Poverty Trap (Hansard, 13 April 1981)

§ Mr. Patrick Jenkin

[pursuant to his reply, 17 March, c. 77.]: The so-called poverty trap, as acknowledged by successive Governments, is the situation in which working people would find that, as a result of an increase in earnings, they pay higher income tax and social security contributions and some means-tested benefits might be reduced or withdrawn. The main means-tested benefits in this context are family income supplement—FIS—free school meals and housing rebates.

The rate at which a £1 increase in earnings may be swallowed up in this way has often been described in terms of "marginal tax rates". For example, a working family paying tax and receiving family income supplement may be described as facing a marginal tax rate of 87¾ per cent. on each £1 increase in their earnings. The 87¾ per cent. is made up of 30p extra tax in the pound, 7¾p extra contribution, and 50p which eventually might be lost on account of FIS.

If the family were being assisted not only by FIS but by other means-tested benefits which were subject to reduction or withdrawal as income rose, the component parts of their marginal tax rate could add up to over 100 per cent. This, of course, would mean that their £1 increase in earnings would be more than swallowed up. For the reasons explained below, such a situation is more theoretical than real.

It follows that working people who are already taxpayers and being helped by a means-tested benefit or benefits would face a higher marginal tax rate if the rate of deduction of tax or contributions or the rate of withdrawal of a means-tested benefit or benefits were 60W raised. If they were not already taxpayers, they could be caught in the poverty trap when they became taxpayers for the first time.

Although employees'—and self-employed—national insurance contributions rates went up last week as a result of the Social Security (Contributions) Act 1981, there were no proposals for changes in income tax rates or rates of social security contributions in my right hon. and learned Friend the Chancellor of the Exchequer's Budget Statement.—[Vol. 1000, c. 757–783]. The personal tax allowances were also unchanged. Thus the Budget and uprating proposals could increase the numbers in the poverty trap either

(a) by drawing more working people already receiving means-tested benefits into tax as and when their earnings rose above the tax threshold in 1981–82; or
(b) by drawing more working people already paying tax into entitlement to means-tested benefits for the first time.

As to (a), I gave in my reply to the hon. Member for Birmingham, Perry Barr (Mr. Rooker) on 19 March—[Vol. 1, c. 183]—an estimate that some 10,000 families who were not taxpayers in 1980–81 would be drawn into tax in 1981–82. It is not possible to estimate the number of recipients of free school meals who may be drawn into tax. The number of recipients of housing rebates, not also receiving FIS, who may be drawn into tax is most unlikely to exceed 20,000; because of the size of the sample in the source—the Family Expenditure Survey—from which this estimate was made, it is impossible to distinguish between families and people. As to (b), it is not expected that the November 1981 uprating will draw more working families into entitlement to FIS.

In any event, a FIS award lasts for 52 weeks and no adjustment would be made for a pay rise or any other change during that period. If, therefore, there were a loss of FIS as a result of a pay rise, it would occur only when the 52 weeks' award expired and a renewal claim was made. Even then, a loss would be unlikely if the November 1981 FIS uprating had intervened.

The hon. Member will appreciate from what I have said that the poverty trap arises from the existence of a number of carefully targeted means-tested benefits that have been specifically designed to alleviate "poverty", overlapping the impact of income tax and social security contributions on incomes above certain levels. In practice, however, these high marginal tax rates are more theoretical than real because some benefits run on for a while even if income rises—for instance FIS, with the free school meals to which it acts as a "passport", runs on for a year. Hence the statement in the analysis of current tax and benefit policy which the Study Commission on the Family recently published: The idea that an increase in earnings can result in a sudden drop in disposable resources is nonsense".