Families face tax-credit crisis again

We had been warned it would be painful, and the Chancellor didn't disappoint. Benefits are to be cut and taxes pushed up, but one of the little-explored financial blows may come in the form of tax- credit reform.

The headline changes to the system – a £150 rise in the credit given for each child, and the lowering of the income threshold for receiving credits from £50,000 to £40,000 – have been broadly welcomed by social campaigners, but they warn that other measures will fall disproportionately on poor households.

"Some of the Budget changes will be hard for people to spot and understand," says Katie Lane from Citizens Advice. "Families need to be alert for changes to their income that they had not anticipated."

The changes causing most concern are the "income disregard" amounts. These allow for a household's income to rise or fall without changing their tax-credit entitlement for that year. Tax credits are based on the previous year's earnings and, currently, so long as any rise is not more than £25,000, HMRC will not try to claw back overpayments: the credits are simply adjusted the following year. But George Osborne will reduce this to £10,000 next April and then to £5,000 in April 2013.

A lower threshold can create havoc in the system and in people's lives. When tax credits were introduced in 2003, HMRC could reclaim payments if a household's income rose by more than £2,500 in a given year. The pursuit of £2bn in overpayments, spent by families in good faith, created a public outcry that led to select-committee hearings, an apology from Tony Blair and a rise in the threshold to its current rate.

"There is a danger that we will see a return to the overpayment crises, though maybe not this year," says Robin Williamson of the Low Incomes Tax Reform Group, as the average rise in income for promotion or a new job is around £5,000. " When the threshold was raised, overpayments dropped by a third. It is a worry that we may return to those days."

Mr Osborne's introduction of a disregard for a fall in income has also caused concern.

At the moment any drop in a family's income can immediately trigger a rise in tax credits. But from next April, HMRC will ignore a drop of less than £2,500 within the year.

"If you are low paid, that's a lot of money to have to lose without any redress, particularly in a recession," says Mr Williamson. "This is such a bad decision by the Chancellor. The lack of a fall disregard was one of the things that made tax credits so effective at helping low-income families."

Another "hidden" Budget measure which experts fear will hurt household incomes is the change in the taper, the way credits are withdrawn as income rises, from 39p for every pound earned over the threshold to 41p.

"A couple earning £29,000 with two children will have to earn 15p in the pound more, just to keep the same income level because of the increased rate of taper," says Helen Barnard, of the Joseph Rowntree Foundation. "If you also take into account the announcement to switch the inflation measure used to uprate benefits and credits, it will very quickly erode low incomes."

The decisions that Mr Osborne did not address in his speech, but which appear in the Budget Report, also concern Ms Barnard and were attacked by acting Labour leader Harriet Harman last week.

"The Chancellor failed to say that the threshold for tax credits will fall to £30,000 in 2012 and that payments will start to be reduced for families earning more than £25,000. The more you analyse this Budget the more regressive it becomes," Ms Barnard says.

The "slow-burn" aspect of the tax credit changes, those elements that will be brought in over time, also worry Edward Graham, from the Child Poverty Action Group.

"Mr Osborne said that the Budget will have a neutral effect on child poverty, but at best it will be neutral for only the first two years before we feel the full negative impact of all of his changes, particularly to tax credits," he said. "We are concerned that the poorest people are having to pick up the bill for the mistakes of the banks and governments."

Expert View

Katie Lane, Citizens Advice

"The introduction of a lower disregard for a fall in income is worrying. The Budget book says the Treasury hopes to save £500m from this disregard, which shows just how many people will lose out, and will struggle to make ends meet."