The coalition can do more for less on benefits reform

There is a lot to like about Iain Duncan Smith’s new proposals for welfare reform.  The chance to move towards a radically simplified benefits system is enormously exciting.  As I wrote for Coffee House last week, the current system is a complete mess and failing on just about every criteria.  It is so complicated that £4.5 billion a year is lost to error and fraud; working at the minimum wage of £5.80 an hour can be worth as little as 26p an hour; and too many families slip through the net so that the number living in severe poverty has actually increased from 5 to 6 per cent in the last decade.  We can definitely do better and it is great news that the Government are planning to overhaul the system properly instead of applying more counterproductive sticking plasters.
 
21st Century Welfare sets out a number of options for reform that would create a drastically simpler system.  One of those options is the negative income tax that we recommended in our report, as the new paper says:

“The TaxPayers’ Alliance recently published a report that recommends a reform that brings together a large number of the existing benefits. However, unlike other approaches that introduce a single benefit, it suggests the introduction of a negative income tax.   […]   A household’s eligibility for the negative income tax would be based on their characteristics, and set equal to a given proportion of (equivalised) median income. As household income increased from individuals moving into work or progressing in work, the level of the negative income tax would be reduced in such a way that the Marginal Deduction Rate (inclusive of Income Tax, NI contributions and the withdrawal of the negative income tax) was constant until all support was exhausted. This implies that the system does not have a system of earnings disregards.”

The unfortunate thing about the report today is that the DWP aren’t yet taking on the tough choices that would make it possible to achieve really serious change in the welfare system while still saving money.  As we set out in our report, the problems with the current system are driven by an unrealistic poverty line, at 60 per cent of median income.  If we moved that line to 50 per cent pending a shift to an absolute standard of poverty, then we could improve things in a number of ways:
 
Have a maximum taper rate of 55 per cent, massively improving incentives to work; cut the system down to a single, simple negative income tax as set out above; save money immediately, then save more once we start getting people back into work; and stop people falling through the net and thereby sharply reduce severe poverty.
 
As the DWP aren’t willing to cut the poverty line, their report still envisages very high marginal withdrawal rates.  It would be a real shame if reform simplified the system but still left some households facing marginal withdrawal rates of around 70 per cent, as is envisaged under the “Universal Credit” option that appears to be Iain Duncan Smith’s preferred way forward.  Do we really want £5.80 earned at the minimum wage to be worth as little as £1.74?  I think that would still put plenty of people off entering the labour market.

Not moving the poverty line also means that reforms to improve incentives to work increase the cost of the welfare system.  That will mean some difficult decisions for a Government that can ill-afford higher welfare spending, and will go down poorly with a taxpaying public who think they already spend more than enough on benefits.
 
The paper also doesn’t consider the option of tapering benefits over time to improve incentives or time-limiting benefits.  That has been absolutely key to successful reforms in the United States and there is a detailed discussion of the issues in our report from page 25.
 
It is extremely good news that Iain Duncan Smith has released such a serious statement of intent to do something about our failing welfare system.  There is a huge opportunity for the coalition to achieve great things in this area.  But we’ll get a better welfare system, and better value for taxpayers’ money, if he takes some tough choices over the poverty line instead of getting into a fight with the Treasury for more money from overstretched taxpayers.

Matthew Sinclair is research director at the Taxpayers’ Alliance.