Plans to reform the tax credit system to make it more flexible and reduce the scope for overpayments have been broadly welcomed by campaigners.

Chancellor Gordon Brown yesterday announced plans to increase the amount by which a family’s income could change before they had their tax credit payments cut, and to put a cap on the level of overpayments that could be taken back in any year.

The changes come in response to a wave of criticism about the way tax credits are managed. Yesterday Mr Brown insisted he would not scrap the system, but admitted it needed reform.

“Some have suggested we should cut back the child tax credit,” he told MPs in his pre-Budget report.

“This I refuse to do because, with child benefit, the child credit is doing more to help families meet the costs of bringing up their children and helps more families out of poverty than any other single measure.

“While a case has been made for fixed awards based on last year’s incomes, to which we continue to listen, it would be better to have a system that flexibly responds to changes.”

The level of tax credits is calculated at the end of the financial year, at which point it may turn out that a family has been paid too much and HM Revenue and Customs must recover these overpayments.

A report by the public accounts committee this summer found that 1.8 million overpayments had been made in 2003-04, but warned there was “no kindness” in the way claimants, many of them in dire financial circumstances, were made to pay them back.

Under the new arrangements, which will come into force next April, families will be able to increase their income by £25,000 without facing a cut in their child tax credit – previously the limit was £2,5000 – which ministers hope will reduce the number of overpayments.

When overpayments are made, a new cap would be put on the amount of money that can be taken back by the government in any given year, the government said, to avoid putting claimants under too much financial pressure.

Child Poverty Action Group (CPAG) welcomed the admission that while child tax credits were working, they needed to be improved.

Head of policy Paul Dornan said: “CPAG will be watching closely to see how the changes are implemented in practice, but we hope that the new system will make life easier for claimants, reduce the scope for errors and restore confidence in tax credits.

“However, we urge the Revenue to stop automatically clawing back overpayments and give claimants a breathing space in which they can challenge the recovery. The Revenue should also introduce a right of appeal.”

Citizens Advice was also positive about the announcement, with director of policy Teresa Perchard saying that a cap on the recovery of overpayments would end the sudden drops in payment that have left thousands of families in debt.

But she expressed disappointment that this would not come into effect until November next year, and in the meantime called for the Revenue to write off completely overpayments arising from error.

In addition, the charity warned that administration of the child tax credit system must improve “dramatically” for any changes to make a real difference.