Chancellor's plan for family tax credits must prove its worth, says JRF report

But the JRF review - drawing on specially-commissioned research from Australia, Canada and the United States - shows that tax credits could bring either benefits or disadvantages to families, depending on the detail of their design, how much money is spent on them and how they influence the behaviour of working and non-working parents.

The biggest potential benefits identified by the analysis will only arise if the Government commits extra resources. These could be used to raise the minimum income of parents who work and to reduce the rate at which benefits are withdrawn as income rises - known as the taper.

At present, the combined effect of Income Tax, National Insurance and the benefit tapers can be to leave low-paid workers only 3p better off for every £1 pay rise. The 10p starting rate for income tax which the Chancellor has also proposed would, on its own, do little to change this. Some low-paid workers would still retain less than 4p of every extra £1 earned.

The review argues that a co-ordinated strategy to help low-paid workers escape from poverty is needed not only to tackle the tapers on Family Credit, but also those on two other in-work benefits: Housing and Council Tax Benefits. The switch to a tax credit system would create a welcome opportunity to consider reductions in these tapers as well as other measures for creating a simpler, clearer system. Such reform could ensure that any tax cuts for the low paid are well targeted so as to improve incentives.

But the review stresses the importance of retaining some of the positive aspects of Family Credit, which is widely agreed to have worked well as a benefit. In particular, it has proved popular with families because it arrives promptly, gives a stable supplement to family income over a six-month period and is almost always paid to mothers, who most commonly manage spending on children.

The review welcomes the Government's assurance that families receiving the new tax credit will be able to opt for direct payments to mothers, even when they are not working. But it points out that much will depend on how many families take advantage of this option, as an alternative to payment through the wage packet.

Summarising the effects of tax credit systems in the United States, Canada and Australia, the review notes that the detailed rules have had a crucial bearing on whether they achieve their objectives of encouraging work and reducing family poverty. There is evidence in the US that the system creates severe work disincentives as credit is withdrawn. Canada has, meanwhile, abolished its Working Income Supplement scheme after finding that it reduced incentives to work in twice as many cases as it improved them.

Fraud appears to be another serious problem in the United States, with a high proportion of claims relating to children who do not exist or are being claimed for more than once. The review warns that a tax credit in the UK might lead to collusion between unscrupulous employers and staff to reduce their level of declared income. Firms might be also tempted to reduce wages, anticipating that their employees' lost pay would be made good by the tax credit.

Donald Hirsch, advisor to the Joseph Rowntree Foundation said: "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. Even so, the unforeseen problems with tax credits in other countries, including work disincentives and widespread fraud, make it vital that 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."