Briefing Note on Child and Family Tax Credits: the UK Experience

Transcription

1 Briefing Note on Child and Family Tax Credits: the UK Experience This Briefing Note examines the UK experience of introducing Child and Working Tax Credits. It outlines what a tax credit is, why tax credits were introduced in the UK in 1998, the practicalities of UK tax credits, as well as the positive and negative impacts of this change. It concludes with some lessons for Ireland based on the UK experience. What are Tax Credits? Tax credits are means tested payments. Tax credits may be characterised as either refundable or non refundable, or non wasteable or wasteable. Refundable or non wasteable tax credits can reduce the tax owed below zero, and result in a net payment to the taxpayer beyond their own payments into the tax system, appearing to be a moderate form of negative income tax. Examples of refundable tax credits include the earned income tax credit (EITC) in the US, and the working tax credits or child tax credits in the UK. A non refundable or wasteable tax credit cannot reduce the tax owed below zero, and hence cannot cause a taxpayer to receive a refund in excess of their payments into the tax system. Some examples of non refundable tax credits are the former children's tax credit in the UK and the declared gifts made to registered charities under the Giftaid scheme, which attract tax relief (claimed by the charity) at the standard rate but which cannot reduce the donor's liability beyond the amount of tax actually paid by them in a given year. All tax credits in Ireland are non refundable. Focus on the UK System Background In 1998 the UK had the highest proportion of children in low income households in the EU. This high figure was the result of years of bad policy or lack of policy in this area. By the late 1990s research demonstrated that the negative impacts of growing up in poverty were transferred from one generation to the next, creating cycles of deprivation in families and areas. The structure of the tax and benefits system in the UK had created financial barriers to work for those with low potential earnings and families in particular, for example: In work financial support for families had been introduced but it was narrowly focused, and help with the costs of childcare were limited (this affected lone parents in particular) Little support or incentive to search for work led to long term dependence on benefits Insufficient support in the transition from benefits to work and lack of certainty about the likely level of in work income meant low numbers transferred from welfare to work. The New Labour Government took power in the UK in 1997, after 18 years in opposition. From 1998, they introduced reforms to the tax and benefits systems designed to tackle the problems of poor incentives to work, and to increase financial support to vulnerable groups. 1 P age

2 The modernisation of Britain s Tax and Benefits System The UK started with two separate systems: one for assessing and collecting income tax and liabilities (revenue) and another for providing financial support to families and disadvantaged or vulnerable groups (social security). The separation between the tax and social security systems tended to obscure the fundamental financial relationship between government and individuals or families over their life cycles, and led to people being labelled as either taxpayers or claimants, rather than both at different points in their lives. Support through the social security system involved complex and burdensome means testing. The tax system based on the principle of independent taxation was less intrusive, but could not easily take account of household circumstances and joint incomes. This made it a very ineffective way of targeting support to families. The Government began a focused reform process, underpinned by the principle of progressive universalism, or providing the most support to those with the greatest need. The process required strategic (e.g. partial) integration of the tax and benefits systems. This was done based on five principles: 1. To promote incentives to work by reducing the tax burden on the low paid and reducing the number of low income households on high marginal withdrawal rates 2. Ensure it is targeted at those that need it most financial support should be assessed on a household basis where possible, while respecting the principle of independent taxation 3. To tackle poverty minimum levels of income should be guaranteed for the most vulnerable in society 4. To reduce stigma and maximise take up the income test should not be intrusive and the hassle of claiming should be minimised 5. To improve customer service and increase efficiency the administration of tax and benefits should be modernised and brought closer together. The most radical of the reforms undertaken in the modernisation process were the introduction of payable tax credits. Tax Credits in Action Tax credit awards reflect and respond to the needs and circumstances of different households. They follow broadly the same rules as income tax, are closely aligned with the tax system and are administered and paid by the Inland Revenue. Under this system families receive state support for their children through the Child Tax Credit and Child Benefit. Workers on low incomes and those with a disability, receive additional support through the Working Tax Credit. Parents can get help with their in work childcare costs through the childcare element of the Working Tax Credit. The system began in 1999 with the Working Families Tax Credit (WFTC). It was focused on moving parents off welfare and into work and aimed to: Provide more generous financial support to tackle poverty among working families on low earnings Improve incentives to move into and progress in work Tackle childcare costs as a barrier to work through the childcare tax credit. The Working Families Tax Credit was abolished in 2003 and was replaced by two new tax credits: Child Tax Credit (CTC) and Working Tax Credit (WTC). The introduction of these two new tax credits meant that instead of four separate instruments directing support to families with children there would be two: Child Benefit (universal) and the Child Tax Credit (targeted). Child and Working Tax Credits (2003) aim to: 2 P age

3 Simplify support for families with children so that parents have a clearer idea of how much they can expect to receive in respect of their children, and provide a single system of support for families with children, which is independent of the parents employment status. This provides a stable source of income as parents move into work, easing the transition to paid employment Enhance work incentives for second earners through a new and fairer assessment of family income, and a reduction in the rate at which awards are withdrawn Increase the gain from work for tenants part time through improving the interaction between Working Tax Credit and Housing Benefit Reduce the number of working families in the poverty trap. Who qualifies and how? The Working Tax Credit is intended to top up the earnings of low paid workers and includes a childcare element for working parents. Qualification depends on being in paid employment (or selfemployed) for at least 16 hours a week. 1 The Child Tax Credit is intended to provide a single source of support for families with children, which is independent of the parents employment status. The credit is available to all families with a household income of up to 58,175 a year (or up to 66,350 a year if there is a child under one yearold). The amount paid depends on individual circumstances. A range of factors are taken into account, including earning and number of hours worked weekly. In 2006, families could get an annual child tax credit of up to 545, regardless of how many children they had. On top of this, they were entitled to up to 1,765 a year for each child, based on certain criteria. The Child Tax Credit can be more if a child is less than 12 months old or disabled. 2 Working Tax Credits and Child Tax Credits work in parallel. Both are non wasteable credits the actual payments may exceed and are not limited by the annual income tax payable by the claimant. Both credits are assessed jointly and families remain eligible for Child Tax Credit even if there is no adult working or they have too much income to receive the Working Tax Credit. Parents may qualify for help with the costs of childcare as part of Working Tax Credit. This can cover up to 70% of their childcare costs. The amount of help received depends on a parents level of income. It can be up to 80p for every 1 spent on childcare, up to a limit of 175 in costs per week for one child and 300 for two or more children. This means the most a parent can receive for the childcare element is 140 for one child or for two or more children. This support is provided further up the income scale to ensure that more families on moderate incomes can receive help with childcare costs. 3 Since 1997 expenditure on childcare through tax credits has increased fifteen fold in real terms. 4 The advantages of the Working and Child Tax Credits over previous sources of support are: 1 Under the Working Tax Credit benefits are exhausted for a lone parent or a couple working full time at an income of just under 15,000 per annum, or 13,320 if working less than 30 hours per week. Benefit is withdrawn at a rate of 37% for incomes over 5,000. See Callan, T. et al, 2007, Child Poverty and Child Income Supports: Ireland in Comparative Perspective, in T. Callan (ed.) Budget Perspectives 2007, Dublin: ESRI for further detail. 2 Families with an annual gross income below 13,230 are entitled to the full credit. Entitlements are reduced by 37% of income above this level until the family is left with just the per family element. Incomes above 50,000 per annum reduce entitlement to the perfamily element by 6.7% in the pound until it is exhausted. Callan, T. et al, 2007, Child Poverty and Child Income Supports: Ireland in Comparative Perspective, in T. Callan (ed.) Budget Perspectives 2007, Dublin: ESRI. See also Q & A: tax credits [accessed 16/05/08]. 3 HM Treasury, 2005, Tax Credits: reforming financial supports for families, London: the Stationery Office. 4 Ibid., p Page

4 Alignment with the tax year: assessed against income over a whole tax year and last the duration of the tax year Awards based on family income: ensuring support is fair between dual and single earners Inclusivity: nine in ten families are eligible for the Child Tax Credit Acknowledge families changing circumstances: reduction in income or increase in childcare costs. 5 Results Around 6 million families benefit from the Child Tax Credit, and 3.5 million families have benefitted from the increases in the per child element of the Child Tax Credit. 6 Despite this apparent success the system has experienced some serious difficulties, which raise questions about its suitability. These are addressed below. Analysis of the UK System The principle underpinning the UK tax credits system that of progressive universalism is honourable, and its aims to tackle the problems of poor incentives to work, and to increase financial supports to vulnerable groups are good ones. But the application of the system in practice is deeply flawed. The positives of the system As the figures above outline, the Child and Working Tax Credits support a large number of families and individuals in the UK, and are an important part of the policy mix to support families on low incomes. Tax Credits are an effective means of ensuring that families with low incomes face a negative tax rate, taking into account both paid tax and support received. Compared with the income tax system or child benefit they provide a more flexible way of providing support to families who need it most, because they can respond both to family income and household circumstances. Tax credits have also enhanced the way the tax system can be used to target support and improve work incentives, though it is more generous to lone parents than to couples it is much more likely to take a lone parent who works full time out of poverty, than a couple where one person works full time. 7 This is important in the UK context, as over 80% of poor children in with working parents live in couple families. The Joseph Rowntree Foundation (JRF) lists the six main changes that have helped to reduce child poverty in the UK over the past decade. These are all related to the system of tax credits, and are outlined in the box below. Table 1: Six main changes that helped to reduce child poverty by 700,000 from 1998/99 to 2004/05 8 Change Consequence for child poverty The number of children with workless lone Reduced by 60,000 parents fell from 14% to 13% of all children The number of all children in workless couple Reduced by 63,000 families fell from 7% to 6% of all children The chance of being poor with a non working Reduced by 107,000 lone parent fell from 79% to 72% 5 Ibid. 6 Ibid., p Hirsh, D., 2006, What will it take to end child poverty? Firing on all cylinders, York: Joseph Rowntree Foundation, p Ibid., p Page

5 The chance of being poor in a workless couple fell from 82% to 72% The chance of being poor with a lone parent working part time fell from 45% to 27% The chance of being poor in a couple with one full time worker and the other not working fell from 28% to 21% Reduced by 88,000 Reduced by 132,000 Reduced by 154,000 The negatives of the system So far, the positives of the system have been far outweighed by the negatives. The main criticisms are: Overpayments to recipients Complexity of the system Design of the system Inconsistency between stated policy objectives and the tax credits system in practice. Overpayments to recipients: Tax credits in the UK are granted on an annual basis, based on income from the previous year. This means that if a recipients income increases during the year their tax credits entitlement is diminished, but this (generally) will not be addressed until the end of the tax year. Where overpayments are made, recipients are expected to pay them back within an agreed timeframe. This has caused significant difficulties. Many families did not realise they were overpaid, as they misunderstood the basics of the system. Others realised when it was too late and the money was spent. For many, repayment has landed them in debt and their experience of the system has been deeply stressful and in some cases traumatic. 9 In its first year of full operation ( ) overpayments there were 2.2billion in overpayments. In almost one third of all payments made had (again) been overpaid. This amounted to 1.7 billion. Almost half a million awards (494,000) had been overpaid by over 1,000 and some 25,000 of those by over 5,000 in one year alone. A significant proportion of those payments (363,000) were made to those on low or very modest incomes, where household income was less than 10,000. Complexity of the system: Five years in operation, many users of the system do not understand how the tax credits system works, and have found themselves in serious debt as a result. Many users of tax credits simply do not understand that it is possible for them to have provided all of the correct information and for their award to have been assessed on that basis but because of changes in their circumstances during the year they have debt to repay. Although many children may be lifted out of poverty by the tax credits system, others may be forced into it. 10 This raises serious questions about how appropriate this system is for the customers it serves. System design: Underpinning the failures associated with the system is a fundamental question, raised by the Parliamentary Ombudsman, about its design. Many complainants remain unable to fully grasp the basic principles of an annualised system... The customer experience of this group raises fundamental questions as to whether a system of this nature, which includes a degree of financial uncertainty and the possibility of debts arising, can really meet the needs of this particular group of individuals and families For case studies see Parliamentary and Health Services Ombudsman, 2007, Tax Credits: Getting it wrong, London: The Stationery Office. 10 Ibid., p Parliamentary and Health Services Ombudsman, 2007, Tax Credits: Getting it wrong, London: The Stationery Office, p. 8 & Page

6 The Ombudsman s comments are rooted in concerns about the financial uncertainty inherent in an annualised system. Overpayments and underpayments are unavoidable aspects of the system which will continue to occur, however well the system is administered, because that is how it is designed. Working against policy objectives: Even when working as intended the system has been criticised for working against the policy objectives it was set up to achieve helping to tackle child poverty (through income related support for families with children), and encouraging more people into work by making work pay. Changes in circumstances in year (typically improvements in income) result in overpayments of tax credits to customers, which then have to be paid back, often resulting in debt. What is the logic of a system designed to encourage people into work that creates disincentives (through a fear of debt) to accessing work until the end of the tax year? Initially, there were a further set of problems with the way Tax Credits were administered and delivered. They were addressed in the Ombudsman s first report, and have since been addressed, but raising them may be useful in providing lessons for the Irish context, they include: One size fits all system the original system was heavily reliant on technology, and was designed for minimal human intervention. The was a key flaw given the diverse and often vulnerable nature of the client group, who required human support and individually tailored advice and information Awareness levels customers were not aware of the need to report any change in circumstances immediately, and so suffered overpayments and had to make re payments as a result. An intensive media and more general awareness raising campaign was undertaken to address this. It has had some success, but as the figures above demonstrate the problems with overpayment continue Information customers were often provided with information that was unclear or unreliable from staff. Staff were not adequately trained in dealing with clients or providing necessary information Complaints the system for handling complaints was unsatisfactory, and there was a significant degree of human error. Learning for Ireland The UK experience of partial integration of its tax and benefits systems and of introducing Child Tax Credits provides valuable learning in the Irish context, as new options for Child Income Supports are considered. The experience in the UK is an example of what happens when good intentions are not matched by a close understanding of the lives of those whom the policy will affect. 12 Although the idea behind awarding tax credits to low income families is straightforward to simultaneously improve incentives to work and the income situation of those on low wages the design and implementation of tax credits require careful preparation and planning within the context of the country in question. 13 The biggest challenge to implementing a change like this lies in the public administration system. Lessons from the UK include: Keep it simple: explaining and accessing the system must be simple and easily understood by non experts. Understand clearly how tax credits interact with other benefit payments: loss of housing benefit in particular was a disincentive to moving into work in the UK. Put a good and tested IT system in place: before introducing the policy. 12 See W. Davies, Better Living through Tax Credits Prospect, June 2007 edition. 13 See A. Zaidi (2008), Tax Credit Policy in the UK and its lessons for Austria, European Centre Policy Brief. 6 P age

7 Supplement IT systems with well trained help staff: building customer understanding and trust of the system is a key first step. Over reliance on IT, particularly given the client base, is an error Train staff thoroughly: acknowledging the cultural and structural nature of this shift. Dealing with a new kind of customer requires a new set of skills and understandings Invest in awareness raising and building understanding: this is a complex change and clients must be supported to understand what it means for them Design the service with its users in mind: for those on low incomes, a system where debt is an almost inevitable consequence may not be appropriate. The Children s Rights Alliance intends to continue its work in the area of Child Income Supports throughout Updated briefing papers will be provided on our website 7 P age