a further £961 million to be written off eventually. The committee says that the factors cited by the Paymaster General and her officials as contributing to the causes of overpayments do not give the full reasons why the overpayments have arisen. The Paymaster General has referred only to those causes of overpayments that can be attributed to error by the claimant, or omission, or to the design of the tax credits regime, or a combination of those. The Paymaster General, in the committee’s view, makes no reference to causes of overpayments that have arisen due to HMRC’s own processes—for example, official error and information technology system error. Does the Minister agree with the committee’s conclusions?

The report goes on to state that recent research indicates that the tax credits regime, which is designed to deliver the correct amount of state assistance over the year as a whole, could be aligned more closely to the financial needs of those families who tend to and need to budget over a month or less, rather than the whole of a tax year. The committee goes on to say that it is obvious that HMRC cannot, however, as a whole take steps to improve the way that it administers tax credits without first identifying and developing a detailed understanding of the factors that cause overpayments and the extent to which each individual factor has contributed to the overpayments problem. It recommends that as a priority the Government should provide a detailed breakdown of as much of that information as is currently available. Does the Minister agree, and will he provide the House with the necessary information?

The committee is clear that official error has been a cause of overpayments in a significant number of cases. The Paymaster General has said that no complete analysis exists of official error causing or contributing to overpayments. In my view, that is a significant gap in HMRC’s understanding of the reasons that overpayments arise. Does the Minister not agree with the committee’s view that if HMRC is to succeed in improving the administration of the tax credits regime, it first needs to understand what is going wrong within its own processes before it looks to problems elsewhere? Does he not agree also with the committee’s argument that the Government should undertake a complete analysis of the incidence of official error and the extent to which that causes or contributes to overpayments, that they should publish that analysis, and that if they cannot carry out such analysis, they should explain why?

The committee also believes that HMRC has failed to assess the contribution made by information technology error. It recommends that the Government undertake a complete analysis of the incidence of that and the extent to which it causes or contributes to overpayment, and that they publish that analysis. Does the Minister agree?

The IT system delivered by EDS for running the new tax credits system was unsatisfactory in several respects, as was highlighted by the NAO’s evidence to the committee. Yet, when the Government ended the contract with EDS in June 2004, an extraordinary agreement was made. While the Government were to be compensated for EDS’s mistakes by £71.25 million, up to £26.5 million of that, in staged payments, would be contingent on EDS winning new business with the UK Government. But there was no guarantee that EDS would win sufficient business to trigger payment of the full amount.

The committee strongly questioned the wisdom of an agreement that made the payment of compensation to the affected government department by the provider of that unsatisfactory service contingent on that provider winning other contracts with the Government. The committee’s concern, rightly, is that contingent payments will influence future decisions by government departments to award contracts. It believes that:

“The agreement has the appearance of impropriety, if not the fact”.

Will the Minister say whether the full £26.5 million has been received and how many government contracts have been awarded to EDS since June 2004?

On the recovery of overpayments, I agree with the committee that HMRC should not seek to recover either an excess payment made in the current year or an overpayment from the previous year until it has come to a decision on whether the excess should be recovered, in accordance with COP 26, which requires two questions to be answered satisfactorily: did HMRC make a mistake and, if so, was it reasonable for the claimant to think that his or her payments were correct? Why do the Government appear to be delaying implementation of the “pause before recovery” of an overpayment? In any case, is there not a statutory right of appeal to a tribunal, under Section 12 of the Social Security Act 1998? Does the Minister support calls from the voluntary sector and the ombudsman for the introduction of an appeal to an independent tribunal?

On the subject of fraud, error and organised crime, I am concerned, as is the committee, that it is now over two years since the end of the 2003-04 tax year, yet HMRC has yet to establish the final levels of claimant error and fraud in the tax credits regime for that year. An interim figure of 3.4 per cent has been indicated, but the committee understands that the figure will be significantly higher.

Apparently, organised criminals were able to make claims over the internet without proving their identity. However, HMRC’s internal office concluded that there was a lack of comprehensive information to allow a robust analysis of the problem. Then, in December 2005, HMRC announced the closure of its tax credits portal, following attempts to defraud the tax credits regime by making claims through it. Those claims falsely used internal information held by DWP about its staff. The Paymaster General admitted in February 2006 that some 8,800 staff identities may have been stolen in 2003-04. Of those, 6,800 had been used in an attempt to defraud the tax credits regime in 2005.

The Paymaster General gave details of another fraud, involving the use of identities stolen from Network Rail employees, stating that HMRC’s investigations had resulted in at least 16,000 claims being stopped. The Paymaster General also disclosed that, from April 2004 to November 2005, HMRC intervened on approximately 56,000 incorrect claims where fraud was suspected, of which HMRC estimated that 19,500 arose as a result of organised attacks. From October 2004 to November 2005, HMRC identified and stopped over 22,000 tax credit claims in payment where organised fraud was suspected.

Does the Minister have any updated figures of the loss to HMRC due to fraud, other than the figure of £2.7 million from the DWP fraud and the £15 million general figure from organised fraud as stated by the NAO in the committee report? Can he guarantee that there are no plans to reduce the number of staff in the tax credits compliance department of HMRC?

My final subject on the report is the way forward. I welcome the fact that the Government are seeking to improve the operation of the tax credits regime by introducing a package of reforms. However, how can they be confident of their estimates of the overall costs of the package? For instance, they expect the package to be broadly revenue neutral, but how will this be when the disregard threshold is being increased from £2,500 to £25,000, which could prove costly?

We on these Benches believe that HMRC should improve its service to claimants. We want the tax credits system to work properly so that those who are most deserving benefit from it. We want to make the system as user-friendly as possible so that no one will be put off by its complexity and we want its administration to be as efficient as possible. Therefore, I commend the Treasury Committee report and look forward to the Minister’s response.

My Lords, I think that I would like to thank the noble Lord, Lord Northbrook, for his introduction to this short debate tonight. He is certainly right to bring to the House’s attention some of the ongoing concerns surrounding tax credits, which we all recognise are a powerful government tool to address child poverty—it is a tool of which I, for one, am very proud.

Tax credits probably would not have been necessary in Beveridge’s time, but now that wages are individual wages and not family wages—rightly so, given changing demography, lifestyles and family patterns, as well as the fluidity of family forms and of labour—the state, rightly in my view, takes responsibility for additional payments where necessary to reflect family need and family dependency. That started with Eleanor Rathbone’s family allowances in 1948, going through to the family income supplement, which was introduced by the party opposite, to family credit, and now to tax credit.

If I have any criticism of the speech of the noble Lord, Lord Northbrook, it is that he did not contextualise it by suggesting in any way the extent to which tax credits have begun to bridge some of the gaps in after-pay earnings between rich and poor and between the childless and families with children. Tax credits also, rather interestingly, bridge the gap between entry wages and median wages; the 40 per cent difference between the two is one of the biggest gaps in Europe, so tax credits help to sustain people who are in low-paid jobs. Tax credits also bridge the gap between women’s full-time and men’s full-time work, and between women’s part-time and men’s full-time work—we know that pay rates for women’s part-time work are roughly 50 per cent lower than pay rates for men.

In all these problems in the distribution patterns in our society, tax credits have made a major contribution. But, as is inevitable in any such redistribution, there will be trade-offs that conflict with each other. I shall describe two of the most complex. First, if you make out-of-work benefits sufficiently generous—especially for larger families, in tackling child poverty—you can make it more problematic for people to find it worth while to go into work. That is why in the 1970s we had the wage stop. We call that situation the poverty trap, in which it is not worth working. The second problem is that, as tax credits are rightly related to income, and therefore withdrawn as income rises, there can be a very high deduction rate, along with tax and NI, for every extra pound earned. That is what we call the employment trap. Of course, one could reduce the taper and make it less severe, but then the problem moves higher up the income scale. In any case, the problem is not the taper but the interaction with other means-tested benefits—above all, housing benefit and council tax benefit.

There are no right answers to this, just judgments to be made about how we trade the one problem off against the other. It is worth stating that some of those concerns may be more theoretical than real. On the poverty trap, for example, it is clear from research that people work for more than money: they work for adult status, autonomy, pride and family responsibility. As a result, the reserve wage that a number of people will take is amazingly low—often barely at benefit level—and that will be sufficient to bring them into the labour market. However, if a job is difficult to sustain around fluctuating childcare problems and if the pay is not good enough, a lone parent in particular is more vulnerable to dropping out of the labour market. The Institute for Fiscal Studies has shown that over the past 10 years or so, the levels of both the poverty trap and the employment trap have been reduced, largely due to tax credits.

As for the problem of tapers and the complaint that, once in work, too much of each pound that a person earns goes in deductions, you obviously cannot simply universalise the benefit and then take it away from the better off. The income tax bands are not sufficiently progressive and it would be too expensive to do that. In 1997, I estimated that putting £10 on each and every benefit would wipe out almost the entire expenditure on the NHS, as it stood at that time, and still leave families poor. It cannot be done in that way.

The result is that we have constructed a tax credit system which, rightly I think, has a sharp taper for adults—the working tax credit—and a shallower taper for children. In its recent report, the Institute for Fiscal Studies has shown that both incentives to work and progress within work, though varying by family type, have largely improved satisfactorily over the past few years.

Therefore, the first problem is the generalised one of targeting, means-testing, the poverty trap and the employment trap. I was sorry that the noble Lord, Lord Northbrook, did not refer to that in his otherwise very detailed and analytical speech.

The second problem, to which he devoted most of his time, is what the Opposition, and he today, have called “errors”. It is fair to say that when we introduced the Tax Credits Bill we did not predict that 50 per cent of lone parents would undergo more than a dozen changes in circumstance a year. Those include changes in childcare arrangements virtually every school holiday, changes in hours worked and sometimes a change of partner. The result is that if, as the noble Lord suggests, you seek to track every change and every three to four weeks change the credit for half the population claiming tax credits, even if the computer could handle it, I doubt very much whether the lone parent could. Such adjustments would be made six weeks in arrears and there would be no way in which that parent would be able to construct a family budget with such unreliable and non-robust flows of income, especially as some of the changes in circumstance cancel each other out.

That is why the Government, rightly in my view, went for a balance-sheet adjustment at the end of the year. The problems occurred disproportionately because, again, I think that the Government underestimated the occasions on which the female in a couple household went into work and produced a major increase in family income—often used to pay off the debts acquired by the couple over the previous years—but that was not reported early enough. Therefore, at the end of the year, the couple faced a very large overpayment bill, which the departments involved rightly sought to reclaim. It is a fact of human nature that people are much more likely to report a drop than a rise in income. The Government increased the head space from £2,500 to £25,000 so that in the one year in which the female goes back to work the couple is not bedevilled by these problems—it may be the one opportunity that they have to pay off their debts. Simultaneously, the Government also require monthly, as opposed to three-monthly, reviews of information. I hope that those measures together will address the problem.

As for errors in the conventional sense, mentioned by the noble Lord, I was amazed at how few there are. Something like 95 per cent of the poorest families—lone parents—claim their entitlement. There is something like a 98 per cent accuracy rate, which is amazingly good.

I have three questions for my noble friend. The first concerns the problems associated with larger families. Half of all poor children live in larger families—not necessarily one-parent families, but often couple families who are out of work, or black, minority ethnic families. Yet in Britain we concentrate benefit and support on the first child. In most of Europe, more money goes to later children in the family. Will my noble friend tell us the Government’s thinking on introducing either a later-child premium or some balancing factor, so that that problem can be addressed? The Institute for Fiscal Studies has shown that that would be the single most effective tool in simultaneously reducing out-of-work poverty for children and increasing in-work incentives for parents because they would continue to take that premium into work with them. I hope that my noble friend can give us some good news on that.

My second question for my noble friend is whether grandparents who provide childcare might be eligible for the childcare tax credit. At the moment it goes only to registered childminders, but the real test for a lone parent on whether she is willing to go into work and sustain work when it gets difficult—if the child is sickly or if there are difficulties in hours—is whether she has childcare that she can trust, that she is confident in and that will hang on in. That is usually childcare of the sort that she would give, provided by someone who loves the child, so that the mother is guilt-free. That often means childcare by her own mother. Those grandparents may themselves have been lone parents, often living in poor estates. Such a measure would allow us to help three generations of families: the women in their 50s who need to work, their daughters who seek work and their children whom we must lift out of poverty. What is my noble friend doing on that?

Finally, we have a national minimum wage and national levels of tax credits. Yet we all know that the cost of living, transport and housing varies widely within the UK between the south-east and other regions. Has the Government’s thinking moved at all on a regional premium on the minimum wage or on tax credits? If so, what will happen?

Tax credits have been transforming for families—particularly for lone parents. A young mother with a child who would be earning barely £5 or just above on a minimum wage can take home a man’s wage—double that. Because she has a tax credit that makes working pay, and a child tax credit that is earnings related, which means it keeps pace with rises in real wages, we have been able to transform the opportunities for lone parents and their children. Tax credits are a government measure of which I am hugely proud, which along with the introduction of the minimum wage have been transforming for parents and children alike.

My Lords, I am most grateful to my noble friend Lord Northbrook for introducing the debate on tax credits. My gratitude is without the reservation shown by the noble Baroness, Lady Hollis.

I am surprised that it has taken so long for the public at large to ascertain just how inefficient and wasteful is the absurdly complex system of taxes, tax credits and benefits that the Government have introduced. The Government spent £15.4 billion on tax credits in 2006-07 compared with £2.4 billion spent on family credit in 1997-98. The increase in expenditure is equal to more than 4p on the basic rate of income tax. Will the Minister tell us the total cost in the past year of administering the tax credit system, including reclaiming overpayments? Further, will he tell the House what that sum would translate to in terms of the basic rate of income tax?

As proposed by my noble friend Lord Forsyth of Drumlean, and his Tax Reform Commission in an excellent report published last week, the need for tax credits could be reduced by increasing the personal allowance and making it transferable between parents of young children. The tax credits system is so complicated as to be incomprehensible to most people, and a severe disincentive to those in work but on low incomes to work harder and earn higher salaries or win promotion, because the progressive withdrawal of tax credits has created an effective marginal rate of 70 per cent or more for many workers. As the Institute for Fiscal Studies has pointed out, the weakest work incentives are encountered by people on low incomes who face having their means-tested benefits or tax credits withdrawn if they increase their income. More than 2 million workers in Britain stand to lose more than half of any increase in earnings to taxes and reduced benefits. Some 160,000 would keep less than 10 pence of each extra pound they earned.

Tax credits have provided some incentive for people to move from unemployment into low-paid employment. However, as the report of my noble friend Lord Forsyth pointed out, they are not well focused on reducing poverty. The noble Baroness, Lady Hollis of Heigham, has claimed that tax credits have made a great contribution to reducing the gap between rich and poor, and between men and women. However, child tax credits can be claimed by families earning nearly three times the average national income. The poorest fifth of households are therefore paying a higher share of tax, and receiving a lower share of benefits, than they were when the Government came to power. As my noble friend Lord Blackwell pointed out in his excellent paper, Take Poor Families Out of Tax, published in October last year, a further disadvantage of the tax credits system is that, since credits are calculated on the previous year’s income, many families find that their income fluctuates widely. If their income rises, they may find themselves faced with an unexpected and unaffordable bill to pay back credit payments which they have already spent.

This inefficient system has created a serious and expensive problem of benefit fraud. For three consecutive years, the extent of overpayments due to error or fraud has led the National Audit Office to qualify its audits of taxes and tax credits. My noble friend Lord Northbrook has already well illustrated this point.

“Tax credits” is a misnomer. These benefit payments are not credits against taxes. The Government massively overtax low-income families and then, at enormous administrative cost, give money back to the same people. In the process, they create a demotivating dependency culture and remove—or substantially dilute—incentives for people to better themselves.

There is, or was, another kind of tax credit: dividend tax credits. Mr Liam Halligan, economics editor of the Sunday Telegraph, said in his excellent article of 15 October that Terry Arthur, a fellow of the Institute of Actuaries, supported by Watson Wyatt, calculates that the Chancellor’s first and worst stealth tax raid, the abolition of dividend tax credits—real credits against corporation tax—had actually cost pension schemes up to £150 billion. The Minister may, or may not, remember that, in the debate on the Loyal Address on 18 May last year, I estimated that the stealth tax raid had actually cost some £166 billion. I am no actuary, but I feel I am in good company now.

Against the background of changing demographics, the Chancellor’s raid on our pension funds was the largest single factor leading to the present crisis in retirement provision. It is therefore all the more necessary to cast away the cumbersome, wasteful and highly inefficient scheme of working tax credit and child tax credits without delay and use the savings to procure a substantial increase in the personal tax allowance to, say, at least £7,500, transferable between spouses, thus freeing millions of people from the burden of paying tax at all. It will be hard for the Minister to claim that the operation of the tax credit system is satisfactory, and I look forward to his reply.

My Lords, tax credits do not seem to be bringing out noble Lords in droves, especially during their dinnertime, but I shall be less diffident than my noble friend Lady Hollis in thanking the noble Lord, Lord Northbrook, for initiating this debate. Tax credits may not be in the foxhunting league, but their impact on the country is much greater.

Tax credits have a long history. They were initiated in the United States in the 1970s by Senator Russell Long. They began as a relatively uncontroversial, small scheme of incentives to get to people into work. They were generalised during the Clinton Administration, and they effectively became a very large anti-poverty programme. As the noble Lord mentioned, tax credits have been used for many other purposes—for example, President Clinton introduced environmental tax credits—but I shall speak mainly on the relationship between tax credits and the alleviation of poverty because that is where they are most important.

If we look at the record of the Clinton Administration, the impact of tax credits was immense. They were the main reason why approximately 10 million people were lifted out of poverty during his period in power. At the end of that period, the number of people below the poverty line in the United States was the lowest it had been for 25 years. In the United States, it was a very successful policy, and it is not surprising that it was initiated here, albeit under a different name: the working families’ tax credit.

As my noble friend Lady Hollis said, tax credits are a powerful instrument. That is so for several reasons, and it is important to bear them in mind when discussing issues of complication, overpayment and so forth. First, they are non-stigmatising. They are not perceived, as orthodox, passive benefits often are, as stigmatising to the people who claim them and to the rest of the population who fund them. That is an important quality of tax credits compared with orthodox benefit payments. Secondly, they are a positive incentive for job search and job creation more generally. When Senator Long introduced tax credits, they were a reaction against Milton Friedman’s negative income tax, one of the problems of which was that it would effectively have acted as a disincentive to work, unlike tax credits. Thirdly, tax credits connect social policy and economic policy. That is why they have been such an important element of government policy. They get a lot of people into work and alleviate poverty at the same time because we know the best way of doing that is to get people into jobs. At the same time, they directly contribute to economic dynamism. There are very few social policies that do both those things.

The record of this country in job creation and employment is substantial. Some of the major EU economies, such as France or Germany, have about 64 or 63 per cent of the labour force in work. In the UK, about 74 per cent of the labour force is in work—one of the top figures not only in the EU but among OECD countries. That is crucial, because it generates the tax revenue that makes possible investment in public services.

A fourth reason why tax credits are so important is that, unlike many other benefits systems, they have a proven track record. They have been used in the United States for quite some time and a large number of studies show that they work: they benefit some of the poorest sectors of society and, crucially, they provide an important and direct incentive for job search and job creation.

One must concede, as my noble friend Lady Hollis conceded, that there are problems with tax credits. The question is whether those problems are, in the light of what the noble Lord, Lord Northbrook, said, structural or the result of how they are implemented. That is crucial. One should recognise that all benefits have problems. Again, as my noble friend said, if you have a straightforward universal benefits system, the problem is that a lot of money goes to people who do not really need it. There will always be problems and dilemmas in the relationship between targeted and universal benefits. No system is perfect.

The first problem, much discussed in the British press recently, is that of overpayment. It is best to look to the United States to see whether that is a structural problem or whether it is largely the result of the computer system—or, I think one must say, mistakes made. The evidence from the United States is pretty clear. There was overpayment in the beginning in the United States. That has been radically reduced. There was a lot of fraud initially in the United States, but that has been radically reduced. There is still some overpayment in the US, but it is much less than it was. That leads me to conclude that overpayment is not primarily a structural problem of tax credits and that we should be following the same procedures as have been instituted in the United States to reduce those problems.

The second issue, also mentioned by noble Lords, is the fact that the tax credits are complicated and difficult to understand. If I may say so, one must have a nuanced view of that. Simplicity is of course a virtue, but it is not the sole virtue of a tax system, especially when we recognise the crucial fact that fiscal systems have an impact on behaviour. That is a crucial aspect of what tax credits do. Much more important than sheer simplicity is whether they do the job of bringing the money to the right people in the right way at the right time. I take it that that was the point raised by the noble Lord. I think that we must have a flexible system. Therefore, I am not in favour of the proposal that seems to have been made by the Liberal Democrats of having a six-month stable payment. Because poverty is so complex and changes so much even during the course of a year, you must have a flexible system. One of the main things that we have discovered about poverty is that it is not a unitary state. Poverty has so many different faces and any system must be tailored to that.

Thirdly, we must be careful that the old poverty traps do not return. That can happen if tax credits are not properly adjusted as times and income levels change. We know that the old poverty traps put poorer people in a terrible situation of having a much higher marginal rate of taxation than more wealthy people. There is a danger that the tax credit system can drift towards that as well if we do not modify it as it goes along. I would like to hear the Minister's comments on what has been said by members of our party, such as Alan Milburn, who has expressed reservations from that point of view and, perhaps, on the recent Rowntree report, which also expressed reservations about that. That is an important part of the debate.

However, I very much diverge from the noble Lord over tax credits. I think he would have to look very hard to find another system that links together increasing social justice, economic dynamism and employment in a single-policy system. It would be a great mistake to disentangle them, which is why I was very pleased to hear the noble Lord, Lord Northbrook, say that he fully supported the idea of tax credits in principle. I think that is what he said.

Finally, anyone can make a mistake about tax systems and fail to understand them. I leave noble Lords with this little story. A tax inspector goes to see a businessman with a multi-million pound business. He knocks on the office door and says, “I’m the man from the VAT”. The businessman behind the desk says, “You’re a bit premature. I haven’t decided whether I will join yet”.

My Lords, this has been a short debate but one that shows some of the strengths of this House. We have had a good range of people talking about practical difficulties in the system, as well as with great expertise about its more theoretical aspects.

I congratulate the noble Lord, Lord Northbrook, on keeping this problem in front of us and on continuing to try to hold the Government to account. He painted a serious picture, which I believe is correct, of continuing inefficiency, overpayments, underpayments, error and fraud in the tax credits system.

The noble Baroness, Lady Hollis, spoke with her unique combination of commitment and expertise, and I will certainly develop her argument about the employment and poverty trap and about the effect of housing and other benefits. I do not, however, agree with the thrust of her summary of the very important Institute for Fiscal Studies report, supported by the Joseph Rowntree Foundation, about which I propose to say a little more.

The noble Lord, Lord Giddens, also gave us a useful historical sweep, but I cannot agree that tax credits are not a disincentive to work. A careful study of the IFS report would make him think very hard about that. Briefly, he spoke about the Liberal Democrat proposals to re-fix tax credits every six months. I agree that flexibility is fine, and obviously one would like the system to work better. The problem at the moment is that the system seems to be seizing up, and re-fixing tax credits every six months is a short-term practical proposal to help.

The noble Viscount, Lord Trenchard, concentrated on administrative costs and reclaiming overpayments, and followed the main thrust of the noble Lord, Lord Northbrook. I notice that he called the Forsyth commission’s report excellent. Is the noble Baroness, Lady Noakes, allowed to agree with that from the Conservative Front Bench, or would it break Mr Osborne’s vow of silence? He seems to have invented a whole new concept. Noble Lords may remember that the Chancellor of the Exchequer used to go into pre-Budget purdah for a few weeks. The new Osborne doctrine seems to be that shadow Chancellors go into pre-election purdah for about four or five years and cannot talk about tax at all.

I mentioned the IFS report, The poverty trade-off: work incentives and income redistribution in Britain, which came out earlier this month. I pay tribute yet again to the great work that the Joseph Rowntree Foundation does in supporting valuable public-policy initiatives of this kind. The conclusions were that Labour’s reforms to date have acted to weaken both incentives to be in work at all and incentives for those in work to increase their earnings. It rightly draws particular attention to the fact that housing benefit recipients have some of the weakest work incentives of all. As the noble Baroness, Lady Hollis, pointed out, it is the interaction of that with other benefits that really makes marginal tax rates on poor people very high. The Government must face up to this very serious disincentive to work and let people on housing benefit, particularly, keep more of their earnings as they work more.

The IFS report refers to lone parents, whom Labour talk about a great deal, and points out that this group still has the weakest work incentives of the six demographic groups that it considered. It says that the number of lone parents has more than doubled since 1979 and that this should be a key focus for the attention of policy makers. The IFS goes into considerable detail and puts a very powerful case when it states that,

“the reforms that do the most damage to work incentives are the same aggressively means-tested ones that do most to help the poor”.

We have to face that increasing the child element of CTC in particular would reduce the incentive to work substantially for large numbers of people. The report points out how a classic increase in means-tested support is very successful in targeting money at the poor, but is very weak for work incentives. In the face of this evidence, I do not see how the noble Lord, Lord Giddens, can argue that work incentives are not weakened.

This short debate has focused on operational difficulties, but more on what I would call fundamental design faults in the tax credits system, which, because it is so complicated, makes it operationally very difficult and undoubtedly affects work incentives.

My Lords, will the noble Lord clarify what he just said? I am not sure whether he is arguing against me. I was arguing that negative income taxes tend not to work because basically they are disincentives to work, whereas tax credit systems work much better. If they are fine-tuned properly, they help to get a lot more people into work.

My Lords, I thank the noble Lord for that. I do not think that I misheard him. I do not disagree with him on negative income tax, but I understood him to say that tax credits did not have disincentive effects. Obviously, I accept that he was talking particularly about America, which may have had longer to refine the operation of the system. My point in encouraging people to study this IFS report is that as tax credits operate in the United Kingdom, there are significant disincentives to work, particularly for the poorest in our society. The principle is that it is quite wrong that the poorest people in society should face a much higher marginal tax rate than the richest people, which is the situation that we have at the moment. In Britain, we have 2 million workers who face a marginal tax rate of more than 50p in the pound and 160,000 who face a marginal tax rate of more than 90p in the pound, which is a very serious indictment of a Government after nine years in office.

My Lords, I apologise for intervening again on the noble Lord’s contribution, which is extremely interesting. The IFS report goes into detailed analysis of household types in chapters 5 and 6 in particular, tracks them longitudinally over time and sets against that an array of different possible interventions available to Government—large family premium, CTC, working family tax credit and so on. The Institute for Fiscal Studies recognises, first, that incentives to go into and to stay in work are stronger in 2005 than in 1979 and that, secondly, notwithstanding all the other possible remedies—though some may be more effective than others—there is very little scope. Does the noble Lord agree that because of the trade-offs built into any system linking social and economic policy, government interventions would make differences at the margins that might be worth having, but that that does not mean—the IFS never says this—that tax credits as a policy should be abandoned as a result?

My Lords, no, we do not say that they should be abandoned. I know of course that the noble Baroness will have read the report carefully. I have chapter 6 with me. No one is suggesting that things have not improved since 1979: it would be a grim state of affairs if they had not. It says that identifying those very serious disincentive effects—there are various charts—for some groups shows that tax credits in their current form are not working for those groups. Given all the improvements that have been made under the noble Baroness among other people, that is still a serious criticism of our system nine years into a Labour Government.

My Lords, my noble friend Lord Northbrook has chosen for debate today a very important question which has had too little attention in your Lordships’ House. I agree with the noble Lord, Lord Oakeshott, that it has been a wide-ranging and thoughtful debate which has shown the strength of the House. It has also, incidentally, given my noble friend Lord Trenchard another opportunity to remind the House about the Chancellor’s raid on pension funds by way of dividend tax credits.

The noble Lord, Lord Oakeshott, taunted me with my noble friend Lord Trenchard’s reference to the report last week of my noble friend Lord Forsyth—the Tax Commission’s report—which he described as excellent. I can certainly confirm that the official view is that it is an excellent report. That does not, of course, make it Conservative Party policy.

The importance of tax credits goes beyond the routine assessment of government policies, because they are the Chancellor of the Exchequer’s personal project, and they give us insight into the Chancellor and his aims. The outcomes of the scheme must reflect on him. That is important when we start to look at what might happen if the Chancellor moves into No. 10 as he clearly wishes to in the immediate future.

The Chancellor said some four years ago, when he was launching an advertising campaign for tax credits, that:

“The new tax credits … are central to this Government’s goals of not only tackling child poverty and making work pay but ensuring family prosperity for all”.

Those were the goals he set four years ago. During Starred Questions, the Minister told the House that these goals had been achieved. He said that,

“this has been an ambitious system that has delivered three key achievements. It has improved incentives to work; it has reduced the tax burden on low- to middle-income families; and it has helped dramatically to reduce child poverty”.—[Official Report, 7/6/06; col. 1259.]

I should like to examine these claims and set what has been achieved against the very real problems that exist in the tax credits system, which my noble friend Lord Northbrook laid out so well.

The first claim made by the Minister was that the tax credits system has improved incentives to work. The noble Lord, Lord Oakeshott, referred extensively to the IFS study on behalf of the Joseph Rowntree Foundation—neither organisation could be said to be a spokesman for Conservative Party thinking. The report found that incentives to work and earn more had strengthened since 1979 but they have weakened since 2000, the period during which tax credits were introduced. It said:

“Overall, reforms under the Conservatives acted to strengthen average work incentives whereas Labour’s reforms to date have weakened financial work incentives on average; since 1999 tax and benefit changes have increased the average effective marginal tax rate by almost 3 percentage points”.

We have discussed the effective marginal tax rates today. For the best paid workers in the land, such as the Minister, it is 41 per cent. As the noble Lord, Lord Oakeshott, and my noble friend Lord Trenchard have pointed out, more than 2 million workers stand to lose more than half of any increase and 160,000 would keep only 10p in the pound. As the noble Baroness, Lady Hollis, pointed out, this is the toxic effect of the combination of tax, national insurance, tax credits, council tax benefit, housing benefit and any other benefits that have a withdrawal rate. The plain fact is that means-tested benefits, which is what tax credits are, weaken work incentives. The UK has the worst poverty trap in the OECD for moving from part-time to full-time work.

I do not dispute—I could not—that many families have benefited from the introduction of tax credits alongside part-time and low-paid work. But if effective marginal tax rates are too high, this effect will not encourage those families to progress further into reduced dependence on benefits by working more hours or otherwise seeking higher pay. Instead, they become trapped in benefit dependence at a higher level of income than before—a new form of poverty trap. This dynamic will, over time, tend to produce higher levels of benefit dependence than before because the incentive to escape benefit dependency is too weak. The cost to the public purse, currently over £15 billion a year for tax credits alone, will remain high.

The second claim is that tax credits have reduced the tax burden on low- to middle-income families. One of the features of the tax system in this country is that income is taxed at relatively low levels and that fiscal drag, especially engineered by the current Chancellor by holding allowances down below the rate of earnings growth, has ensured that many more people come within the fiscal net. That has been a feature of the past 10 years. So it might well be true to say that some low- to middle-income families now pay less tax, but that rather begs the question whether they should, in a rational system, have been paying tax in the first place. It certainly begs the question whether there should be two parallel systems—to collect tax and to pay tax credits—if the effect is only to churn income between the two.

The claim to reduce the tax burden on low- to middle-income families sits very uneasily with the fact that, in practice, child tax credits are given up to income levels of £56,000 and, if the £25,000 disregard is added, up to income levels of well beyond £80,000.

The third claim is of a dramatic reduction in child poverty. Let me be clear: we applaud reductions in child poverty, and I am not going to talk this evening about the Government missing their own targets. The tax credit system has certainly directed further resources to families with children, thereby helping to reduce poverty. But the Joseph Rowntree/IFS report highlights the fact that while increasing the child element of the child tax credit has had the direct effect of reducing child poverty, it can have the indirect effect of increasing poverty by weakening the incentives of parents to work, thereby taking themselves out of poverty eventually.

Since the children of families in which parents do not work are themselves more likely to be workless and benefit dependent, it may simply be that the reduction in child poverty through tax credits hardwires benefit dependency into the system. I am reminded of Mr Alan Milburn’s conclusion earlier this year in another place that, in the past decade,

“poverty has become more entrenched”.—[Official Report, Commons, 28/3/06; col. 710.]

It is not the aims of tax credits about which we have concerns; it is whether they are the best method of dealing with the problems that exist in our society. I have outlined some of those doubts, but they are reinforced by the way in which tax credits have been implemented, as my noble friend Lord Northbrook so excellently laid out this evening. I should like to read out a brief summary of the charge sheet. They are expensive to operate, costing, I believe, more than £500 million a year. My noble friend Lord Trenchard asked the Minister that question, and if I have that figure wrong, I look forward to being corrected when the noble Lord responds. The way in which tax credits have been implemented has caused genuine hardship to very many families, at the extreme requiring some to rely on food parcels from the Salvation Army just to survive the chaos of implementation. The system has been poorly implemented in the way that it has opened itself up to major fraud via the online portal and the operation of wholly inadequate helplines for much of the period. Tax credits are so badly designed that nearly 2 million overpayments and 1 million underpayments occur each year.

I said at the outset that I would want to see how the Chancellor’s own project of tax credits could shed light on what kind of Prime Minister he would be. If the experience of the tax credit scheme were anything to go by, it would indicate that ambitious aims are not matched by effective delivery. That is true whether effectiveness is measured at the level of practical implementation or at the level of achieving good, long-term outcomes. It does not bode well for the country.

My Lords, I thank the noble Lord, Lord Northbrook, for initiating this debate and all noble Lords who have spoken. I have had posed to me this evening far more questions than I could possibly answer if I had an hour in which to speak, but I will do my best.

Tax credits help support 20 million people—6 million families and just over 10 million children. They have made a significant difference to the well-being of families and individuals across Britain. The take-up of tax credits is substantially higher than in any previous system of income-related financial support for in-work families who most need it. In the first year of tax credits, 93 per cent of families on incomes below £10,000 claimed their entitlement. That should be compared with a take-up rate of 50 per cent for the early years of family income supplement, 57 per cent for family credit and, at best, 65 per cent for working families tax credit. Take-up is around 80 per cent across the board and 93 per cent for those most in need.

I reiterate that tax credits have delivered three major goals. They have improved incentives to work; they have reduced tax burdens for low-to-middle-income families; and they have dramatically reduced child poverty. Tax credits in the context of our wider economic stability have contributed since the spring of 1997 to an increase of more than 2 million in the number of people in work, with long-term unemployment reduced by some 450,000.

Tax credits have reduced the tax burden. The latest OECD study shows a large fall in the tax burden for low-to-middle-income families as a result of tax credits. The burden on a single-earner couple with two children earning £21,000 a year has fallen from more than 17 per cent of gross earnings in 1997 to 9.8 per cent in 2004. That is the lowest rate of any G7 country. In the UK, a single-earner family with two children can now earn just under two thirds of the average wage before it starts to pay any net tax. Tax credits have helped ensure that the number of families with children paying no net tax has risen from under 2.5 million in 1998 to more than 3 million this year. They have made a major contribution to reducing child poverty, with 700,000 children lifted out of relative poverty since 1997. More than 1.8 million fewer children are in absolute low-income families than in 1997 on a before-housing-costs basis. I believe that that is an achievement that we would all applaud. My noble friend Lord Giddens made another important point about tax credits. He said that they delivered support in a way which is non-stigmatising.

The introduction of tax credits has been a huge undertaking for HMRC. It is the biggest single change to the welfare state since the Beveridge reforms. Problems with the IT system in the early days created difficulties, but HMRC has made significant progress. There is, however, more to be done. Last May, the Paymaster General set out a series of administrative measures designed to reduce the risk of errors, to clarify communications with tax credit recipients and to improve procedures for recovering overpayments. Since then, significant progress has been made in each of these areas. Building on the progress so far, major software releases were successfully implemented last November and this April, delivering real improvements in operational performance, not to mention in the service to claimants.

Since the introduction of tax credits, HMRC has worked closely with the voluntary and community sector to improve its service to claimants. For example, responding to feedback from the voluntary and community sectors, it has revised award notices to include a clearer summary of what will be paid and, for the first time, an explanation of how this has been calculated. HMRC has been working with the voluntary and community sector also to make claimants aware of their entitlement to tax credits; for example, with the tax credits take-up resource pack, which was provided by citizens advice but funded by HMRC. Building on the progress made on administration in Pre-Budget Report 2005, the Government announced a package of further improvements to the tax credits system. This struck a balance between providing more certainty and stability for families, particularly those on lower incomes, and maintaining the flexibility to respond to changes in income and family circumstances.

A number of noble Lords touched on the issue of end-year adjustments, which are inevitably an integral part of a flexible financial support system. Payments are based on household incomes which can, of course, change during the course of the year. Payments are therefore subject to adjustment during the course of the year and, if necessary, at the end of the year once these changes in incomes are known.

National statistics show that year-end adjustments leading to an overpayment have fallen by one-fifth from 2003-04 to 2004-05. Improved performance of the tax credits system has meant that fewer overpayments are now caused by IT or administrative error. The statistic of 97.75 per cent accuracy in processing and calculating awards was quoted by my noble friend Lady Hollis. HMRC expects to recover the majority of the money overpaid, except where there has been a mistake by HMRC and it is not reasonable to expect the claimant to have noticed the error.

The national statistics relate to 2004-05, and so do not show the impact of measures announced at the time of the 2005 Pre-Budget Report to give greater certainty to families while maintaining flexibility to respond to changing circumstances. Once these come fully into effect the level of year-end adjustments are expected to fall by a further third in future years. Eliminating the need for adjustments altogether would require a move to a fixed system in which eligibility was based on the previous year's income and circumstances—a system where, as a result, flexibility would be diminished. This flexibility to respond to changing circumstances is a key part of the system, especially in today’s modern labour market where in any single year 3 million people change jobs and 200,000 men and women who move into new or better jobs see their family income rise by more than £10,000.

Noble Lords raised a number of questions. The noble Lord, Lord Northbrook, pressed me on a whole raft of questions relating to the Treasury Select Committee report, and I hope that he will forgive me if I do not deal with all of those in detail. The Government have not responded formally to that report but will do so shortly, and perhaps we might have another debate in due course when those responses have been made formally.

I was asked about overpayment awards for 2004-05. The amount currently calculated is £1.8 billion. The figures for 2005-06 are not yet available as the claims have not yet been finalised.

On our confidence about the costings relating to the £25,000 disregard, we have two years’ data from 2003-04 and the 2004-05 overpayments, which help us to a better estimate of the costs involved. I refer the noble Lord, Lord Northbrook, to the letter written to the Public Accounts Committee, which sets out some of the background to that.

The noble Lord asked, too, about the causes of overpayment. The main causes are income rises, families overestimating income falls, provisional payments being made on out-of-date information and delays in reporting changes of circumstances.

On the issue of error and fraud, figures published on 11 July gave HMRC’s estimate of error and fraud in the tax credits system for 2003-04, which was of course several years ago. The information on organised fraud shows that HMRC successfully stopped the majority of claims identified as being submitted by organised fraudsters. Some £409 million of fraudulent claims have been prevented, and there is no evidence of new major organised frauds comparable to those involving organisations such as DWP and Network Rail, which were reported to the House in January. It is planned to increase the number of compliance staff by 190.

My noble friend Lady Hollis raised the issue of the large family premium. The Government recognise that children in large families are at a disproportionate risk of being poor. The 2004 child poverty review set out a long-term aspiration to improve the financial support available to large families. The introduction and increase in the per child element of the child tax credit has disproportionately benefited larger families and, compared to 1998-99, the risk of poverty has fallen by 33 per cent for large families compared to 23 per cent overall. Nevertheless we will continue to consider options to go further, including the introduction of large family unlimited tax credits, along with equalising child benefits, as others have suggested, and increasing the child element.

I am afraid I do not have any good news about the position on financial support for grandparents. I think my noble friend is aware of the situation. It is one thing where there are formal childcare arrangements in place, but it is difficult for a Government to involve themselves in commercialising arrangements within families. It is important to differentiate between situations where the Government are paying, such as the carer’s allowance, and those where you would be encouraging payments between family members. There would be difficulties if it were judged that grandparents were not felt able to fully undertake their responsibilities.

The issue of regional differences is an interesting one. I think it has been considered recently in relation to the minimum wage. The Government felt it was not the right way to go. Marginal tax rates, which a number of noble Lords raised, are high but effective marginal rates of over 70 per cent have fallen by half a million since 1997.

I admire the ingenuity of the noble Viscount, Lord Trenchard, on the dividend tax credit. Forgive me if I do not rehearse the debates we have had on that before, but I am sure we will have ample opportunities to do so in the future. The cost of administering the system was £467 million in 2005-06, which must be something like 0.25 pence in the pound.

The noble Viscount made reference, as did others, to the Tax Commission, chaired by the noble Lord, Lord Forsyth. We would say that transferable tax allowance is an untargeted measure that is of most benefit to those on higher incomes. Indeed, policies have increased the personal allowance by £7,185 by abolishing the 10p starting rate, which, it was suggested, would cost £4.6 billion. An increase in the personal allowance disproportionately benefits the better-off on higher marginal tax rates and is therefore regressive. Changes to tax allowances cannot reduce tax liability below zero and therefore fail to support the poorest. The combined effect of the new higher income tax allowance, the proposed abolition of the 10p starting rate, the new 20p basic rate and the abolition of tax credits for hard-working families higher up the income scale would mean that of the poorest quarter of households only one-third would see any benefit from the package and two-thirds would not get a penny, while every single household in the wealthiest quarter would benefit. We simply do not see that as the right way to go.

My noble friend Lord Giddens raised issues arising from the Joseph Rowntree report, which suggests a basic rate of income tax of 37 per cent to pay for changes to the system. If anything, we would say the tax system they have designed is very much like the current system except with higher rates, and we have a manifesto commitment not to raise basic or higher rates of income tax.

We have touched upon issues of year-end adjustments. I quote again the figure that each year at least 200,000 men and women move into new and better jobs and see their family income rise by more than £10,000. The noble Lord, Lord Oakeshott, in particular, talked about the IFS report. In response I say: look at the evidence. Employment, which my noble friend Lord Giddens touched on, is at record levels, with 28 million people in work. The UK’s employment rate is the highest of the G7 economies bar the US and Canada. Since 1997, New Deal programmes, which are part of the strategy, have helped reduce long-term youth unemployment and long-term unemployment by over two-thirds. Working tax credit provides financial support on top of earnings and, together with the national minimum wage, helps to improve work incentives and relieve in-work poverty. Lone parent employment has risen by 11.3 percentage points to 56.6 per cent, the highest on record. There are now over 1 million lone parents in work, over 300,000 more than in 1997.

The noble Baroness, Lady Noakes, made a number of points on marginal tax-rate issues and on the Chancellor’s approach to those matters. I have no doubt that a Chancellor who is about tackling poverty and improving incentives to work and who wishes to reduce tax burdens for low-to-middle-income families would make an excellent Prime Minister, as I am sure that he will.

I have run out of time. I hope that noble Lords will forgive me for not having dealt with all the points that have been raised. I conclude by saying that tax credits and economic stability have helped to increase the number of people in work by more than 2 million since spring 1997. Since 1997, long-term unemployment has reduced by 450,000. Tax credits have improved work incentives, reduced the tax burden on low-to- middle-income families and helped to reduce child poverty dramatically. Of course, we should remain vigilant to the administrative challenges that these bold measures create, but we should celebrate the outcome of the policy and the substantial improvement it has made to the lives of many.

House adjourned at ten minutes past eight o’clock.