£1bn extra for poor in benefit reform

The Treasury's plans to revolutionise the tax and benefit system by integrating child support and extending tax credits to all the working poor will cost more than £1bn on top of the £9bn welfare bill.

The calculation by the Institute of Fiscal Studies think tank follows a consultation paper issued by the inland revenue setting out its plans for the credits which allow the recipient to keep more of their income after tax instead of getting state support through benefit payment.

The reform represents the biggest benefits shake-up for many years. Masterminded by the chancellor, Gordon Brown, the plans will fundamentally alter the relationship between millions of benefit recipients and the state, including the way in which they receive and claim state support.

Mr Brown believes the changes will further integrate tax and benefits, so increasing incentives to work and making the system more understandable and easier to administrate.

The changes are due to come into force in 2003, and may require parliamentary legislation in this session.

Fiscal experts, including the IFS, said the system was potentially more generous and less punitive than the existing regime. Mike Brewer at the IFS estimated the proposed reforms would add well over £1bn to the welfare bill.

The IFS also predicted higher take up since recipients for child credit will only have to make one initial application, forgoing the need to fill forms at six monthly intervals.

But a consultation document prepared by the inland revenue shows the government still wrestling with many unresolved issues.

In the biggest single change, the inland revenue proposes the level of tax credits - in future the main form of state support- will be based on the household's income over the previous 12 months, the same time frame as a tax assessments.

Mr Brown is introducing a child credit for those in and out of work, covering most forms of child support, and an employment credit for the working poor. The working families tax credit will be abolished with its budget funnelled into these two credits.

The inland revenue admits an annual assessment, rather than the current mainly weekly benefit, is "radical", but claims it will give claimants a level of certainty about their award". But the inland revenue has recognised that an annual assessment could prove unresponsive to a sudden drop in income.

To introduce flexibility, it is proposing that child support credits will be paid automatically at the maximum level as soon as a household's earnings falls to a level low enough to qualify for income support, currently £83 a week for a couple. Families will also be entitled to claim extra credit in the middle of a year if they have a child or develop a disability.

The reforms, imposing administrative demands on businesses, will also transform the inland revenue from a tax collecting department to the hub of welfare policy. It will not only be responsible for administering billions in tax credits to the poor, it will also take charge of administration of the universal child benefit and the child support agency.

The proposals were condemned by David Willetts, the shadow social security spokesman. He said: "The sheer complexity is no improvement on what is currently happening, and tears up much of what Gordon Brown introduced two years ago. The complexity will put people off claiming and also stop clear signals being sent on whether someone is better off or not in work."

Mr Willetts also said the system is bound to be more expensive since the employment credit, unlike the WFTC, would be available to low paid workers regardless of whether or not they have children.

He claimed there were dangers in switching from an essentially weekly system to an annual system. "Mr Brown's obsession with aligning the tax and benefit system means tax credits could be handed out long after the individual's circumstance had changed.

The inland revenue is proposing anyone whose income falls to the level of income support should automatically receive the maximum level of child credit. If the income fall was more modest, the government says there would be "a case for the claimant to be entitled to ask to have their award reassessed on the basis of a forecast of their current year income".

The award would then have to be reconciled at the end of the year against actual income. If necessary, overpaid credit would have to be repaid. Similarly, families will be asked to report significant rises in income, if they wish to avoid an over-payment.

Since the level of credit entitlement is means tested and based on income, the inland revenue is working on a definition of what constitutes income. It will take the definition used for income tax purposes as the starting point.