1 Overpayments of Tax Credits
1. Child Tax Credit and Working Tax Credit (tax credits)
replaced the previous tax credits system in April 2003 as part
of the Government's reforms of the tax and benefits system. The
new arrangements were designed to help families with children
and working people on low incomes. HM Revenue and Customs (the
Department) paid some £47 billion of tax credits in the first
three years of the scheme and it estimates that an average of
5.3 million families benefited in 2005-06.[5]
2. 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 when actual
income and circumstances are known. The final award can differ
from the provisional award, for example where incomes increase.
A system of annual awards based on circumstances which often change
inevitably results in a substantial amount of overpayments.[6]
3. There can be a number of reasons why a claimant
is overpaid, but the tax credits computer system does not automatically
generate information on the cause of overpayments for each award.[7]
Nevertheless, the Department's analysis suggests that overpayments
generally result from:[8]
- rises in income from one year
to the next;
- families overestimating a fall in income when
they seek additional support during the year;
- provisional payments made at the start of the
tax year based on out of date information which the system is
not designed to change until the award is finalised; and
- delays by families in reporting changes in personal
circumstances to the Department.
4. Actual levels of overpayments have been much higher
than the Department envisaged when the scheme was designed. It
originally estimated that overpayments would be around £1
billion a year but in practice around £2 billion was overpaid
in the first year.[9]
5. The Department seeks to recover overpayments wherever
possible. It can only write-off the debt or restrict the rate
of recovery if it considers that repayment would cause hardship.
It can also write-off overpayments which result from official
error or if it finds these are due to organised fraud.
6. In the first three years of the scheme the Department
wrote off £557 million of overpayments. At the end of March
2006, a further £3.6 billion was outstanding,[10]
of which the Department is unlikely to recover £1.4 billion,
making a further write-off inevitable.
Changes announced in the 2005
Pre-Budget Report
7. The December 2005 Pre-Budget Report announced
changes to the tax credits scheme designed to provide greater
certainty to claimants, particularly when the family income rises.[11]
The package comprised five principal measures intended eventually
to reduce overpayments by one third.[12]
8. The most important change raised from £2,500
to £25,000 increases in income which are disregarded when
finalising awards. The effect is that from 2006-07 claimants will
retain some of the amounts they would have been asked to repay
in previous years.
9. The other changes affect the timing of payments
and the recovery of overpayments, for example by reducing the
build-up of overpayments that need to be subsequently recovered.
These changes:
- place additional responsibilities
on claimants to notify the Department promptly of changes in circumstances
that affect their awards; with the aim of reducing overpayments
caused by awards being based on out of date information;
- bring forward the deadline by which claimants
need to finalise their awards from 30 September to 31 August;
- further shorten the period in the following year
where payments continue to be made to claimants based on out of
date information, by bringing the deadline forward from 30 August
to 31 July;[13]
- will increase payments only for the remainder
of the year when claimants report a fall in income during the
year, with a further payment if appropriate when the award is
finalised after the end of the year; and
- introduce automatic limits on the recovery of
overpayments where awards are adjusted in year following a reported
change of circumstance, with the aim of encouraging more families
to report in-year changes of circumstances.
10. In the 2005 Pre-Budget Report, the Treasury estimated
that the overall effect of the package would be a cash cost to
the Exchequer of £100 million in 2006-07, followed by net
savings of £200 million in 2007-08 and £50 million in
2008-09.[14]
11. We had previously asked about the underlying
cost of each of the individual changes, and in particular the
change in the disregard given the significance of its effect on
the underlying cost of the scheme to the taxpayer. The Treasury
chose not to provide an estimate of the cost of the disregard
when the changes were announced, and then took almost a further
year to do so. Our previous Report[15]
requested this information but the Treasury Minute response did
not provide it.[16] The
Department explained that it had information only for 2003-04
awards at the time of the Pre-Budget Report and that it did not
have sufficient confidence in its estimates for them to be released
until information on 2004-05 awards was available.[17]
But if it was confident enough to increase the disregard it should
have been able to give an estimate of the cost when the decision
was first announced.
12. The Treasury eventually wrote to the Committee
in October 2006 giving further information on the effect of the
changes on Exchequer cash flows ('the Exchequer effect'), as shown
in Table 1. From April 2006 the increase in the income
disregard will result in a fall in cash inflows to the Exchequer,
reflecting the foregone recovery of overpayments due to income
rises. The cost and the timing of the Exchequer effect depends
not only on the size of the overpayments that would have accrued
had the higher disregard not been in place, but also on the profile
of recovery of these overpayments. It can take HMRC several years
to complete the recovery of overpayments. Thus, as Table 1 shows,
the full cost of the increase in the income disregard in terms
of its effect on the Exchequer can only begin to be seen after
a period of time. Table
1: Exchequer Effect of the £25,000 disregard
| 2006-07
| 2007-08
| 2008-09
| 2009-10
| 2010-11
|
| Annual cost of Income disregard of £25,000
| £50 m | £100 m
| £150 m | £250 m
| £300 m |
Source: HM Treasury
13. The Department told us that the full cost of
the increase in the income disregard in terms of its effect on
the claimants' entitlement would be around £500 million each
year.[18] This is greater
than the figure disclosed in Table 1 above, because the Department
assumes that some of the overpayments that would have accrued
in 2006-07 with the lower threshold for the income disregard would
have been recovered in 2011-12 and beyond, and in some cases never
recovered at all. The Department's figure is consistent with the
National Audit Office's analysis, which suggested that increasing
the disregard was likely to cost between £400 million to
£600 million annually, depending on assumptions about the
growth and distribution of income changes across the claimant
population.[19]
14. As regards the cost of the other elements of
the 2005 Pre-Budget Report package designed to reduce the build
up of overpayments, the Department's estimates are imprecise.
It estimates that the four elements of the package, described
in paragraph 9, which are designed to reduce overpayments could
each bring an Exchequer benefit of up to £100 million a year
when all the timing effects have worked through. These benefits
will be partly offset by the application of automatic limits on
in year recovery where awards are adjusted following a reported
change. This measure will reduce the rate at which recoveries
of overpayments are made, and the Department estimates that this
could cost the Exchequer anything up to £100 million a year.
5 C&AG's Report, table 1 Back
6
Q 205 Back
7
Q 9 Back
8
C&AG's Report, para 2.12 Back
9
Q 205 Back
10
HMRC Trust Statement 2005-06, Note 3.3 Back
11
C&AG's Report, para 2.20 Back
12
C&AG's Report, para 2.20. Back
13
This change starts with 2007-08 awards and was announced in the
2006 Pre-Budget Report. Back
14
C&AG's Report, para 2.21 Back
15
Committee of Public Accounts, Thirty-seventh Report of Session
2005-06, Inland Revenue Standard Report: New Tax Credits,
HC 782 Back
16
Treasury Minute on Thirty-fourth and Thirty-sixth to Thirty-ninth
Reports on the Committee of Public Accounts 2005-2006, Cm
6863 Back
17
Qq 8, 33 Back
18
Q 5 Back
19
Q 6 Back
| 
