Poor will not benefit from new tax credit

POOR families will not be helped automatically by replacing in- work benefits with a new system of tax credits, the Joseph Rowntree Foundation warns today.

At the moment, poorly-paid workers with children can claim family credit from the Benefits Agency. The working families tax credit is set to replace this with a tax rebate or reduction in tax liability administered by the Inland Revenue. But the biggest potential advantages will come only if the Government commits extra resources to raise the minimum income of parents who work and reduce the rate at which benefits are withdrawn (known as the benefit tapers), the foundation says.

The JRF commissioned research from Australia, Canada and the United States which shows that tax credits can bring disadvantages as well as benefits to families, depending on the detail of their design and how much money is spent on them. At present, the combined effects of income tax, national insurance and the benefit tapers can be to leave low-paid workers only 3p better off from every pounds 1 of increased pay. The JRF calculates that on its own the 10p starting rate for income tax would do little to change this, with some low-paid workers still retaining less than 4p of every extra pounds 1 earned.

In the US, Australia and Canada, maximum benefits are paid at a flat rate for lower-earners and withdrawn relatively gradually. However, there is evidence in the US that the system creates severe disincentives to work as credit is withdrawn, and Canada has abolished its working income supplement scheme after finding that it reduced incentives to work in twice as many cases as it improved them.

Fraud is also a serious problem in the US, with a high proportion of claims relating for children who do not exist or are being claimed for more than once. The review warns that a tax credit in the United Kingdom might lead to collusions between employers and staff to reduce the level of declared income or companies might be tempted to reduce wages, because lost pay would be made good by the tax credit.

"A tax credit is potentially an attractive way of helping needy working families because it allows them to depend less on transfers from the state and more on their own retained earnings and makes it easier for them to escape poverty," said Donald Hirsch, advisor to the JRF. "Even so, the unforeseen problems with tax credits in other countries including work disincentives and widespread fraud make it vital the proposed British system is carefully designed and that its operation is closely monitored."

He added: "Evaluation should not only look at the specific impact of the working families tax credit, but also how it interacts with other welfare-to-work policies for people on low incomes, including the proposed national minimum wage."